This GBTC Bitcoin ETF Analysis Hurts My Head.

From seeking alpha comes this gem about GBTC the Bitcoin ETF. The author acknowledges the extreme premium in which the ETF trades over the Bitcoin price. In other words if you buy GBTC you are currently paying >80% or more than just buying Bitcoin. (see more here)

First, he claims that “buying directly through coinbase has a +40% premium”. I don’t know why and he doesnt support his claim in the article. Yes, coinbase charges a fee, but it is not where near 40%.

He offers that GBTC offers cold storage through Xapo, and Coinbase offers insurnace but it comes with astericks – see authors article here.

Ok, so lets say that GBTC is more secure for storage of Bitcoin over Coinbase. The author ignores the fact that most responsible crypto owners get a hardware wallet or some other “off exchange” wallet.  This fact doesnt help justify the massive premium you’re paying for GBTC.

Finally there is this, the author presents an argument by a GBTC investor:

“I’ve decided to go with GBTC as a way of safely getting exposure to Bitcoin via my brokerage account, because I’m VERY long on it, and I can easily liquidate high dollar amounts (over $10K) at any time I want. And it’s all on the up-and-up, easily trackable for tax purposes, which I care about. My thesis is that the current premium is less important to me than the exposure because it’s 41% (or whatever the current percentage is) of a small fraction of what the ultimate price of bitcoin will be 10 years from now. It’s not perfect, I acknowledge that, but it strikes me as my best option, especially if I’m viewing this as one of my high-risk, high-reward investments.”

The argument is that in 10 years, the GBTC premium will be irrelevant. Of course, this leaves out he problem of P/E compression, or the potential catastrophic failure of Bitcoin in general. But, this line of thinking is congruent with the thinking of a Bitcoin bull. This isn’t “blind” investing or totally ignorant. I can respect part of this.

This completely ignores the fact that there are at least two other proposed Bitcoin ETF’s with the SEC. Care to bet that in 10 years there will be even more? Whats going to happen to the GBTC premium when other ETF’s come out which dont trade a premium?

INVESTORS WILL GO TO THOSE OTHER ETFS, THEREBY ZAPPING THE PRICE OF GBTC. If you’re ETF currently trades at an 81% premium to Bitcoin, and that premium erodes to zero – thats a loss.

I think you lose holding GBTC, there really is no way around it.

Another Bitcoin ETF Proposed

Van Eck, a large ETF provider announced they are seeking approval to launch their own Bitcoin ETF. Instead of actually holding Bitcoin they are going to leverage the Bitcoin Derivatives market to track the price of Bitcoin. This is quite smart and I think has a better chance at approval before the Winklevoss Gemini ETF.

The CFTC approved a Bitcoin Derivatives exchange “LegderX” several weeks back. Because Van Ecks ETF will rely on that rather than Bitcoin it means that clearing and moving funds will arguably be more transparent and secure because the derivatives settle in cash. The SEC and CFTC understand cash better than they do Bitcoin.

I personally thing the challenge the SEC has with the Winklevoss ETF is that they cannot wrap their heads around how the storage of Bitcoin will take place and where the funds will held. There are lots of security issues here which needs to be addressed and that makes for a lot of challenges.

There is “GBTC” which is not actively managed and usually trades at a very high premium to Bitcoin – see here.

Whats Wall Street Waiting For?

Why Is Wall Street Slow to Move into Crypto?

  1. Regulation
  2. Clearing

Not the sexiest topics, so we’ll keep it short.

Hedge funds and Wall Street firms have been slow moving into trading and investing in cryptocurrencies such as Ethereum and Bitcoin. There are some

Enterprise Ethereum Alliance
Enterprise Ethereum Alliance

indicators that sentiment is shifting such as JP Morgan (and others) joining the Enterprise Ethereum Alliance and Goldman Sachs initiating research coverage of Bitcoin.

Assume for a second that sentiment is suddenly 100% positive and that all the “scam” and “crime” stigma has left the building. So, whats the problem?

