Winklevoss Bitcoin ETF: The Long-Awaited Horse-Drawn Ferrari In Digital Asset Speculation

| About: Winklevoss Bitcoin (COIN)


Bitcoin ETFs, like currency ETFs, wrap liquid, spendable cash in a relatively costly and inefficient vehicle for a certain investor base that requires such a wrapper.

Speculation seems largely driven by China and specific events (e.g. Brexit). This could drive relatively high, positive BTC interest rates.

Usage continues to grow, but price volatility likely scares away non-speculative use of the digital currency for payments, which could drive competition from less volatile digital currencies.

Bitcoin is just the first and currently most popular of many digital currencies and blockchain networks, and speculating on its value is very different than investing in the underlying technology.

It may take a while, but blockchain technology may eventually replace ETFs the way e-mail has been replacing paper mail.

For many investors, there are at least two ways to add a foreign currency (say euros) into a portfolio:

Choice 1: Go to the bank (online, by phone, or in person), and exchange some money into euros. Those euros can then be used to buy stocks, bonds, funds, property, wine, train tickets, or just about anything else priced in Euros, or converted back at a profit/loss as needed.

Choice 2: Go to a broker and buy shares of a euro currency ETF, for example the Guggenheim CurrencyShares Euro Trust ETF (NYSE Arca: FXE). Unlike euros in the bank, these ETF shares cannot be spent directly to buy anything else priced in euros, and after paying brokerage commissions and exchange fees, the investor will also need to pay about 0.4% per annum to cover costs of the custodian, auditor, regulatory filings, and other services required for the ETF wrapper.

In theory, choice 2 may provide some investors with a better exchange rate and interest rate than converting money into euros and leaving them on deposit at the bank, but the main reason an investor is likely to put up with the cost and limitations of the currency ETF vs. the currency is because their account may be set up to buy ETF shares but not be set up to convert money into foreign currency for whatever reason.

This would make more sense for slightly more difficult to access currencies like the Chinese Yuan Renminbi (ETF-wrapped as the WisdomTree Chinese Yuan ETF (NYSEARCA:CYB)) and even more sense for truly non-offshore-available currencies like the Brazilian Real (available as the WisdomTree Brazilian Real ETF (NYSEARCA:BZF)). That said, FXE has US$375 million in assets vs. CYB's US$48 million or BZF's US$23 million, so difficulty accessing the specific currency does not seem to be as much of a driver as portfolio demand for the currency itself.

About Current Bitcoin ETFs

Anyone who has experience converting money into bitcoin (or any other digital currency) and spending it is likely to see the above choices 1 and 2 for adding bitcoin to their portfolio. In addition, capabilities of the blockchain technology underlying bitcoin (discussed in more detail later in this article) make wrapping the digital currency in a traditional ETF vehicle look as anachronistic as using a horse to pull a Ferrari or using Gmail as a text editor for letters to be printed and mailed at the post office.

The Winklevoss twins, famous for receiving a $65 million settlement from suing Facebook (NASDAQ:FB) for stealing their idea for a social network at Harvard, first filed for a US$20m Bitcoin ETF offering back in July 2013. Three years later, in July 2016, after the 6th amended filing, it now seems imminent that the Winklevoss Bitcoin Trust will soon be publicly traded on BATS under the symbol COIN.

Meanwhile, another securities product called the Bitcoin Investment Trust has been trading over-the-counter under the OTCQX symbol OTCQX:GBTC. GBTC charges a 2% annual fee but has over US$100 million in assets under management and has recently been trading at an over 60% premium to its net asset value (NAV) of 0.0946 bitcoin per share (US$63.38 per share at US$670 per bitcoin), which optimists may see as a sign of high investor demand for participation in potential Bitcoin appreciation. Another clue on demand is the count of over 3,800 followers of COIN on Seeking Alpha vs. only 1,600 GBTC followers.

The >60% premium to NAV should seem strange to anyone who realizes how easy it is to buy Bitcoin and how ETF exchange mechanisms are supposed to work. Similar to how one would exchange dollars for Euros at a bank, dollars can be exchanged into bitcoin at a choice of online exchanges, many of the largest of which can be compared on sites like Bitcoin Charts. Most ETFs can never trade at much of a premium to NAV because market participants can freely exchange the underlying assets for new ETF shares, buying the former and selling the latter until their prices are equal.

