There is a lot of speculation on what the price action will look like for Bitcoin (BTC) if a spot exchange-traded fund (ETF) is approved in the United States by the Securities and Exchange Commission. There is currently a long list of applicants, including the likes of BlackRock, Fidelity, VanEck and Bitwise. Grayscale, which won a lawsuit against the SEC in August 2023, is seeking to turn its current publicly offered Grayscale Bitcoin Trust into a spot Bitcoin ETF.
This begs the question: Is an ETF better or worse than a trust for investors who have their funds tied up in the traditional finance space?
To complicate things further, some companies hold Bitcoin on their balance sheets and can act as proxies for owning the asset directly.
These three options for Bitcoin investors — ETFs, trusts and proxies — each come with their own pros and cons. While nothing beats the sovereignty of self-custodying one’s own Bitcoin, there are scenarios where people may want to choose one of these three other options.
In the United States, people often have 401K or Roth IRA retirement accounts, which invest money in the traditional stock market. These funds can generally not be accessed until retirement without paying hefty fees, but with ETFs, trusts and proxies, people can get exposure to Bitcoin in the meantime.
All three options are passive, “set it and forget it” instruments, where no one has to keep track of seed phrases and wallets or worry about phishing scams or potential loss due to other human factors.
BlackRock CEO Larry Fink said in an interview on Fox Business that Bitcoin and blockchain technology can help remove the need for custodians from the finance industry. However, “We are not close to there, but it’s an advancement in technology.” Having a trusted custodian is one of the advantages Fink proposed for people to look to invest in a Bitcoin ETF.
The crypto media landscape has written extensively on the potential of Bitcoin ETFs, with people like MicroStrategy co-founder Michael Saylor saying that spot Bitcoin ETFs are the biggest Wall Street development in 30 years. In the United States, 28.2% of the total equity trading volume in Q3 2023 was from ETFs.
Bitcoin ETFs offer liquidity to a traditional finance (TradFi) investment portfolio, but they are only available while the stock market is open for trading. This can be a negative, as spot Bitcoin trades 24 hours a day, seven days a week, preventing ETFs from being traded against price fluctuations.
Some ETFs are available 24 hours a day, but they are still limited to weekdays. This can be an issue, as lower volumes on weekends can lead to price swings that cannot be taken advantage of until the TradFi markets open on Monday. Of course, this only impacts short-term buying and selling patterns, and if buyers of Bitcoin ETFs are long-term investors, this price action is less important, but it should still be noted.
One of the issues some in the TradFi space raise is the lack of regulatory oversight of the Bitcoin markets. The regulatory scrutiny these ETFs will receive can potentially provide some level of investor protection and give the appearance of market integrity to TradFi investors.
Investors may see an increased cost through higher fees over other forms of exposure to Bitcoin. Some of the cheapest gold ETFs have annual fees ranging from 0.09% to 0.6%, based on the investor’s holdings. This expense percentage is important, as it could eat into profits and returns for investors.
Similar to a spot ETF, a trust has to own the underlying asset. However, an ETF has to procure more of the spot asset (in this case, Bitcoin) depending on demand. A trust holds a particular amount of an asset and sells shares of that total amount that is fixed at the launch of the trust.
Trusts can have some advantages, including the periodic disclosure of their Bitcoin holdings, providing some level of transparency in the investment. Trusts have less liquidity than ETFs, which makes them more difficult to trade on secondary markets.
The other issue with trusts could either be a pro or con, depending on when one enters the position. Trusts can allow investors to trade at either a discount or a premium based on the fluctuations in the price of Bitcoin. The net asset value of 1 BTC can be lower than the cost of the equivalent shares of a Bitcoin trust, therefore trading at a premium. The opposite is also true: The price of 1 BTC can be higher than the equivalent shares in a Bitcoin trust, providing a discount.
There are, however, higher fund expense fees because trusts are actively managed. The Grayscale Bitcoin Trust, for example, has an annual management fee of 2%. Compared with the lower fees likely on potential ETFs, this may be an important factor to consider.
An investor may want to be exposed to the price action of Bitcoin but not have direct exposure to the asset itself. This is where a Bitcoin proxy comes into play.
These can be companies or equities that operate in the blockchain space or hold Bitcoin on their balance sheet. Bitcoin proxies in the U.S. include public Bitcoin miners such as Marathon, Hut8 and CleanSpark, for example.
Also included are companies such as MicroStrategy, which holds 189,150 BTC, worth roughly $8.1 billion, at the time of writing.
