Another Bitcoin Backdoor Opens

December 15, 2020

“Time waits for no one, and it won’t wait for me.”
                                                    —Rolling Stones

As it pertains to the ETF industry and the tight bottleneck that is the SEC road to a bitcoin ETF, let me adjust that to: “Time waits for no one, and it won’t wait for the SEC.”

Last week, San Francisco-based Bitwise Asset Management launched a bitcoin-related investment vehicle, which was widely well-received, but the SEC had nothing to do with it. That in itself is a microcosm of the entire problem with the SEC’s approach to bitcoin: Asset managers are finding ways to meet investor demand for access to bitcoin without help from the SEC.

Unsurprisingly, on Monday, Bitwise reported significant trading volume in the first week of its crypto fund:

“Bitwise Asset Management, a leading crypto fund manager, announced that the Bitwise 10 Crypto Index Fund (ticker: BITW) saw record initial trading volumes of its shares in the secondary market following its debut on OTCQX … on Wednesday, December 9. More than $67 million of shares traded in the first three days, making it the highest volume debut of a publicly traded crypto fund in U.S. history.”

As the first publicly traded crypto fund, it’s to be expected that Bitwise should see a high trading volume debut, but the fund traded more than $67 million, a sizable amount for any security traded on what used to be called the “pink sheets,” or over the counter securities, which includes companies like Roche Holdings AG ADR.

But what’s amazing is the embrace of the fund’s costs. This is an index fund that costs 2.5% in annual expense ratio. And at times, this fund traded 200% above net asset value, which is dripping with crazy sauce. To its credit, Bitwise hasn’t shied away from the premium that the fund’s structure has created. It tweets it out to very little backlash, and in fact got more “likes” than I would expect.

More Than One Path To Investors

Because the SEC has so far slammed the door on a bitcoin ETF, issuers are finding alternative paths to investors. Last month, I wrote “How To Buy A Bitcoin” about the only physical bitcoin ETF, which trades in Germany, and that launched in August and has attracted nearly $200 million in assets, with a 2% expense ratio. We’ve covered a bitcoin ETN trading in Sweden, the Bitcoin Tracker One, which has $400 million in AUM. (Read: “How To Buy A Bitcoin ETN”)

There’s also the quasi-closed-end fund that holds bitcoin, the Grayscale Bitcoin Trust (GBTC) in the U.S., which has attracted $8 billion in AUM from investors comfortable with paying a 2% expense ratio on top of a 20% premium to net asset value. And of course, there are many platforms you can buy and sell bitcoin on, and some are reputable, such as Coinbase, but there are many operating on the fringes with creaky security and questionable oversight.

Matt Hougan, president and chief investment officer of Bitwise, is one of the few pushing to get a bitcoin ETF through the SEC. For now, he and his firm are only able to offer an crypto index fund for advisors trying to meet client requests for bitcoin exposure.

Hougan shares here the innerworkings of this battle and how his firm came to launch BITW last week.

                            Explain why this isn't an ETF. What is it?

Matt Hougan: This is the first publicly traded crypto index fund. It holds the 10 largest crypto assets weighted by market cap, screened for risks, and it's designed to make it easy for primarily financial advisors to get high quality exposure to the cryptomarket in the single push of a button from a brokerage account.

This is a model that was pioneered by Grayscale, which is another crypto asset manager, with a fund called GBTC, which many people are probably familiar with. I could rattle off the terms and exemptions under which it exists from a regulatory perspective, from the SEC and FINRA, etc., but they wouldn't mean much to you.

I think in terms of practicality, the way to think about this product is that it's a regulatory structure that shares some similarities with ETFs, but it's not an ETF; and some similarities with the closed-end fund, but it's not a closed-end fund. It's an open-ended public statutory trust.

To break that down, it's similar to an ETF in that it trades on a public exchange and people can create new shares of it on an ongoing basis. It's different in that, as you can see, it can trade to substantial premiums and discounts. And the reason it can trade to substantial premiums and discounts is that the regulatory exemptions that allow it to exist say that accredited investors can create new shares at net asset value, and then they have to hold those shares for 12 months before they can trade them on the market.

So, if you think about what happens when an ETF trades to a premium, authorized participants can create new shares that day and arbitrage that premium away. This works in a somewhat similar fashion in that accredited investors can create new shares of our fund, but those new shares can't come to the market for 12 months.

And so that premium exists, or that discount could exist if there's a difference between demand for those public shares and the shares that are available to trade now, because the other shares have to sort of season, if you will, for 12 months before they're allowed to trade.

People who buy the shares using the ticker BITW in their Fidelity account or whatever can buy and sell them intraday in the same you can an ETF. Why go this end-around on the SEC?

Matt Hougan: The SEC has not yet approved an ETF. We and a bunch of other people, including VanEck and Wilshire Phoenix, and others, continue to work on that. (Read: “Where Art Thou Bitcoin ETF?”) We have a number of people at Bitwise who work more or less exclusively on trying to push for an ETF. The SEC hasn't approved it yet. We're still hopeful that they will. Importantly, it'll be bitcoin only.

The SEC is a long way from approving an index product. The reason for that is bitcoin has a regulated futures market on the CME and other assets don’t. Bitcoin's a more mature asset; the SEC's likely to approve that first.

It's not traded on a national securities exchange, it's not available instantaneously on every platform. It's traded on the OTCQX, which is an over the counter market, and it's a different tier of market.

I don't want to speak for the SEC, but I think it doesn’t want to give the ETF stamp of approval, if you will, for a product until it gets fully comfortable that it meets all the requirements that it has, including concerns about the quality of the underlying market and concerns about surveillance capabilities, and those sorts of things. We're still working to make that true.

Until it does, you have this other way for investors to access crypto. And importantly, the regulatory exemption under which this exists has been applied and has existed for many years and predates crypto, to be sure. So, it's just a different tier.

And we want everyone to understand the premium. We put it at the very top of our website, literally at the top of the page. We want people to fully understand what they're buying and the fact that that premium can exist and that it can vary. But we want to give people the ability to buy it in an easy manner. Why is it so expensive?

Hougan: The answer is that crypto is still a new and emerging asset class. And we made the decision at the firm to go with the highest quality partners at every step of the way—so, the highest quality crypto custodian we could find, the highest quality audit and tax firms, the highest quality lawyers. It's an expensive ecosystem right now.

I expect the market to get cheaper over time as it gets more established and significant. There's no reason that crypto will avoid the fee compression we've seen in other areas of the market; it's going to come. And I expect, as we discussed, for us to move progressively toward better and better product structures.



You can expect more of these types of alternative structures surrounding bitcoin to begin multiplying at a rapid rate as money flows into these products in the states, or in Germany or in Sweden.

Issuers see the demand for a vehicle that offers easy access to crypto currencies, even at a steep price. In the world of fee compression, a market access area charging two to three times or more the average cost of an ETF has to be a breath of fresh air for those who run an investment businesses.

But the sad part of this is the lack of awareness on part of the SEC. For more than eight years, investors and Wall Street have tried to find the right structure and conditions to meet the SEC’s criteria and have offered up several innovative approaches, all of which were met with regulatory rejection.

Today the bitcoin market cap exceeds $350 billion. The crypto has a vibrant futures market trading on CME, and it’s being requested by investors everywhere.

Investors are not going the way of “Waiting for Godot,” and have left the park bench, waiting no longer for the SEC to come around to the new reality.

You can reach Drew Voros at [email protected]


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