Is Cryptocurrency A Complying SMSF Asset?

As SMSF trustees start to chase higher returns in a low-interest rate economy, interest in investing in cryptocurrencies (such as Bitcoin “BTC”) is on the rise. With the ATO releasing its December 2024 statistics showing that 0.2% of the proportion of total SMSF assets was invested in crypto, the question remains: is cryptocurrency a complying SMSF asset?

The ATO has released a guidance paper on cryptocurrency that confirms that BTC (in particular) is neither money nor foreign currency. Any comparison between cryptocurrencies and the Dollar, Euro or Pound is therefore redundant.

While many SMSF trustees don’t understand the mechanics of how cryptocurrency works, a mixture of factors supports a volatile price and high-risk asset through investor sentiment, demand and supply, government policy and impending regulation.

Cryptocurrencies

One of the best definitions for cryptocurrencies is they are a new asset class that enables decentralised applications. These are electronic ledgers located in a decentralised system that’s continuously updated and open to everyone who uses it and those willing to download it.

The technology that underpins this software is called the blockchain, which allows payments without a trusted central party or bank.

Remember, too, that anyone can create a cryptocurrency and BTC is just one of the estimated 9000+ crypto assets used to transact on decentralised ledgers. Other popular ones include Ethereum, Litecoin, Dash, Monero, Zcash, Ripple and YbCoin.

Then there are the failures.

The most noted collapse is The DAO, which raised over $34 million in 2016 through crowdfunding, initially purchased by a multitude of investors. When hackers found and exploited a vulnerability in the technology, they siphoned off one-third of The DAO’s funds resulting in traders dumping The DAO at a loss.

There’s no doubt that the frequency and impact of cybersecurity incidents will continue to increase and adversely affect crypto assets.

Sole Purpose Test

Given that the original purpose of crypto assets isn’t for trading, is crypto a complying SMSF asset and an appropriate investment for an SMSF?

Can it pass the sole purpose test?

Of course, an SMSF trustee can invest in any asset allowed under SIS as long as it is permitted under the investment strategy and trust deed.

To pass the sole purpose test, cryptocurrency must be held as an investment to provide benefits to members on retirement and to their dependents on death.

It must be held securely and not used for personal or immediate financial benefit.

Additionally, it must meet the requirements of r4.09A and be kept separate from personal assets. As a result, all crypto holdings must be in the name of the fund and not the members personally.

The ATO has flagged that it may be a breach of the sole-purpose test where affiliate fees or commissions associated with the fund’s crypto asset investment are paid to a trustee or member personally.

Compliance Breaches

Where an SMSF trustee decides to invest in BTC to trade and not just to hold the asset, the main risk is when the identification of the other party in the transaction results in compliance breaches:

• Is it a related party transaction?
• Can contributions be accepted?
• Has the fund lent money or provided financial assistance to a member or relative?
• Has the fund borrowed money?
• Has there been a charge given over the assets of the fund?

As crypto assets are complex, they should be reviewed in light of the SIS legislation.

Hedging BTC

A ‘wallet’ is required to be set up through an online crypto exchange to start trading in BTC. Depositing funds into the wallet allows trustees to buy and sell BTC, make payments, withdraw cash from ATMs and … hedge BTC against major currencies.

When an SMSF traditionally invests in derivatives, a separate derivative risk strategy is required under r13.15(1A) to 13.15(1G) SIS because there is a charge given over fund assets.

The exemptions traditionally available to an SMSF through r13.15(1A) to 13.15(1G) only apply to approved bodies (being domestic and foreign exchanges and clearinghouses) to whom SMSF trustees may grant security in respect of certain derivatives listed in Schedule 4 of SISR. The list doesn’t include cryptocurrency exchanges.

If a fund trades in derivative products using BTC, the fund will be in breach of r13.14 SIS. The reason is that a charge is given over fund assets (the wallet) to undertake hedging activities or make margin deposits to the exchange in BTC to eliminate counter-party risk.

SMSF auditors and advisors need to be aware that BTC exchanges are quickly developing sophisticated unregulated financial instruments which will result in compliance breaches for SMSFs.

Death of the BTC Wallet

One of the biggest headaches will be when an SMSF trustee dies. Typically, the private key and password to access the wallet are known and stored by the user who set it up. Documenting and sharing this information is critical otherwise, in the event of death, the BTC will be lost because the wallet can’t be accessed.

It’s difficult to think of another asset (unless it’s in a tax haven) that is not recoverable when an SMSF trustee dies. To this extent, ensuring that the BTC wallet details are documented and stored securely should be considered BTC insurance.

Where the BTC is a material asset, the fund should document the fact that precautions have been put in place to securely pass on the BTC wallet details to other trustee/s or beneficiaries in the event of death.

If no such documentation exists, the SMSF auditor may consider qualifying part A of the audit report as fund assets are at risk.

BTC Scamming

Many safeguards protect BTC wallets against hackers and scammers, such as two-factor authentication and encryption.

But even the most alert and tech-savvy SMSF trustee can be taken in by scammers who can manipulate Google search results and direct traffic to a fake, cloned BTC exchange website.

These are known as phishing scams, where a fake website mimics a legitimate website and steals a user’s account details when they try to log in.

In the 2023-24 financial year, Australians reported losing approximately $180 million to cryptocurrency investment scams, accounting for 47% of the $382 million lost to investment scams during that period.

Notably, individuals under the age of 50 were more frequently targeted, comprising about 60% of reported victims.

Conclusion

While the high-risk and volatile nature of crypto assets will stop SMSF advisors from universally accepting this as a new investment class, SMSF trustees will continue investing in them.

The original purpose of crypto assets is to make uncensored payments, not as an investment tool. Irrational returns on BTC will result in SMSF trustees taking further positions and investing in additional crypto assets for fear of missing out.

Additionally, the speed at which new financial products are appearing on BTC exchanges is concerning (such as the ability to hedge BTC without realising it), and will result in compliance breaches for SMSFs.

Ensuring that SMSF trustees are investing in cryptocurrency for the sole purpose of providing retirement benefits to members will see this asset class comply with the legislation and maintain the integrity of the superannuation system.

Download our Cryptocurrency Factsheet.

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