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Traditional financial analysis of equities includes looking at the results of U.S. Generally Accepted Accounting Principles. Under the current rules, Bitcoin’s fall to the $16,000 range was what MicroStrategy had to report on its balance sheet, showing a net loss of $193.7 million in Q4 2022.
This impacted how traditional Wall Street analysts viewed the stock. However, this traditional metric will change in December 2024 when accounting practices will start reflecting the fair value of Bitcoin held by a company. This means that financial numbers for the likes of firms such as MicroStrategy will look very different, especially if Bitcoin’s spot price begins to feel upward pressure from the upcoming halving event around April 2024.
MicroStrategy has acquired an additional 14,620 BTC for ~$615.7 million at an average price of $42,110 per #bitcoin. As of 12/26/23, @MicroStrategy now hodls 189,150 $BTC acquired for ~$5.9 billion at an average price of $31,168 per bitcoin. $MSTR https://t.co/PKfYY59sTW— Michael Saylor⚡️ (@saylor) December 27, 2023
Bitcoin miner stocks (listed in the table below) largely performed well in 2023, with the majority of them up by the triple digits. These miners not only stand to gain greater profits from the potential future rise in the value of Bitcoin they sell but also from the Bitcoin they hold. One of the key factors when analyzing Bitcoin mining stocks is how much debt is held on their balance sheets. While this debt may allow some companies to purchase new and faster mining equipment to stay ahead of their competition, the reduced supply of Bitcoin soon to be on the market may put some miners in a precarious position if they fail to win mining rewards due to a string of bad luck.
While proxies provide the traditional market with indirect exposure to Bitcoin, they also come with the traditional market problems that all public companies face — namely, potential scandals involving leadership misconduct, bad business practices, lawsuits or changing jurisdictional red tape, all of which can impact the value of the stock.
The benefit of owning a Bitcoin proxy stock is the lack of fees in trusts or ETFs. Proxies also have a functioning business that brings in revenue and profit. This means that besides holding Bitcoin on their balance sheet, they can fall back on a type of cushion, lowering the risk of ownership. While the price of Bitcoin can impact the stock price of proxies, the operational business can support some level of market price above zero. Proxies also have an important ability that other options do not, according to Michael Saylor:
“The ETFs are unleveled and they charge a fee. We provide you leverage, but we don’t charge a fee. We offer a high-performance vehicle for people that are Bitcoin long investors. […] We can take advantage of intelligent leverage. We can borrow money at zero percent interest for many many years, and we did that with the convert, and we can use that to buy Bitcoin.”
The ability to take on debt with Bitcoin as collateral cannot be duplicated by ETFs or trusts, and may allow companies like MicroStrategy to take out loans in bull markets and acquire more Bitcoin in bear markets.
One issue that needs to be kept in mind in regard to companies taking on debt and finding finance for Bitcoin procurement is the possibility of share dilution.
As of December 2023, MicroStrategy had 15.64 million shares outstanding, a 25.76% increase compared with 2022. With MicroStrategy holding 189,150 BTC, each share represents 0.012094 BTC. At the time of writing, it would take 83 shares (82.69) of MicroStrategy stock to approximate 1 BTC.
The TradFi Bitcoin trilemma: ETF, trust or proxy?
Not all individuals, institutions, businesses, family offices and sovereign wealth funds are ready or able to directly own and control their own Bitcoin. Many are looking for exposure to Bitcoin — but in the hands of those they deem trustworthy from the traditional “Web2” worldview.
For traders paying attention to the price swings in Bitcoin, there is an opportunity to utilize the current immaturity of the traditional market in understanding Bitcoin with ETFs, trusts, and proxies. The price of each may swing higher during times of exuberance and dump lower in times of FUD (fear, uncertainty and doubt), as TradFi still does not fully understand this asset class. This provides the ability to buy opportunities at a discount and sell at premiums, without trading Bitcoin itself. With retirement accounts like 401Ks or Roth IRAs in the United States and similar schemes in other countries, this can be a way to trade with no tax burdens during Bitcoin’s cycles.
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Declaring the winner of this TradFi Bitcoin trilemma is not so straightforward. For some, there are advantages to owning part of a trust, particularly if the shares are trading at a discount compared with the asset itself. For others, an ETF may remove some of the high fees associated with the management of the trust, but the fluctuation in the amount of Bitcoin held needs to be closely monitored to ensure rehypothecation does not take place.
Others may look to proxies as a way to gain exposure with zero fees, but may have to deal with surprise scandals, mismanagement and solvency issues if corporate debts cannot be paid.
In any event, having more options for participation in the Bitcoin revolution is not a bad thing and will help pave the way for further adoption as we move into future cycles.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.