Bitcoins In This ETF Not What It Seems

Yesterday’s surprise news that the ARK Web x.0 ETF (ARKW | D-30) will start including bitcoins is a bit of a headscratcher to me. There are issues on a few levels that I have with this announcement. Let’s take them in order:

Why Now? Marketing Success

I get the allure of Ark trying to make some noise in its flagship fund. Launched in October of last year, ARKW has struggled to find a footing, and has just $12 million in assets at the moment. It’s also really suffered from on-screen liquidity problems, with less than a few thousand shares trading hands every day.

But the thing is, I can’t help but root for it. It’s not crazy that it’s failed to find traction—it’s actively managed. And like most actively managed funds, it needs time to develop a track record before core ETF buyers, like financial advisors, will be willing to take the leap of faith.

It’s about to come up on its one-year anniversary, and the truth is, it’s actually done very well versus broader-based tech funds. Consider the ~5 percent gap it’s opened up on the more broadly diversified iShares US Technology ETF (IYW | A-96) in just under a year:

Heck, the fund has even outperformed the biggest ETF launch of the year, the PureFunds ISE Cyber Security ETF (HACK | C- 31).

So, as much as I think the fund probably deserves more attention than it’s received so far from investors, I can’t help but think the timing of the bitcoin announcement is slightly set to mark the one-year anniversary and crow-able performance.

It’s Not Really Bitcoins

The timing might make sense. I’m a bit more skeptical about the way in which it’s tackling bitcoins. When I read the press release, my first thought was that someone was stealing the march on the Winklevoss brothers’ upcoming Winklevoss Bitcoin Trust ETF (COIN) ETF—an actual ETF in registration that would solely invest in bitcoins. That ETF has been hung up at the SEC since filing, and there’s no word on when it may come out.

But Ark isn’t—instead, it’s investing in a company listed on the OTC pink sheets—the Bitcoin Investment Trust, which you can find on OTC under the ticker GTBC. GTBC is a strange beast. On the surface, it looks like a closed-end fund—accredited investors can petition authorized participants to create or redeem shares in 100-share baskets in a process clearly based on the fundamental precepts of how ETFs work.

But let me be perfectly clear: It may look like a duck, and quack like a duck, but GTBC ain’t no duck. It’s essentially entirely unregulated by the SEC. In fact, the whole reason Ark can get away with this quasi-ETF-like structure is precisely because the SEC hasn’t even decided what bitcoins are yet. GTBC’s own disclosure documents include this little sword of Damocles:

“To the extent that bitcoins are deemed to fall within the definition of a security for SEC purposes, the Trust and the Sponsor may be required to register and comply with additional regulation under the Investment Company Act of 1940. Moreover, the Sponsor may be required to register as an investment adviser under the Investment Adviser Act of 1940 and register the Trust as an investment company. Such additional registrations may result in extraordinary, recurring and/or non-recurring expenses of the Trust, thereby materially and adversely impacting the Shares.”

To translate that into Human: As soon as the SEC decides what bitcoins actually are, GTBC may get slammed with expenses or have to close.

Even if you love Internet stocks, there’s an enormous difference between investing in a small-cap startup company and investing in an essentially unregulated entity that may have to close precisely when bitcoins themselves graduate into the big leagues at some point in the future.

If that weren’t bad enough, the connection between the underlying net asset value of the bitcoins in GTBC and the trading price is tenuous at best.

This chart comes right from GTBC’s own website—since GTBC started trading on the pink sheets, the actual traded price has born little resemblance to the performance of bitcoins themselves (the blue NAV line itself), at times swinging wildly up or down seemingly in no relation.

From ARKW’s perspective, this may not matter in the long run, as I imagine it will be able to create and redeem through the AP process set up by GTBC. But day-to-day, I don’t see how the value of that investment—and thus your exposure as an investor—won’t be tied to the somewhat-capricious price of GTBC on the bulletin board.

And Then There’s Bitcoin

I admit it, I’m a full-on nerd. I play board games. I love my iPhone and my running gadgets and my voice-activated radio in the kitchen. So I love the idea of bitcoin. I love the idea of an unregulated currency that actually functions a little like gold-backed currencies were supposed to.

But the problem with bitcoin remains one of chicken-and-egg. Until I can get paid in it, and pay my mortgage with it, and buy my groceries with it, it just remains a speculative bet on an intermediate value store. Fundamentally, it’s no different than gold—it has value because lots of people think it should have value and want to use it to store value. And that’s why you end up with charts like this one:

That’s the value of a single bitcoin as reported by coindesk.com. And just like charts of gold, bitcoin has had its crazy hazy days (2014), and it’s had its rapid declines (2014). But here in the fall of 2015, I remain skeptical. For every announcement about a new vendor accepting bitcoin, there’s one about some startup that’s lost its way.

Toe In The Water?

In the end, I suspect the actual positions inside ARKW will be relatively small at first. I also suspect that when and if COIN comes to market, it will be the vastly preferred vehicle for such exposure, as the pink-sheet, unregulated nature of GTBC gives me genuine pause.

As ARKW is actively managed, the decision to add bitcoin now has to be seen as a tactical one, and as such, in a year, we’ll be able to look back and consider it a brilliant move, or a terrible one.

I’d say “grab the popcorn,” but I’m not sure the popcorn guy takes bitcoin yet.

At the time of writing, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.