This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article is by Mike Venuto, co-founder and chief investment officer of New York-based Toroso Investments.
An innovative marriage that promises to combine two unique “fintech” concepts—the ETF and the peer-to-peer digital currency bitcoin—looks like it’s finally about to happen.
Indeed, a bitcoin ETF is likely to be approved by the Securities and Exchange Commission as soon as next month. The idea was first proposed to the SEC about three years ago.
Combining ETFs and bitcoin is likely to be consequential. After all, ETFs have been revolutionizing investments for 25 years, and bitcoin, since its 2009 introduction, has shown potential to completely change financial transactions. In an age where asset allocation is its own asset class, a bitcoin ETF could have a place in many portfolios.
There are three competing ideas currently coursing their way through the SEC, so there’s a lot to chew on here. To make all this a bit easier to digest, I’ll ease into the bitcoin ETF discussion in the following way:
- I’ll describe bitcoin in greater detail to help explain what everybody is so excited about.
- I’ll describe the three proposed ETFs that will be designed to give investors access to bitcoin.
- I’ll discuss what I think the odds are that these ETFs will actually be approved.
- We will analyze whether it will be a good investment, should it go through.
Measuring Excitement About Bitcoin
So, why is everybody so excited? Charts like this one showing rapidly increasing use of bitcoin help illustrate why so many people want to be part of this growing phenomenon. They think: “OK, it’s a new currency; it’s crowd-sourced. I'm in!”
‘Internet Of Value Exchange’
It's not quite that simple. In a recent white paper, Deloitte & Touche described bitcoin as an “Internet of value exchange.” The real value of bitcoin is about the utilization of the infrastructure on which it is based. The more bitcoins are mined, or “hashed,” the more a free encrypted version of the internet is expanded.
This self-reinforcing infrastructure that becomes more dependable as more people participate, is called the “blockchain.” It can be used in a way to transfer securities, to create artificial intelligence, secure real estate or art transactions and, potentially, for all kinds of other transactions.
Look at bitcoin this way: 20 years ago, the internet democratized access to information, and now the bitcoin blockchain is democratizing access to commerce.
A Bitcoin ETF?
This growing bitcoin phenomenon is clearly something people might want to invest in. But can they? Can bitcoin be integrated with something like an exchange-traded fund—the ETF being what I consider to be the most flexible and tradable pooled investment vehicle yet invented.
Before diving into my analysis of the proposed ETFs that are already in the works, I want to be clear that you can purchase bitcoins today.
So, putting bitcoins into an ETF structure is not about making them accessible in a basic sense. It's about making bitcoins more accessible—that is, investable for any investor within a brokerage account.
With that in mind, let’s look at the three ETFs that are gestating with the SEC.
The Winklevoss Proposal
The first bitcoin ETF to go into SEC registration—the one you’ve probably heard about—is the one designed by the Winklevoss twins Cameron and Tyler, of Facebook and U.S. Olympic rowing team fame. We’ll know by the March 11 deadline whether their idea has wings and will be approved.
One possibly important aspect of the Winklevoss ETF is that the twins are proposing structuring their bitcoin ETF as a grantor trust. That’s what the SPDR Gold Trust (GLD), the gold bullion ETF, uses (more on that below).
Their ETF will also make use of their own bitcoin exchange called Gemini, to set the price, so you can see the benefit—to them, by legitimizing Gemini as the preferred pricing source for bitcoins. Also, the creation and redemption of ETF shares will be "in-kind," similar to GLD.
There’s another proposed bitcoin ETF from a company called SolidX that is also structured as a grantor trust. We’ll know by a March 30 deadline—just after the Winklevoss deadline—if this proposal will be approved.
The biggest difference between this bitcoin ETF proposal and the Winklevoss one is that SolidX included a type of insurance in case there's a hacking or some security breakdown on the price exchanges they’ll be using. The irony of such a feature is that the chances of any sort of a hack would be greatly reduced simply by using the encryption of the blockchain infrastructure.
Another difference is that the SolidX Bitcoin ETF would not use the Winklevoss price-discovery exchange, but would instead make use of an amalgamation of multiple exchanges to set the price.
Finally, the SolidX regulatory filing appears to include the ability of this bitcoin ETF to redeem “in-kind,” a key benefit in most ETFs that contributes both to liquidity and tight trading spreads.
The Grayscale Proposal
The third bitcoin ETF proposal is distinct from the other two in that, in a very real way, it already exists. This product, from a firm called Grayscale, is an already-existing exchange-traded product, though not an ETF.
Grayscale used the JOBS Act to create a limited partnership (LP) that owns bitcoins. After 13 months, they listed the LP on the over-the-counter (OTC) market. So if you wanted to, you could trade the Grayscale Bitcoin product today. They charge a hefty 2% expense ratio for facilitating investable access to bitcoin.