The main cases of ETFs trading at a significant premium were when the ETF's assets could not be freely purchased - for example, Chinese A-shares with limited foreign purchaser quotas. Bitcoin can be freely purchased on many different exchanges, with the US$20 million daily volume on just the current top USD exchange of Bitfinex being over 10x the average daily trading volume of GBTC, so such a large premium likely says more about the relative inefficiency of creating and exchanging new shares than of any difficulty acquiring the underlying asset.

The 2% fee for GBTC (still not sure what it will be for COIN) should also seem very high given that holding simply holding bitcoin is purely a digital activity of storing and securing information (the bitcoin keys) on a hard drive, or for added security, on "cold storage" devices disconnected from power and networks.

By comparison, the SPDR Gold Trust ETF (NYSEARCA:GLD) (the world's first and largest gold ETF) has a gross expense ratio of 0.4% in exchange for saving the investor the cost of physically transporting, storing and securing the actual metal. Investors who put real money into a bitcoin ETF might see even this high fee as worthwhile insurance against a lost password, failure to back up a disk, or online hacks and scams, but it shouldn't take long for competition to drive this fee down closer to the truly low cost of securely storing digital keys.

How to Earn Interest on Bitcoin

An even more valuable service than simple access or secure storage bitcoin ETFs could provide is competitive institutional lending at interest, in the same way many other ETFs supplement their revenue by lending shares of stocks in their portfolios to short sellers.

As long as bitcoin remains so volatile against fiat currencies, demand to borrow it will likely remain dominated by speculators wanting to sell it short rather actual economic investors or spenders of borrowed coins. This demand may also be extremely volatile, but is almost certain to keep interest rates on such loans above zero. Unlike the yen, euro or Swiss franc, decentralized digital currencies have no central bank or other institution that can impose a negative policy rate on deposits, and can be far more easily secured and backed up than paper money.

So far, markets for borrowing and lending digital currencies are even fewer and farther between than the exchanges for the currencies themselves. The exchanges would be the most natural place to transact such lending, as their customers already have accounts holding both the digital currencies and dollars/euros/yen/ renminbi (which would need to be held as collateral against borrowed coins), and adding borrow/loan functionality would be as simple as a few blocks of code on the trading interface.

Unfortunately, it seems like COIN has stated on page 97 of its latest prospectus that it will not be lending out its assets at interest.

Speculation Largely Driven By China, Followed by Event Risk

Tables (like the BitcoinCharts table above) listing the most active exchanges by volume as well as sites like Fiat Leak show direct bitcoin trading activity is largely driven by China, with OKCoin and BTC China being two of the largest three bitcoin exchanges by volume as of summer 2016, despite scattered attempts by Chinese authorities to regulate or limit it. China is likely to be the source of two types of demand for bitcoin: desire to get money out of China in a more freely traded and less regulated form, and the insatiable Chinese appetite for betting on almost anything with a chance of doubling in a short amount of time.

News stories have also highlighted spikes in demand for bitcoin whenever an event leads to uncertainty, usually uncertainty around one's ability to get money out of a country. Bitcoin famously saw surges in interest in Cyprus in 2013 and in Argentina in 2014, and perhaps more curiously in June 2016 around the Brexit vote, as seen in the chart below.

Bitcoin Slow to Become Mainstream and Easily Replaced by Competing Networks

Total bitcoin transaction volume is still growing, averaging around 70,000 transactions/day in 2014, 120,000/day in 2015, and 200,000/day so far in 2016. This includes purchases and sales of bitcoin for cash, as well as transfers and payments, but is still a drop in the bucket compared to the 300,000,000/day average transaction volume by Visa (NYSE:V).

Even Apple (NASDAQ:AAPL) Pay, a mobile payment solution backed by the world's largest company that can make using a Visa card slightly easier and safer, has seen slow adoption in large part because paying by traditional cards or even cash is still easy and secure enough for most uses.

The difficulty the average user may face in converting money to and from bitcoin at wildly fluctuating rates on online exchanges may not seem worthwhile in places where easy payment cards already work so well, but may seem more worthwhile in places like Mainland China where there are still problems with counterfeiting and bank transfer reliability.

