Decoding Bitcoin Investments: ETFs, Trusts, and Proxies Unraveled
Summary:
The article discusses the potential impact and considerations of a Bitcoin (BTC) exchange-traded fund (ETF) approval by the U.S. Securities and Exchange Commission. It explores various forms of Bitcoin investments—ETFs, trusts, and proxies—and their respective pros and cons. It talks about reduced accessibility in financial instruments like 401K or Roth IRA accounts and how ETFs, trusts, and proxies allow Bitcoin exposure. The article further addresses regulatory scrutiny, higher costs, liquidity concerns, and fee structures linked with these forms of investments. The piece ends by stressing that although each investment avenue comes with its unique challenges, the availability of more options is beneficial for wider Bitcoin adoption.
The potential approval of a Bitcoin (BTC) exchange-traded fund (ETF) by the U.S. Securities and Exchange Commission has triggered large speculation about expected BTC price movements. Heavyweight contenders such as BlackRock, Fidelity, VanEck, and Bitwise have made their applications, with Grayscale, having defeated the SEC in court in August 2023, presently working on transforming its established Grayscale Bitcoin Trust into a genuine BTC spot ETF. This prompts an examination of the potential benefits or drawbacks of selecting an ETF over a trust for investors active in the traditional financial spheres.
The complexities are further amplified given that several companies possess Bitcoin on their balance sheets, therefore serving as alternative virtual possession of the asset. These three BTC investment avenues – ETFs, trusts, and proxies – come with their unique advantages and challenges. Despite the independence offered by individual Bitcoin self-custody, there are situations where individuals may opt for one of these three alternative routes. In America, most people have retirement accounts like 401K or Roth IRA, which predominantly invest in conventional stock markets. These funds are usually inaccessible until retirement without incurring substantial penalties. However, ETFs, trusts, and proxies make Bitcoin exposure possible in the meantime. All three of these methods are passive, obligating no one to manage seed phrases and wallets or agonize over fraudulent scams or losses due to human missteps.
BlackRock's CEO, Larry Fink, highlighted in an interview on Fox Business that Bitcoin and blockchain technology could potentially eliminate the necessity for financial custodians. He added that while there was still a long way to go, it was a technological progression, and the utility of having a credible custodian was one of the advantages he proposed for investing in a Bitcoin ETF.
Many have written extensively on the prospects of Bitcoin ETFs. Industry experts like MicroStrategy's co-founder Michael Saylor have suggested that spot BTC ETFs represent the most significant development on Wall Street in the last 30 years. For instance, in Q3 2023, 28.2% of overall equity trading volumes in the U.S. comprised ETFs. While Bitcoin ETFs present significant liquidity to a traditional finance portfolio, they are exclusively accessible while stock market trading is underway. This unfortunately is a limitation, since Bitcoin’s 24/7 trading availability facilitates trades against price changes at any time, which is not possible with ETFs.
Even though some ETFs are available around the clock, their operation is confined to weekdays. This poses a problem, as lower volumes on weekends could potentially result in price swings that can't be capitalized on until traditional financial markets reopen on Monday. However, this only impacts short-term trading patterns, and if the ETF’s purchasers are long-term investors, this price action is of less concern, but is of note nonetheless.
Another concern, often raised in the traditional market space, is the perceived lax regulatory oversight of Bitcoin markets. Bitcoin ETFs, as they would be subject to heightened regulatory scrutiny, could potentially offer a degree of investor protection and lend an impression of market integrity to traditional investors.
However, investment in a Bitcoin ETF may result in higher costs through increased fees relative to other methods of Bitcoin exposure. Some of the lowest-cost gold ETFs have annual fees between 0.09% and 0.6% based on the investor’s holdings. This expense percentage is vital, as it could impact the investor’s profits and returns.
Similar to a spot ETF, a trust also possesses the underlying asset. However, an ETF must procure more of the spot asset (e.g., Bitcoin) based on demand. A trust retains a specific amount of an asset and sells shares derived from this total fixed amount initially introduced when the trust is launched.
Trusts can have some benefits, including the periodic disclosure of their Bitcoin holdings, which fosters some level of investment transparency. Trusts tend to be less liquid than ETFs, making them more challenging to trade on secondary markets. The other challenge could turn out to be a pro or con, depending on the timing of the investment. Trusts allow investors to trade at either a discount or premium based on Bitcoin's price fluctuations. The net asset value of 1 BTC might be lower than the cost of equivalent shares of a Bitcoin trust, thereby trading at a premium. The converse is also possible: The price of 1 BTC may exceed the Bitcoin trust's equivalent shares, offering a discount.
