Bitcoin ETFs For Dummies

February 17, 2017

Spencer Bogart is vice president of equity research for Needham & Co. He joined the firm in 2014 and currently leads the research efforts on blockchain technology and bitcoin while supporting research on cloud software (SaaS) companies. ETF.com recently sat down with Bogart, a former ETF.com analyst, to get his take on all the important developments in the bitcoin market ahead of the key SEC decision on the Winklevoss ETF, expected within the next month.

ETF.com: Before we jump into more specifics, in a nutshell, how would you describe what bitcoin is to the layperson?

Bogart: Bitcoin is peer-to-peer digital cash that's not issued by any central authority.

ETF.com: Tell us about the highly anticipated decision that's coming from the SEC. What is it ruling on and what are the odds the ruling will be positive?
Spencer:
There's a number of bitcoin ETFs that are going through the regulatory approval process. The one that's been going through the process the longest is the Winklevoss bitcoin ETF [Winklevoss Bitcoin Trust (COIN)]. That's been going on for about 3 1/2, four years now.

The exchange they would like to list that particular ETF on―which in this case is Bats [owner of ETF.com]―has filed a proposed rule change, which would be necessary to list the ETF. It's that proposal that essentially we've been watching go through the regulatory approval process.

At each point along the way, the SEC has had the option to approve, disapprove the ETF or to extend its time to make a decision. All along the way, it’s chosen the opportunity to extend the time to make a decision, including submitting requests for public comments.

We’ll now see an end to that process before March 11, which is the deadline. Before that, we’ll either get an approval, a disapproval or Bats will withdraw its request for a rule change. Or, if no decision is made by March 11, then the rule change is automatically approved.

ETF.com: What factors are the SEC considering?

Bogart: I don't have any inside information, but my sense is that the majority of the things that the SEC is particularly concerned about revolve around bitcoin itself as opposed to anything specific about the Winklevoss filing.

They're asking if a digital asset such as bitcoin―which, unlike a commodity doesn't have a physical form, and unlike a security or derivative, is not under any kind of regulatory supervision―is a suitable underlying asset for an ETF.

At the highest level, that's the kind of thing they're considering. A little bit more in the weeds they're asking if the specific markets that bitcoin trades on are stable, fair and efficient, and if they facilitate or enable or encourage any kind of market manipulation.

And then of course, there are the factors that are more specific to the ETF itself, which I think, in this case, probably the most important ones are what do you use as a reference price for bitcoin, and how are you going to securely store that bitcoin?

 

ETF.com: Does the Trump administration have any influence on the process?

Bogart: I’m hearing there are a number of bitcoin-friendly people that have taken up various posts within the administration. I'm hearing that it's, on the margin, at least a little bit positive for bitcoin.

I'm not sure if any of those people are in influential roles at the SEC. They may or may not impact the ETF decision, but overall, the probability of onerous legislation or regulation against bitcoin decreases on the margin with the administration change.

ETF.com: All that said, you say you believe the odds of approval aren't very high. Why is that?

Bogart: We've pegged the odds at less than 25%. That's because the very first thing the SEC lists in its own mission statement is protecting the investing public. When you think about the game theory aspect of this, if I work at the SEC and I approve this ETF and it goes well, nobody is probably going to come around and pat me on the back and give me a promotion. But if I approve it and a lot of money flows into it and something goes wrong, I'm likely to lose my job.

The SEC has gone very deep on this, and it’s really explored it far deeper than I expected it to. It would have been a pretty easy thing for it to just write off three years ago and forget about it. But I just don't know if it can get comfortable with the number of risks related to bitcoin itself.

ETF.com: If you're wrong and the SEC allows the launch, how much money do you see it attracting, and what will be the impact on the bitcoin price?

Bogart: Roughly speaking, we've estimated that at least $300 million would flow into this fund in the first week. An ETF would be the first time that the gates have been opened to bitcoin for institutional capital.

Most institutional money managers have mandates that require they invest in registered securities, and bitcoin itself is not a registered security. So for most institutional money managers, they can't touch bitcoin itself. The ETF would basically be the first time institutional money could really flow into bitcoin in a meaningful way.

