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Exchange Traded Funds and Bitcoin, the future of Cryptocurrency Investment.

By March 12, 2018 November 3rd, 2018 No Comments

Old world meets the new

Exchange Traded funds, the ‘old world’ mechanism for gaining low fee, easy exposure and diversification to a variety of asset classes. In the future, these funds are going to change Bitcoin and Cryptocurrencies forever, as they have been slowly trying to creep their way in to the industry over the past several years. In this Bitcoin News blog, we are going to talk about ETF’s and how these have the potential to take the cryptocurrency market to the next level.

What are ‘Exchange Traded Funds’?

An ETF stands for ‘Exchange Traded Fund’ and as the name suggests, is a managed investment fund that has shares tradeable on a stock exchange. The investment funds themselves typically track an index of stocks, a specific asset, or a basket of assets.

ETF’s were launched for the first time in around 1989, and have since become one of the most popular investment vehicles for institutional investors due to the lower fees when compared to mutual funds, the offering of lower cost diversification, and the option to trade and arbitrage across different exchanges.

ETF’s have become so popular in fact, that hundreds of new funds are listed every year, some with over $1 Trillion assets under management (AUM).

Coming back to what is an ETF, it is a fund that owns underlying assets such as stocks, precious metals, bonds or foreign currencies, and divides up the ownership of these assets into shares. So when someone wants to invest into an ETF, they buy some of the shares that represent the underlying assets that the particular ETF is invested into. They don’t directly own those underlying assets, but are entitled to a portion of the profits as interest or dividends depending on the margin the ETF makes and the quantity of ETF shares they hold.

The advantages of an ETF are that is makes it easy for investors to own a single share that represents wide diversification. This saves the investor having to invest individually into all those shares, avoids the large transaction fees associated with building a diversified portfolio, and because ETF’s have no minimum deposit requirements, as little as one share can be purchased.

Another similar investment vehicle is a Mutual Fund, with the major differences between ETFs and mutual funds is that ETF’s trade during the day, have lower operating expenses, no investment minimums, are more tax efficient and have no sales load (which are essentially commissions).

So in summary, if your someone who wants to invest with a small or large amount of capital, and you want an investment with diversification, low risk, liquidity (being the opportunity to buy and sell when you want), and you want low fees and better tax rates, you buy shares in an ETF.

Bitcoin and ETF’s

So here is where we arrive at Bitcoin ETF’s, and it all started with the Winklevoss twins back in 2013.

Now for those of you who don’t know the Winklevoss twins, they are who sued Mark Zuckerberg in 2004 for claiming he stole their original idea which eventually led into Facebook. They ended up settling and received $65M in damages, of which they invested $11M into Bitcoin, which at the time was trading for $120. That $11M investment is now worth over $1B as their original investment is up close to 10,000%.

Between their settlement and 2013, Tyler and Cameron Winklevoss developed into venture capitalists, leading seed funding rounds for Bit-instant, a Bitcoin payment processor.

The twins later filed an S-1 Registration Statement for a Bitcoin ETF called the ‘The Winklevoss Bitcoin Trust’, to the S.E.C in late 2013, with the filing describing shares of the ETF to be “Easily accessible and Cost Efficient” by offering a Bitcoin investment product that could be bought on a regular exchange, allowing investors to avoid having to directly purchase Bitcoins on cryptocurrency exchanges.

See here’s the thing, up until that point, the only way to buy Bitcoin was either directly through a cryptocurrency exchange, or through the Bitcoin Investment Trust.

A company called Grayscale, which is operated by the Digital Currency group – founded by Barry Silbert – was and still is the only way for investors to gain exposure to Bitcoin without having to directly go and buy the Bitcoin themselves. The trust is a privately offered and is only available to accredited investors, with shares of the trust also available for purchase either directly at the daily NAV price, or as the securities listed on the OTC Markets under the ticker symbol GBTC.

OTC Markets, Bitcoin Investment Trust (GBTC)

Because the Bitcoin Trust acts as a managed investment trust, there are management and administrative fees associated with it. So when owning shares in the Bitcoin Investment Trust verse owning Bitcoin directly, there is a slight margin of loss due to the fees.

Your probably thinking, “what is the point of investing into a trust or a fund when you can buy it yourself and save on fees?” We will come back to that.

The first rejection

Four years from the original 2013 Winklevoss ETF application, the S.E.C handed down its decision in March 2017, rejecting the fund due to the commissions concerns about the global nature of Bitcoin markets and the lack of regulation.

