The SEC will make a decision on a proposed bitcoin ETF by March 11, 2017. Will it approve? An optimist and pessimist weigh in, touching upon bitcoin’s liquidity, the impact recent events in China have had on its trading, as well as proposals for bitcoin ETFs by other companies. Plus, they reveal what impact an ETF could have on the bitcoin market.
Show Notes
https://www.forbes.com/sites/laurashin/2017/02/07/with-deadline-looming-will-the-sec-approve-a-bitcoin-etf/#6700d097732dTranscript
Laura Shin:
Hi, everyone. Welcome to Unchained, a podcast engineered by Fractal Recording and produced by your host, Laura Shin, a Forbes contributor covering blockchain, crypto currencies, and Fintech. Thanks for tuning in.
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For today’s episode we’ll be discussing the prospects for a bitcoin ETF. Here to debate the likelihood of SEC approval for one are Spencer Bogart, Vice President of Equity Research at Investment Banking, an Asset Management firm, Needham & Company, and Daniel Masters, Director of Global Advisors, Bitcoin Investment Fund. Welcome, guys.
Spencer Bogart:
Hi, Laura.
Daniel Masters:
Hey, Laura. Thanks for having me.
Laura Shin:
Spencer, let’s start with you. What’s your background and how did you come to learn about and then cover cryptocurrency at Needham?
Spencer Bogart:
Yeah, so I guess for background, you know, I’m Vice President of Equity Research here at Needham & Company, originally kind of joined the firm as part of our SaaS equity research team so I was doing investment analysis of cloud software companies such as NetSuite, Salesforce, and HubSpot, and then you know, I first kind of dipped my toes in the water with bitcoin with a small purchase in 2013. I pretty much top ticked a run up to about 100 dollars which felt insanely expensive at the time. The purchase was mostly just out of fascination with how it worked.
The process is borderline sketchy. I had to go down to a kind of sketchy side shop in Chinatown here in San Francisco and I handed someone cash which was subsequently wired to Japan. Even the gentleman at the counter kind of warmed me that you know, make sure you’re not getting scammed here. And from there it was kind of the classic story that nearly everyone in the bitcoin industry shares, which is that I just kept tunneling down the bitcoin rabbit hole.
Laura Shin:
And do you remember how you learned about it initially, and then also I just want to make sure, so when you sent that money to Japan it was to Mt. Gox?
Spencer Bogart:
Yeah, exactly.
Laura Shin:
And how did you come across bitcoin?
Spencer Bogart:
Yeah, I first heard about it actually in a team member meeting where previously the Needham & Company, I was working helping build a proprietary ETF research platform and you know, kind of in one of our meetings we were talking about things that are going on out in the financial media and it was the time that kind of Silk Road was getting very popular and you know, a few of the guys on our team were particularly tech oriented and started talking about bitcoin, and that was where it all began for me.
Laura Shin:
Okay, and keep going, you were going to say something else.
Spencer Bogart:
Well, yeah. I had the opportunity to start kind of shifting bitcoin into kind of my professional work life in early 2015 and never looked back. I mean, it’s just bitcoin is really intellectually stimulating and I don’t plan to stop anytime soon.
Laura Shin:
Okay, and Daniel, what about you? What’s your background and how did you learn about bitcoin and come to launch Global Advisors?
Daniel Masters:
Well, I have to say I’ve never been to a back street in San Francisco and bought bitcoin, that sounds quite fascinating. I’m a physicist and a statistician by training. I spent 13 years in investment banking for Salomon Brothers and JP Morgan. My last job was head of Global Energy Trading at JP where I was also a member of the bank’s risk committee.
I started Global Advisors to focus on commodities and launched two quite large commodity investment funds club that advises commodity investment fund and global advisors commodity systematic fund. I came to bitcoin at the end of the commodities super cycle and I was attracted, you know, with my commodity trade as _____ 00:04:08 by the volatility. I was intrigued by botanical platform and all the questions it raised about the nature of money.