However, trusts attract higher fund expense fees as they are actively managed. The Grayscale Bitcoin Trust imposes an annual management fee of 2% compared to the potential lower fees on prospective ETFs, which is an essential factor to note in the decision-making process.
An investor may want to experience the price action of Bitcoin but without direct exposure to the asset itself, which is where a Bitcoin proxy comes into play. These could be companies or equities functioning in the blockchain space or holding Bitcoin on their balance sheet. Public Bitcoin miners such as Marathon, Hut8, and CleanSpark, among others, serve as Bitcoin proxies in the U.S. Companies such as MicroStrategy, which has about 189,150 BTC in funds, approximated to be worth nearly $8.1 billion, can also serve this purpose.
Traditional financial analysis of equities often involves reviewing the results of U.S. Generally Accepted Accounting Principles. For example, MicroStrategy’s reported net loss of $193.7 million in Q4 2022, due to Bitcoin's fall to the $16,000 range, had an impact on how Wall Street analysts perceived the stock. However, this traditional metric will be amended in December 2024 when accounting practices will start reflecting the fair value of Bitcoin held by a company. This will potentially transform the financial figures for firms like MicroStrategy, especially if Bitcoin's spot price receives an upward nudge prompted by the forthcoming halving event slated for around April 2024.
Bitcoin miner stocks (as highlighted in the table below) had a robust performance in 2023, with most of them posting triple-digit increases. These miners stand to earn huge profits not only from the potential future surge in the Bitcoin price but also from their Bitcoin holdings. The burden of debt on their balance sheets is a critical factor in analyzing these Bitcoin mining stocks. While this debt may enable some companies to afford new and more efficient mining equipment to bypass their competition, the impending reduced supply of Bitcoin in the market could put some miners in a precarious position if they are unable to obtain mining rewards due to unfavorable luck.
While proxies provide traditional markets with indirect exposure to Bitcoin, they also come with the usual issues that all public companies face. These include potential scandals involving leadership misbehavior, poor business practices, lawsuits, or shifting jurisdictional bureaucratic tape, all of which can influence the stock's value.
The upside of owning a Bitcoin proxy stock is the lack of fees present in trusts or ETFs. Proxies also operate businesses that generate revenue and profit. This means that apart from Bitcoin on their balance sheet, they possess an extent of cushioning, reducing the risk of ownership. While Bitcoin's price can impact the stock price of proxies, the operational business can support some level of market price above zero. Proxies also have an important advantage above other options according to MicroStrategy’s Michael Saylor, who explained that ETFs are unleveled and charge a fee, while his company provides leverage without a fee. MicroStrategy presents a high-performance vehicle for long-term Bitcoin investors and can leverage intelligent borrowing to buy Bitcoin.
One issue connected to companies taking on debt for Bitcoin procurement that needs consideration is the potential of share dilution. As of December 2023, MicroStrategy had 15.64 million shares outstanding, a 25.76% increase compared to 2022. With MicroStrategy holding 189,150 BTC, each share stands for 0.012094 BTC. At the time of writing, it would take about 83 shares (82.69 to be precise) of MicroStrategy stock to match 1 BTC.
Not every individual, institution, business, family office, or sovereign wealth fund is prepared or equipped to own and manage their Bitcoin directly. There are several parties looking for Bitcoin exposure, but prefer that it be managed by trustworthy entities in the traditional “Web2” setting.
Traders paying attention to price fluctuations in Bitcoin have the opportunity to take advantage of the traditional market's current lack of understanding of Bitcoin through ETFs, trusts, and proxies. The price of each might experience sharp increases during times of optimism and steep declines during periods of pessimism (commonly known as FUD, fear, uncertainty, and doubt), as the traditional financial markets are still unfamiliar with this asset class. This provides opportunities to buy at discounts and sell at premiums without directly trading Bitcoin. Retirement accounts like 401Ks or Roth IRAs and similar structures in other countries can be a way to make tax-free trades during Bitcoin’s cycles.
Identifying a winner in this traditional financial Bitcoin trilemma isn’t as simple as it seems. Some might find advantages in owning a part of a trust, particularly if the shares trade at a discount compared to the asset itself. For some, an ETF might take away the high fees associated with trust management but monitoring the fluctuating amount of Bitcoin held is crucial to ensure there isn’t any over-leveraging. Others might turn to proxies to gain exposure with zero fees, but may have to deal with sudden scandals, mismanagement issues, and solvency problems if corporate debts aren't repaiD.
Nonetheless, having an array of options to participate in the Bitcoin revolution is always a positive, as it will encourage more adoption as we move into future cycles. It is important to remember that this article does not provide investment advice or recommendations. Every investment and trading decision involves risk and readers should evaluate their options independently when deciding to invest.
Published At
1/4/2024 5:03:00 PM
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