Even with increasing transaction volume, consumer demand to convert into bitcoins may be matched by merchant demand to convert those coins back into their own fiat currency, meaning demand to hold bitcoin as a store of value may not necessarily drive its price higher.

Most of this article so far has focused on Bitcoin, but it should be noted that Bitcoin was simply the first and best known of many different digital currencies and blockchain networks. The current runner up is Ethereum with a US$1 billion "market cap" compared with Bitcoin's US$10 billion. Microsoft's (NASDAQ:MSFT) cloud computing service Azure announced support for "blockchain as a service" based on the Ethereum platform late last year, which combined with Ethereum's more developed support for features like "smart contracts" provide advantages over using Bitcoin.

For consumers, merchants, or investors, it is far easier to switch from Bitcoin to Ethereum than it would be to move all one's videos from YouTube to Facebook, and even easier than opening up a new Visa card. Having lower switching costs and a less valuable "network effect" than a network like Facebook explains why Bitcoin's value continues to be far more volatile than that of Facebook shares.

Canada seems to be working on a digital version of its currency, which could provide many of the benefits of digital currencies (fast, low-cost, bank-free payments and transfers) but without the volatile exchange rates. Digital forms of fiat currencies consumers, merchants, investors, and governments are already comfortable with would provide huge efficiency gains in obvious areas like money transfer, which are just the first of many potential applications and advances blockchain technology can bring over the next decade.

Potential of Blockchain and "BTFs"

Just as the Internet has far outgrown its original intended use in sharing scientific papers, the blockchain technology underlying Bitcoin and Ethereum will outgrow its initial uses as a tool for bank-free micropayments (with a heavy dose of exchange rate speculation). Blockchain technology is the future of verifying signatures and transfer of value both openly and securely.

It is built on "public keys" which work like email addresses in the sense that everyone knows my email address and can send me an email, but only I know my email password and can send an email from my account, with the security built into blockchain addresses making it far more difficult if not impossible for hackers to steal my bitcoins or forge my signature.

The earlier mentioned term "smart contracts" hints at many possible applications of coding around this, such as digitizing a living trust to automatically start distributing a certain amount of CAD-Coins to one's children starting on their 25th birthday. One major application being watched is NASDAQ's use of blockchain technology on its Private Market, and perhaps becoming the ledger platform for all other exchanges of stocks and bonds.

The NASDAQ application is why I believe ETFs may eventually be replaced by Blockchain Traded Funds or "BTFs." As described in choice 2 above, buying an ETF means having to open and fund a brokerage account, submit an order for an ETF for a broker to route to an exchange, and then waiting two business days for the back offices to complete the exchange of ETF shares for your money.

By contrast, a BTF transacted on a blockchain would have the buyer's and seller's blockchain addresses each being digitally verified for funds and share positions, and then settle the whole transaction in seconds by secure software running on that blockchain. I described how to do this in my 2014 article "How Bitcoin Technology Can Make it 100x Easier to Start Your Next Fund".


Both COIN and GBTC ETFs wrap the volatile and easily replaceable digital currency bitcoin in a wrapper that is more expensive and inefficient than simply buying bitcoins directly. While these ETFs may be one of the few with the potential of multiplying one's money 2-10x within a year, they could just as easily result in instant 50-100% losses and will be unsuitable for very many portfolios.

The real revolution these technologies promise is doing to a wide range of financial transactions what the Internet did to a wide range of communications media. Just as the real money on the Internet has been made by investing in good, economically profitable businesses like Google rather than by speculating on the value of domain names, the real money in digital currencies will be made by investing in good, economically profitable businesses that use this new technology to serve users. Rather than speculating on bitcoin through an old-fashioned ETF wrapper, look out for opportunities to invest in quality financial technology (FinTech) firms, possibly through a BTF.

Tariq Dennison is a Hong Kong based wealth manager with US Registered Investment Advisor firm GFM Asset Management LLC. He has previously posted several other articles on bitcoin on his blog.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have no positions in any of these ETFs, but do have some money in Euros and Chinese Yuan Renminbi and occasionally buy and sell small amounts of bitcoin.

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