I founded GABI, Global Advisors Bitcoin Investment fund, the world’s first fully regulated bitcoin investment vehicle, in 2014, and my firm also now owns a company called XBT Provider, an issuer of NASDAQ-listed bitcoin tracking certificates, so we manage now about 40 million dollars for many clients in the bitcoin space, and we also have holdings, I’m a direct _____ 00:04:42 shareholder of three blockchain companies, Gradbase, Glint, and Aventus Systems.
Laura Shin:
And you had actually also told me an interesting story about how when you first learning about bitcoin you even hand solved a problem and it got you thinking about the nature of money. Can you talk about that a little bit?
Daniel Masters:
Well, it was more to do with the technical infrastructure of the platform itself and what I did was I hand solved the block, so this process that miners go through to attract the block reward for essentially what would be described as a clearing process in other financial markets whereby all the transactions are verified and transmitted to the network. That involves this complex cryptographic process and hashing process that is quite mysterious to people, so I actually took a piece of paper and it took me about two days to work it through, but it gave me an understanding of how that mining process worked.
Laura Shin:
I remember that you said something interesting to me about how it got you thinking about the nature of money.
Daniel Masters:
Yeah. Well, once you see how elegant the bitcoin stack is and how the concept of a peer-to-peer distributed, immutable, time stamped, globally synchronized ledger has these tremendous advantages when transferring money from person to person, you sort of then think well, you know, bitcoin at the end of the day is an entry on a ledger, has no meaning in the physical world and it only has a value in the sense that people are prepared to exchange other currencies or goods or services for a higher entry on their particular ledger, and so, you know, that’s a very abstract concept. It’s not like having a dollar in your pocket or a gold coin and you need to get your head around what money really is.
Laura Shin:
So before we get into the reasons of you know, why we think a bitcoin ETF may or may not be approved by the SEC, let’s talk in general about the back story on bitcoin in traditional investment vehicles thus far. Daniel, you know, you mention actually some of these so can you describe a little bit more about you know, maybe not just yours but other bitcoin-related financial products?
Daniel Masters:
Yeah. Look, like with any emerging asset class or emerging commodity which I’ve seen a number in my career, the early days are populated, it was almost like a space program with sort of trial and error experimentation where one is always running up against, you know, the limits of the technology which in this case might be regulation, and so we’ve seen and we have a universe currently of some quite diverse and you know, both geographically and structurally diverse products, and I’ll list a few of those if you want, in no particular order.
So we have a company called Revoltura who have a bitcoin exchange-traded instrument listed on the Gibraltar Stock Exchange, trading by appointment on the Frankfurt Stock Exchange. That’s an asset-backed Euro denominated note custodied by Coinbase. It’s not been very successful, I think the bit to offer spread is far too wide and the ticket size is too big.
Then we have another company, Vontobel, operating in Switzerland. Vontobel and investment bank issue a number of derivatives, tracking all sorts of different assets. That instrument’s on the Swiss floor, it’s on the Swiss SIX Exchange, and has currently something like 7 thousand certificates outstanding at a bitcoin per certificate, so quite a small instrument, no word on the sort of custody provisions there.
We have a company called EXANTE operating in Malta. It’s quite a popular exchange with offshore Russian trading. It is not as tightly regulated and controlled as some of the Western multi product brokers like Interactive Brokers, for example, and it’s also got a fairly wide bit to offer, doesn’t really trade a lot of volume, and very skinny on the documentation front.
We have the Bitcoin Investment Trust, GBTC, which I think we all probably be discussing in more detail later, a US trust vehicle that’s been selling some of its units to accredited investors. We have Pantera, backed by Fortress, Ribbit, and Benchmark out in San Francisco. They’ve turned into a much more private equity-focused firm but they do have a bitcoin liquidity fund. I haven’t seen the details on that but I suspect that’s a Delaware company so it’s just a sort of private, limited liability company.
Lee Robinson, famed for his work at Trafalgar, the UK brokerage company, has a group called Altana. They have a small bitcoin fund and that’s based in Monaco, or he’s based in Monaco, and then yeah, our GABI fund, around 5 million in assets, custoded by Gemini and itBit, listed on the Channel Island Securities Exchange. That fund is around 5 million dollars in assets, and then the two trackers we have, Coin XBT and Coin XBE listed on NASDAQ, OMX, and Stockholm, about 35 million. That’s a passively-traded exchange tracker, very, very similar to an ETF with a two and a half percent fee and a 10 percent, so a 10 basis point bid offer.