The commission went on to say that Bitcoin is still in the early stages of development and that over time, regulated Bitcoin markets of significant size may develop.

The twins made a statement saying they are not giving up on an ETF and that they agree with the SEC that regulation and oversight is important to the health of the marketplace and safety for investors.

Why do we need a Bitcoin ETF?

Well, this is really a two-part answer. Put yourself in the shoes of a wealthy investor who wants exposure to some Bitcoin but doesn’t have the time, the energy or perhaps even the ability to make an account on a cryptocurrency exchange, navigate the market, buy some bitcoin, then transfer it to a wallet, then store the wallet somewhere safe. We have to consider bitcoin and cryptocurrencies are highly complex and the cryptography and technology concepts behind it are not easy to grasp.

A wealthy investor wants an easy avenue where they can call their broker or financial advisor and say hey, I want to buy $50K of bitcoin. The advisor simply finds a fund, places the order then they are done. They do pay fees, but they don’t wear the risk of doing something critically wrong like losing the private key, misplacing the hardware wallet or transferring the bitcoin to the wrong address. They are happy to pay the fees because its easy, and they don’t need to ‘understand’ the technology because again they are not exposed to the same risk.

The need for an ETF is exacerbated the when you’ve got worldwide headlines of Bitcoins sky rocketing price during all time highs, leading to global ‘fear of missing out’. Without these funds and ETF’s, a lot of money is not coming into Bitcoin.

Google Trends for Bitcoin and Cryptocurrency News past 12 months

Cryptocurrency Market Capitalisation for previous 12 months

The second part to this is large financial institutions, who want to play by the rules and only gain exposure to assets that are regulated and sit well with the government.

Morgan Stanley said that in 2017, up to $2B USD has gone into specialist cryptocurrency focused hedge funds, which is a lot, but $2B pales in comparison to what large institutional investment funds put into traditional asset ETF’s.

For example, in the list of top 100 ETF’s by assets, the AUM of number one hundred on the list is $7B. Number one on the list, which is the S&P 500 ETF, currently has $270B of funds under management.

The Vanguard group currently has $4.5 trillion AUM and Blackrock Investment Management (which is the largest in the world) currently has $6.288 trillion AUM.

See the thing is with ETF’s, is they are approved by the U.S Securities and Exchange Commission, so they have the seal of approval for large financial investment firms to start buying up bitcoin without the risk of the Government coming down on Bitcoin or Cryptocurrencies with burdensome regulation or even outright bans.

The present state

Following the approval of the Bitcoin futures trading on the CBOE exchange on December the 10th, we have now had a Blockchain based ETF approved in Canada and two similar ETF’s approved in the United States.

The first is called NextGen Economy ETF (ticker symbol BLCN) and the second is called Transformational Data Sharing (ticker symbol BLOK), which have both listed on the Nasdaq technology exchange. Both funds will be investing into companies exploring or developing blockchain technology, not cryptocurrencies themselves, and only companies with a market capitalisation of greater than $200M and that have daily trading volumes greater than $200M.

The ETF approved in Canada is called Blockchain Technologies ETF (ticker symbol HBLK) but again like the two American based funds, they are investing into Blockchain based companies and not into the cryptocurrencies themselves.

So up until this point, we still do not have a Cryptocurrency ETF that invests directly into Bitcoin or alternative cryptocurrencies. The S.E.C made a statement in January 2018 indicating there is still too many issues with the underlying technology before they would be willing to approve one.

Some of their concerns included what happens it the cryptocurrency forks, and if it does, how would the fund handle the newly created forked coins? They are also concerned with market manipulation and liquidity, as the cryptocurrency market is still so volatile. The other major issue is how the fund would manage security and protection from digital wallet hacks.

The S.E.C concluded their statement by saying that until these issues could be resolved satisfactorily, they do not believe it is appropriate for Bitcoin and Cryptocurrency ETF’s to essentially be approved.

Where to from here?

Although an ETF has not been approved yet, there has clearly been significant headway made in the progress towards one. Many of the issues described in this blog I see as ‘teething’ issues, and given how new and revolutionary Bitcoin and blockchain technology is, it does not come as a surprise.

The S.E.C is there to protect investors, and ultimately that is what they are trying to do by ensuring the foundations are in place to reduce risk before an ETF is approved.

With that being said, when will be it be? I cant answer that question, but with the progress made to date, and the recent statement from the S.E.C on crypto exchanges potentially needing to be registered as a securities exchange, we are coming closer and closer to the regulation needed to have an ETF approved.

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