Written by: Thejaswini M A

Translated by: Chopper, Foresight News

Any default option eventually becomes the choice of the majority. This is referred to as the "default effect" in behavioral economics.

The history of the entire pension system in the United States is a history of default options. In the 1980s, default options shifted from traditional pensions to 401(k) plans, which most employees accepted without fully understanding what they were giving up. In the early 21st century, target date funds became the default option for the vast majority of pension plans, with tens of millions holding these funds without ever having made an active choice.

Each change in default options involves a massive transfer of funds and ultimately alters the retirement strategies of an entire generation. Most affected individuals only realize this later when reviewing their statements.

In the coming years, a new default option is set to emerge. It currently does not appear to be a default option but rather a rule draft proposed by the Department of Labor, which is undergoing a 60-day public comment period. Its language is cautious and emphasizes trustee responsibilities and compliance with the Employee Retirement Income Security Act (ERISA). These options often appear in the form of choices that gradually become prevalent and ultimately become the default for people.

On March 30, the U.S. Department of Labor released a rule that, for the first time, opened the door to cryptocurrencies in the U.S. 401(k) pension market, which is worth up to $12 trillion. Indiana passed legislation in March requiring state pension plans to provide at least one cryptocurrency investment option by July 2027; Wisconsin's pension system already holds $321 million in a Bitcoin ETF; Michigan has allocated $45 million to Bitcoin and Ethereum ETFs. Florida and New Jersey are also advancing similar policies.

Let us first look at how cryptocurrencies were previously kept out.

The Wall Keeping Cryptocurrency Out

Before this rule was enacted, cryptocurrencies were not explicitly prohibited from entering 401(k) plans by law. The real barrier was more effective than any ban.

Under ERISA, which regulates pension plans, trustees are held personally liable for investment decisions that lose money. It is the individuals who make decisions, not the company or the fund, who are held accountable.

Since 2016, there have been over 500 lawsuits alleging violations of ERISA; since 2020, the associated settlements have exceeded $1 billion. Pension plan managers have seen their peers sued over high fees, improper selection of index funds, and issues with mutual fund share classes. Such lawsuits are frequent, often facetious, and directly target individuals.

Consider the incentive mechanism that forms as a result: you manage a pension plan, buy Bitcoin, and then Bitcoin crashes by 50%. A plaintiff's attorney sends a letter, and you spend three years defending yourself in evidence collection.

Conversely, if you do not invest in Bitcoin, even if it rises to $200,000, no one will sue you for that.

The rational choice has always been: stay away from cryptocurrencies. And practically everyone has indeed done so.

During Biden's administration, the Department of Labor even stated in 2022 that trustees must be "extra cautious" before engaging with digital assets. This guidance has now been withdrawn and replaced with a six-factor safe harbor rule: as long as trustees complete a review according to written procedures covering performance, fees, liquidity, valuation, benchmarks, and complexity, they will be deemed to have fulfilled their ERISA-mandated prudent obligations. As long as the process is compliant, even if asset prices drop, they can be immune from personal litigation liabilities.

Do not mistake changes in rules for changes in market fundamentals. For ordinary investors, the volatility of crypto assets remains unchanged. This rule really protects fund managers. It corrects the imbalanced legal risks that have marginalized cryptocurrencies for a decade, allowing trustees to finally say yes without worry.

Transmission Mechanism: Target Date Funds

The Department of Labor itself anticipates that the primary entry channel will be target date funds. This has crucial implications for ordinary savers.

Most people, upon employment, will default into a target date fund. You only need to choose a fund closest to your expected retirement year, for example, a 2045 fund, which will automatically adjust the stock-bond ratio as you age, becoming more conservative as the target date approaches. The vast majority of those holding such funds have never taken a second glance.

If crypto assets are allocated through target date funds, investors will not actively buy Bitcoin. Their retirement investment portfolios will automatically allocate 1%–3% of Bitcoin, managed by professional institutions and automatically rebalanced.

Just as many people have gold in their 401(k) plans without knowing it. Gold entered the pension system this way; the same vehicles, the same logic; no one asked about the true owners of the money.