The effect on price would be very profound. There's something on the order of $15 million to $60 million worth of bitcoin typically traded against the U.S. dollar on the world's major exchanges. If you're trying to source $300 million worth of bitcoin within a few days, there's really no way to do that—even in a normal market—without significantly disrupting the price.

Then you add into that the market where an ETF has just been approved and price is going to start rallying, liquidity's going to dry up really quickly just because nobody really wants to sell into that market. Everyone's going to want to hold their bitcoins in a time when the SEC has just approved an ETF.

At the same time, you're going to have a favorable shift in public perception away from "Bitcoin is only used for the sale of illegal goods" to "Oh, wow, the SEC has just given it a stamp of approval." And because you’d potentially have a much greater percentage of the population saving bitcoin, the propensity for the regulators to enact onerous regulation on bitcoin would at least decrease on the margin.

If you put all this together―you put this large sum of capital trying to flow into bitcoin at a time when price is already rallying, you add in the fact that there's a favorable shift in public perception, coupled with a marginal decline in regulatory risk―and the effect on price would be very significant.

 

ETF.com: The bitcoin price is up tremendously in the last year―about 150% in the past 12 months. How much of the run-up has to do with the ETF?

Bogart: I think very little of it has to do with the ETF. It's possible some of the recent price action has been related to the ETF. If at all, it's a small effect on the margin. It's mostly just about general growing adoption and a shifting perception.

ETF.com: If the SEC rejects the ETF, do you expect some kind of crash?

Bogart: I definitely don't expect a crash. There would be some downside to disapproval. We'll see price slump a bit, but I would guess it won't slump more than 10%.

ETF.com: If the SEC rejects the Winklevoss ETF, is there a chance it’ll revisit the issue down the line and another ETF can muster the support to come to fruition?

Spencer: Absolutely. This will be an ongoing process. The particular decision that we have coming up before March 11 is only related to the Winklevoss filing. There are two other major filings out there. Even if the SEC rejects the Winklevoss filing, eventually they will try to address whatever concerns the SEC has, and I wouldn't be surprised to see them go back and try to take another swing at this. But it's anybody's guess how long they would wait to do that.

ETF.com: Let me ask you about the underlying bitcoin fundamentals, aside from the ETF. What's the current market price and market cap of bitcoin? How much higher can it go?

Bogart: We're at about $1,000 today, which translates to a market cap of about $16 billion to $16.5 billion. How much higher can the price go? It's really anybody's guess. There's definitely a heavy percentage of total bitcoin ownership related to speculation.

I divide investors into two camps, and if you draw them on a Venn diagram, the overlap between them is probably extremely high.

For one, there are people who invest in it kind of as a commodity. These people invest in it for the same reasons they might invest in gold. They're assuming that for reasons outside of bitcoin, bitcoin will become more valuable. They believe maybe hyperinflation in a particular currency, a global financial crisis or things like that will drive up the value. Those are factors that are unrelated to bitcoin itself; they're external factors.

On the other side are people who almost look at it like a venture capital investment. They're thinking this is a payments network that is going to have a lot of value in the future, and they want to own a piece of that real estate.

Of course, there's a lot of overlap between both camps. I personally own bitcoin and I own it for both those reasons.

ETF.com: Is bitcoin like gold in the sense that it's difficult to put a price target on it? Can you say it's going to $5,000 or $10,000? Or is that just impossible to do?

Bogart: You can, but you're totally right. To some extent, you're pulling numbers out of the air. The way we look at it is, we ask, "Five years out, what percentage of the gold market might bitcoin be, and what percentage of payments volumes do we think bitcoin might account for?" And then we use a quantity theory of money to come up with what would be a fair price of bitcoin five years from now, and then use a discount rate to get that back to a present value.

We've done some of that work in the past. The last thing we published was a price target for $848. That was back when bitcoin was in the $500-600 range. We have not updated that price target since then.

Contact Sumit Roy at [email protected].

 

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