Why Aren’t Investment Banks Getting into Bitcoin?

On Monday the US Senate Committee on Homeland Security will attempt to clear up some of the murkiness concerning the digital cryptocurrency bitcoin. The timing of the hearing comes just as bitcoin continues to increase in value exponentially, having gained 50 percent in value since Nov. 16 and over 400 percent in the value since mid-October.

The hearing is also acting as a presentational debut for bitcoin, with Peter Cook telling Bloomberg TV that “this is about bitcoin arriving at the Washington stage and having policymakers look at it seriously.”

The currency has become an increasingly popular place for investors around the world to store value – virtual gold, if you will. It’s clear from the rapidly rising value that bitcoin has attracted serious interest. The question then is, if bitcoin is the fastest-growing investment opportunity possibly in the entire world, why haven’t the big investment banks like JP Morgan Chase and Co. (JPM) or Goldman Sachs Group (GS) gotten in on this red-hot market?

Reason #1: Bitcoin is too opaque.

First, traditional investors want to understand why bitcoin is spiking. More people are obviously getting into bitcoin, and injecting more capital into the digital currency. But because of the anonymity, guessing where exactly the capital is coming in (or coming out) from is largely vague conjecture.

Due to its anonymous nature, bitcoin is purportedly a favored choice of people who are trying to hide money, be it money launderers, tax dodgers, and drug dealers. Another theory holds that the spike in the currency’s price is due to increased Asian interest, or as Marketwatch put it, a “Chinese feeding frenzy,” which is derived from the fact that the largest market cap bitcoin exchange is in China and downloads have been increasing in frequency there.

But nobody can say for sure who exactly the buyers are. Certainly, bitcoin has been on an unprecedented ride this month. But the currency’s trading is opaque, so it’s unclear what kind of buyers are driving the price up, and when (or if) they’ll suddenly decide to “cash out.”

Reason #2: Bitcoin exchanges make banks skittish.

The Big Four are not going to start making big bitcoin plays until they have assurances that their money won’t be seized. Banks in fact have been pretty skittish about being too closely associated with pretty much any bitcoin and bitcoin-related startups. In a Forbes article on the subject, Bitinstant CEO Charlie Schrem claimed he’d been kicked out of “every major bank in New York.”

The reason being is that banks still fear bitcoin is being used to facilitate money laundering, with Steve Kenneally, VP of regulatory compliance at the American Bankers Association saying bitcoin exchanges are money service businesses like Western Union (WU) and need to be regulated as such. But bitcoin exchanges don't have backing like traditional banks, and their whole "full faith and credit" of the US government to reassure assets. If an investor loses their bitcoin due to fraud, there’s little they can do to get their investment back.

Until the exchanges are regulated, or backed by some kind of insurance, banks will be wary to sink money in.

Reason #3: Right now, the market is too volatile.

Nobody likes money like the big investment banks, and a 400 percent return is a 400 percent return. But volatility spooks them and their clients, and until bitcoin becomes more predictable, the major players are staying on the sidelines. Or, they’re waiting to be able to invest in bitcoin indirectly – that is, with traditional currency.

To soften the edges of bitcoin’s spikes, mainstream investors like the Winklevoss Twins are setting up bitcoin exchange-traded funds (ETFs) that will allow investors to essentially bet on bitcoin’s rises and falls by proxy, without actually playing the bitcoin market.

If the bitcoin ETF and Second Market’s Bitcoin Investment Trust do gain traction, you might see the banks betting on the exchange like they do a commodity or forex. But whether or not that can happen will be decided, at least in the US, after the Senate weighs in.