So that’s one, two, three, four, five, six, seven, eight vehicles in total and I think that just about covers the universe.
Laura Shin:
Well, it’s interesting to me that most of them aren’t really, you know, traded at a high volume because you know, of the fact that GBTC tends to trade at a premium on over-the-counter markets. You know, why do you think that is?
Daniel Masters:
Well, I think one has to be very mindful of the tremendous power of the onshore domestic US investor and I think that, you know, GBTC has a number of issues which we may get into, and which may or may not be solved by a subsequent filing with the SEC that is now underway, but it’s redeeming factor is that it’s available easily to onshore US investors, and the premium of the tracks which is quite substantial, I think is quite indicative of the native demand, the pent-up demand that exists in America for this kind of thing, and the limited supply of product because I believe that most of the investors that would look at GBTC perhaps wouldn’t look at some of the other jurisdictions of the products that I just mentioned.
Laura Shin:
So this actually then is a natural segue to today’s main topic which is the Winklevoss Investment Trust, or you know, more generally actually, a bitcoin ETF, but this is the one that is sort of in the news now. Three and a half years ago the Winklevoss twins who were actually previous guests here on Unchained but they weren’t able to talk about their filing with the SEC, but three and a half years ago they did file with the SEC to offer the coin ETF and that is you know, likely to result in a decision in March.
So Spencer, can you tell us so far what’s happened in their quest to get this approved and what we may end up with in terms of SEC’s decision?
Spencer Bogart:
Yeah, absolutely. So you know, the exchange that the Winklevoss twins are hoping to list their ETF on has filed a request for a rule change with the SEC, and that rule change has kind of been going through the process, and it’s a multi step process and at each point the SEC can either choose to approve, disapprove, or extend their time period, and so far they’ve gone through all the options of kind of extending the time period, seeking additional public comments, and posing some questions for the public as well.
So now we’re at a point where March 11 is the final deadline, so there is no opportunity to extend beyond March 11 as far as I’m aware, and so before March 11 one of three things will happen. Either the SEC will approve or disapprove the necessary rule change, the sponsoring party, so it’s the _____ 00:12:55 Exchange in this case, will withdraw the rule change, or there’s kind of a third called an extremely low probability event where we hit the March 11 deadline and at least as far as I’m reading the rules and with everyone I’ve checked with, there is a clause that says that if the SEC has not made a decision by that deadline the rule change is automatically approved, and we can get into why that’s a little bit interesting from kind of a game theory or political dynamic perspective a little bit later.
Laura Shin:
Okay. So before we get into you know, what might happen, let’s talk about all of the different factors that the SEC considers when it’s deciding whether or not to approve an offering like this. First of all, why don’t you guys tell me what you think all those factors are and then amongst those which are in favor of approval?
Spencer Bogart:
Yeah, I mean, I think there’s the things that are specific to the Winklevoss filing, then there’s things that are broader to bitcoin itself, right? And so I think that overall, I think the greater concerns are probably with broader bitcoin issues itself or concerns there, as opposed to specifics of the Winklevoss filing. But if you do want to dive into some specifics of the Winklevoss filing, you know, I think that there is some concern about whether or not the spot price on the Gemini exchange accurately represents the price of bitcoin. It is not one of the most liquid exchanges out there but it does have the kind of highest regulatory approval in the form of a Federal Trust Charter, and so that Federal Trust Charter is actually the same thing that for example BNY Mellon uses.
Laura Shin:
Just to clarify for listeners who may not know, Gemini is the exchange that the Winklevoss brothers run themselves, but also a question for you, is that a conflict of interest for them to do that?
Spencer Bogart:
Exactly. Yeah, so that’s exactly my next point here is just that you know, there is I think at least some level of concern of conflict of interest. There’s at least the perception of it, right? So I’m quite confident there’s not another ETF that exists in the US where a single party or at least an affiliated party is both the sponsor, the custodian, and is responsible for kind of the exchange for the spot price and that asset value is derived from. That is the case with the Winklevoss filing.
