A relatively obscure type of Isa is gaining attention as a vehicle for tax-free cryptocurrency investments.

The Innovative Finance Isa (IFIsa), often seen as the least understood and potentially most risky option, is set to become the sole Isa allowing investments in major cryptocurrencies like Bitcoin and Ethereum.

Previously, up until April 5 of last year, investors could track Bitcoin and Ethereum prices through a stocks and shares Isa. However, starting this new tax year, such tracking will need to occur within an IFIsa.

The challenge is that no current providers offer crypto investments within these specialized accounts.

Nonetheless, this regulatory change might renew interest in IFIsas, which were initially created for investors interested in peer-to-peer lending.

Jason Hollands from the investment platform Bestinvest notes, “To my knowledge, no platform will be ready by April 6 to offer this… Some traditional stocks and shares Isa providers might launch an IFIsa specifically for this purpose.”

The Innovative Finance Isa (IFIsa) will soon become the only Isa to allow investors to back the biggest cryptocurrencies, including Bitcoin and Ethereum

Crypto and Isas

Millions of people hold cryptocurrency in the UK but until last year it was difficult to hold these investments in a regulated account. 

Despite firms requiring the authorisation from watchdog the Financial Conduct Authority (FCA), crypto investment has been unregulated and unprotected.

Following the introduction of Bitcoin and Ethereum exchange traded funds (ETFs) in the US – which blindly track the underlying price of both – the FCA was under pressure to allow a similar form of investment in the UK.

The watchdog granted permission in October for UK investors to buy crypto exchange-traded notes (ETNs). 

These track the price of a specific cryptocurrency and, unlike direct investment into Bitcoin or Ethereum, they can be held in a regulated account and allow investors to earn returns linked to their success.

However, ETNs – unlike ETFs – do not provide investors with ownership. If the ETN provider goes bust, investors could lose all their money.

Crypto ETNs can be held in stocks and shares Isas until the end of this tax year. At that point, shortly after their introduction, crypto ETNs will shift to the IFIsa. However, no platform in the UK is authorised to sell both the IFIsa and crypto ETNs.

Investors who have already bought crypto ETNs in stocks and shares Isas will be able to continue to hold them if their platform allows, but some may be forced to sell up.

What is an IFIsa?

Innovative Finance Isas were created in 2016 by the then-Chancellor George Osborne.

Until now, they have allowed investors to take advantage of what’s known as peer-to-peer lending, typically to businesses. 

You lend your money for a fixed period of time and, in return, receive interest payments from the company or project invested in.

As with all types of Isa, any returns are tax-free and you can invest up to your full annual allowance of £20,000.

A key danger is that Innovative Finance Isas are not covered by the Financial Services Compensation Scheme

Investments are made through a peer-to-peer lending platform. Some of the original big players such as Zopa, Funding Circle and RateSetter no longer offer peer-to-peer lending to investors.

The platforms now on offer for individual investors include Folk2Folk, Kuflink and CrowdProperty. 

When you open an IFIsa, you’ll be given a target rate of interest, typically between 4 per cent and 8 per cent, but these returns are not guaranteed.

IFIsas are not hugely popular and the most recent official figures reveal the number opened in the 2022-23 tax year fell 23.5 per cent annually, according to HMRC.

Investment options

Most IFIsa investments are peer-to-peer loans with a property development element. But there are other options for those who are eco-conscious or want to make a social impact.

One of the IFIsa platforms, Abundance, allows holders to dabble in municipal investments to help councils fund green and social projects.

Alternatively, Triodos Bank offers an account focused on ‘direct investments delivering positive change’ – such as investing in a 7.75 per cent bond to lend to Birtenshaw, a specialist school for vulnerable children and youngsters. 

Peer-to-peer lending may be a good investment to hold alongside stocks and shares, but holders must be aware of the risks. It cannot be considered akin to a cash savings account.

Risks involved

Innovative Finance Isas may sound exciting, but you will be investing in high-risk assets. They should only be opened by someone who can afford to lose their stake.

A key danger is that they are not covered by the Financial Services Compensation Scheme (FSCS).

If your savings are held in a cash Isa and your bank or building society goes bust, for instance, then your money is protected up to £120,000 under the scheme.

The FSCS does not cover IFIsas, however. If the platform you have saved with goes bust, then you are unlikely to get your money back.

While your IFIsa investment won’t go up and down in value in line with the stock market, you could lose some or all of your money if the borrower defaults on their loan repayments.

Some IFIsa platforms have a contingency pot to compensate lenders if this happens, but this is no guarantee of protection.

Mr Hollands says: ‘If the economy goes down further some of those you have lent to might go bust and you may not get your money back.’