Regulation of Bitcoin, Ethereum

Party of the beauty and attraction of crypto is the decentralization and lack of regulation. There are many reasons why this is beneficial. But if you’re a big bank or managing billions of dollars, regulation matters. First, Bitcoin is not “legal” in all countries. Just look at what China did a few months ago when they started “regulating” Bitcoin. As per wikipedia: “While private parties can hold and trade bitcoins in China, regulation prohibits financial firms like banks from doing the same.” Not only is there  (outside) risk of the US doing this, but if you’re a fund thats has Chinese investors or does business with China this clouds the water.

Most assets are also considered collateral. If I have $10 million in gold I can bet that the bank I deal with would consider that an asset against which I can borrow. Does every bank see Bitcoin in that same light?

What about tax treatment – the IRS has made some comments but I’d say nothing is set in stone. Just this month the IRS is talking to Congress about strategy.

A lower risk, but still foreseeable is the risks of regulators such as the SEC or FINRA coming after you for engaging in (for example) an investment used to launder money. Maybe you buy Monero and build up a large position and

Bitcoin SEC Regulation - image courtesy
Bitcoin SEC Regulation – image courtesy

those assets are seized because the FBI thinks they were used in some hacking blackmail scheme. Probable? Probably not. Possible? Sure.

The facts are that until a regulator “green lights” Bitcoin and/or Ethereum its going to be tough for large institutions to trade or invest.

When Might Regulators Weigh In?

I’ve been watching the SEC’s ruling on the Winklevoss Bitcoin ETF launch. Its taken years for a ruling, and earlier this year it was initially rejected. However in April the SEC decided to take another look. I think its a bit underestimated the impact that approval would have to the price of Bitcoin. This would give not only a regulatory stamp of approval, but paves the way towards clearing and settlement of Bitcoin at an institutional level.

Clearing and Settlement is a Major Problem

Take stock or ETF trading as an example. When funds (or anyone as a generalization) trade publicly listed stock that stock clears through a central clearing house called the DTC. If I am a hedge fund and have my assets at say, Goldman Sachs (your “prime broker”), I can trade stock with JP Morgan. JPM sends the stock to my account at Goldman through the DTC. Its a pretty seamless process and universal to US stock trading.

Now, lets say I’m a hedge fund and I want to buy $1 million Bitcoin. Buying is easy enough – you go to one of the exchanges, wire money and buy your Bitcoin. The problem is there is no way to get your Bitcoin back to your prime broker. No, a wallet even with vaulted cold storage wouldn’t work. The risks associated with that are high, but the mechanics of trading in and out are a huge hindrance. If the fund needs to immediately raise assets by selling Bitcoin they need to have immediate access to those coins. While yes, you can work out the mechanics if you are a small fund or “crypto” is your dedicated business. But for large institutions who want to simply invest in crypto this is a major hindrance.

How Could Clearing Change?

One possible way is for clearing houses/prime brokers like Goldman or Morgan Stanley to have some type of central clearing wallet. Linked to that wallet would be “sub-wallets” for each fund that owns Bitcoin. Therefore if I go to Gemini Exchange and buy 1000 Bitcoin, I tell Gemini to send that Bitcoin to Morgan Stanley on my behalf. Morgan Stanley then has custody and can allocate the Bitcoin to my funds sub-wallet. This “sub-wallet” concept seems to peripherally exist and I’d imagine banks could pay someone to hash it out rather quickly.

If the Bitcoin ETF launched this would circumvent all of this, because you could just buy the ETF and it would clear via the DTC like all other stocks and ETFs. (Yes, I am aware the GBTC exists, but the premium on that product is absurd). To this point I think this clearing/custodial aspect is probably one of the problems the SEC is having with the product.

In the End

I’m confident these issues will be worked out. The fact that they haven’t yet makes (in my opinion) Bitcoin and Ethereum such an interesting investment at the moment. The door is currently cracked open to big investors, but eventually we could see a real flood of assets.