Fidelity took the lead in 2022, offering options to incorporate Bitcoin into pension plan portfolios before the Biden administration issued guidance. At that time, Fidelity allowed plan sponsors to include digital asset investments in their portfolios, and participants could invest up to 20% of their account balances in Bitcoin. All along, plan sponsors lacked the corresponding legal protections that would allow them to confidently allocate Bitcoin without assuming personal responsibility. Relevant legal protections are currently being developed.

$12 Trillion

The U.S. 401(k) plan is approximately $12 trillion in size. Even a mere 1% allocation would result in about $120 billion flowing into digital assets, exceeding the total locked amount of the entire DeFi sector. Even with only 0.1%, that would mean $12 billion, which is equivalent to the top five Bitcoin ETFs.

Every previous wave of institutional crypto adoption has stemmed from active decision-making: ETF buyers actively buy, MicroStrategy actively holds, banks actively create custody products. These decisions can all be reversed: the CFO can sell treasury holdings, ETF investors can redeem.

However, the 401(k) channel is structurally different; this is what the industry has been waiting for since spot ETFs became available. Pension funds are passive funds that can be held for as long as 30 years. They will not panic-sell during a crash, will not be influenced by the fear and greed index, and do not care how oil prices fluctuated last week.

Amy Oldenburg of Morgan Stanley points out that currently, 80% of crypto ETF trading comes from self-directed investors rather than allocations recommended by advisors. The 401(k) market is almost entirely advisor-driven. The new rules from the U.S. Department of Labor have opened a channel that was previously difficult to access due to structural reasons, as those controlling the channel bore excessive personal responsibility and were afraid to open the door.

This has also been a point emphasized by cryptocurrencies for years: the real wave of popularization will not come from traders or early technology adopters but will arrive when the infrastructure of ordinary people's savings systems automatically shifts towards cryptocurrencies. Target date funds represent this infrastructure.

Risks and Concerns

A trading account falling by 50% can only be considered a bad quarter. However, when a 55-year-old teacher's retirement account drops by 50%, it is a completely different matter.

Bitcoin has dropped over 80% in past bear markets; this cycle has seen a drop of about 50%, some interpret this as "maturity." But losing half of retirement savings does not become easier because it is called "progress."

TD Cowen’s Jaret Seiberg writes that he remains skeptical that trustees will take action easily before a court confirms that the safe harbor provisions can truly protect them from lawsuits. ERISA is a process-based law, but the final interpretation rests with the courts.

The safe harbor may well exist on paper, but if a target date fund with crypto allocations dips 40% in a bear market, leading to the first round of lawsuits, whether it can withstand that remains unknown.

The public comment period for the rules will end on June 1. The Department of Labor can modify the rules, withdraw them, or directly advance their implementation. Even if the final version is not modified, the process from the proposed rules to actual incorporation into pension accounts will require several months, and most likely years, going through compliance teams, investment committees, record-keeping system integration, and trustee reviews.

Indiana's July 2027 deadline is a hard mandate, while the federal rules are only soft permissions, and the implementation paces between the two will be vastly different.

In the 1980s, stocks entered pension accounts through mutual funds; in the early 21st century, international stocks entered through target date funds; followed by REITs, inflation-protected bonds, and commodities. Their arrival was not due to proactive demands from retirement savers.

Cryptocurrency is now at this turning point. Spot ETFs are products, the Department of Labor's new regulations are regulatory support, and Fidelity, Charles Schwab, and Morgan Stanley are distribution channels. The CLARITY Act will formalize classifications of crypto assets into written law, providing trustees with a legal basis for prudent review.

All the pieces of the puzzle are in place, only the final piece is missing.

If one day in the future, a pension plan manager adds Bitcoin to a target date fund, and Bitcoin subsequently crashes by 60%, resulting in significant losses for a retiree, a lawsuit could be filed.

At that time, the only important question will be whether the judge acknowledges that the safe harbor protected the person making that decision.

Currently, no one knows the answer. The Department of Labor believes it can be done, while TD Cowen thinks it may take years to reach a conclusion.

Before the first case is heard and judged, all pension plan managers in the USA are required to believe a document that has never been tested in court.