But crucially, the Grayscale Bitcoin Trust, which trades on the OTC market under the symbol “GBTC,” doesn’t have the ability to create or redeem shares in the open market, which can significantly crimp liquidity. GBTC trades like a closed-end fund—often at a price that can be substantially different than the value of the underlying asset.
Grayscale has potentially addressed this issue by filing to create an exchange-listed ETF version of this existing idea, which will include the creation and redemption mechanism so crucial to the success of ETFs. This idea of taking a closed-end product and potentially converting it to an ETF structure could have massive impacts on the ETF industry if the SEC approves.
The Long Road To Approval
Before guessing who might win this race to approval among the three bitcoin ETF competitors, let's talk a little bit about the SEC’s process for approving new ETFs.
Unfortunately, an innovative product like a bitcoin ETF is entirely new, and won’t benefit from the simplification of the approval process for more generic products that has developed over the 25-year history of the ETF industry.
All these bitcoin ETF applicants are going through a painstaking registration process. They have to persuade the exchanges that a bitcoin ETF is worth listing and, not least, they have to convince the SEC that their proposals meet all its requirements to allow for the exemptive relief that will grant them the legal right to launch a bitcoin ETF.
There’s a lot going on here, and if you have any interest, there’s actually a website where you can use futures to express an opinion as to whether you think an idea like a bitcoin ETF will be approved by March 11.
Again, that’s the date the SEC is expected to rule on the fate of the Winklevoss ETF and, indirectly, on the viability of other bitcoin ETFs as well. Right now, those futures are telling us that there’s a 45% chance of a bitcoin ETF being approved. That’s up from 10% and 25% just a few weeks ago.
Structure Of Bitcoin ETF Is Crucial
Which one of the three will be the winner remains an unanswered question, and while it seems most of the issues have been resolved to the SEC’s satisfaction, there’s still a question surrounding structure and liquidity. To my mind, the SEC will choose the winning bitcoin ETF based on its having a superior structure and maximum liquidity.
One potential issue with a grantor trust structure is that assets within a grantor trust structure have historically had to be physical assets as well as homogenized. Saying bitcoin is physical is a difficult argument to make, regardless of the demand for bitcoin.
That said, the Commodity Futures Trading Commission has classified bitcoins as a commodity asset. Additionally, the amount of bitcoins available is growing, but that number is ultimately finite—about 77% are currently in circulation. By 2140, all of the 21 million bitcoins will have been created. The implication is that an asset with finite supply can create obvious liquidity concerns.
Bullish On Bitcoin
It’s important to look at the how the existing ETP from Grayscale has performed, because trading patterns can give us clues about the appetite for a bitcoin ETF and about how the market is handicapping the prospects of the SEC approving the concept.
The Grayscale ETP has historically traded at a substantial premium to the value of its underlying bitcoins. That premium has manifested, because the ETP created liquid access to those bitcoins and an investable vehicle where none existed before. In other words, there’s clear demand for this idea packaged in a tradable vehicle.
You can see here in the chart below that, over the last few weeks, the premium that people are willing to pay to access it has come down substantially. There have been times when it has had a 90% premium to net asset value. Now its premium is in the 12% range.
The recent decline in the premium tells me many people think an ETF approval is imminent in the short term.
For a larger view, please click on the image above.
Will It Happen, And Should You Use It?
So, will this happen or won’t it? I’d say that there’s a greater than 50% chance there will be a bitcoin ETF. More than that, I’m generally optimistic, because while the SEC may take its time granting approval, historically it has not said no to new ideas that are well-conceived and carefully presented.
So, if this is approved, the question then becomes, should investors invest in a bitcoin ETF?
The answer is yes. This bitcoin infrastructure—the blockchain—has value. The added value of a bitcoin ETF is about broadening the accessibility of bitcoin, and thereby legitimizing it. The way I see it, the ETF structure will help make the bitcoin structure more mainstream.
In the end, I believe this marriage is very good for bitcoins and potentially good for traditional buy-and-hold investors. As far as traders go, I’ll take a more Jack Bogle-like view—putting bitcoins into an ETF wrapper could increase speculation and volatility, and be detrimental to both ETFs and bitcoins.
Still, I believe the SEC will eventually come to a place where it is convinced enough of the integrity of one of these proposed structures—or perhaps a yet-to-be-proposed structure—and approve a bitcoin ETF.
At the time of writing, Toroso Investments held a position in GBTC and GLD on behalf of clients. Toroso is affiliated with Global X Management Company. Toroso is a New York-based investment advisor focused on researching ETFs and other exchange-traded products, and designing asset allocation strategies, using ETFs that seek to perform well in various economic climates while emphasizing future objectives over past correlations. For more information about Toroso, call 844-986-7676, visit www.torosoinv.com or email [email protected]. For a list of relevant disclosures, please click here.