I think it’s easy to be highly critical of that aspect and to look at it and say oh, they’re just trying to make money on all sides of the table here. I think when you dig in, that’s not really the case and I think the Winklevoss twins would gladly you know, give up any of those sides if they thought it would increase their chance of approval, but really, I mean, I think that they use their own exchange because again, there are only two exchanges in the US that have a Federal Trust Charter, that’s the Gemini Exchange that they run and also itBit which they use as the backup exchange in case there’s any kind of technical interruption on the Gemini exchange.
And then as far as being the custodian, I mean, certainly there are other third-party custodians that you can use and some of the other filings out there do use third-party custodians, but in this case I think that they really feel most comfortable just building, you know, controlling that end to end and being able to install kind of their own proprietary system where they feel it’s really safeguarded the bitcoin and has appeased all the concerns kind of from the SEC.
Laura Shin:
And Daniel, do you have anything to offer here on you know, what factors the SEC will consider when making its decision?
Daniel Masters:
Yeah. I mean, I think Spencer makes some really good points there and generally speaking one would say, you know, is there a sufficiently good structure in place, and that’s, you know, composite of just not the quality of the counter parties but the sort of chain of fiduciary management through that process. Now ironically I think if you look at the individual pieces, so the trustee, Delaware Trust Company, the exchange is actually the Gemini auction price that happens every day that the price of the _____ 00:17:06 value is calculated by.
If you look at the very sophisticated storage protocol that Gemini Trust has put in place in order to store bitcoins on behalf of the trustee and therefore confer the ownership of those bitcoins to the investors themselves who own the stock, the ETF, those things are all very, very high quality, in fact our fund GABI uses the same storage protocol that the Gemini Trust provide because we see them as a really highly-regulated, really professional, very technically astute group of people who’ve adhered to the NYDFS regulations which put tremendous personal and corporate responsibility on the activities you do in the financial market.
So each of these components are actually very, very high quality. You’re getting, you know, fidelity bonds to ensure some performance, you’ve undoubtedly got professional indemnity insurance, directors and officers liability insurance, and so on and so forth. So it really is a very good structure and that’s why we use part of it in what we do, but there is this question about sort of both being the poacher and the gamekeeper and in fact, you know, strategically you know, there is a case to say that one might use perhaps a different price index, a couple of the other prospective ETFs do. TradeBlock for example provides a suitable index, and you might, you know, potentially use alternative custodians or indeed spin the custody business out to another party. There are some large US institutions making moves into the custody space in bitcoin.
Now those things may come too late for this particular filing and it is unfortunate that you know, having filed 21 times now with the SEC since July of 2013 that there’s a concept here we’re running out of road, but in many cases I think you know, the pieces of the structure that have been put together didn’t even exist when this filing began and in some cases have only recently sort of come to fruition so that at some point there was a need to actually self create the components that put this ETF together.
But as it stands, they’re all the same balls sort of under one group of controllers and that is obviously asking some questions in the SEC’s mind.
Laura Shin:
Well, I actually want to step back. You know, we’ve really dived into the details on the Winklevoss brothers’ proposal here, but you know, I just even want to ask kind of more big picture questions like do you think that bitcoin itself as an investment is ready for you know, being put into an ETF structure and like I don’t know if you…do you guys think that that’s a question that the SEC is grappling with or do you think that they consider it a foregone conclusion and it’s just really the details about how such an investment vehicle is structured? I mean, because could think of other questions about you know, liquidity or…I mean, you guys mentioned this a little bit but it was more around like how the Winklevoss brothers are coming up with the price, but you know, do you think that SEC thinks that bitcoin is really ready for being put into an ETF?
Daniel Masters:
I personally believe it is. I’m operating, you know, three listed products currently and they seem to operate very well. I don’t see necessarily why, you know, US investors should be in principle deprived of that. I think with bitcoin you have to take a view as an investor that this is an emerging asset, but it comes with some very high-profile historical issues largely around, you know, use of bitcoin for illicit activity and to money laundering issues, and the issues around security, theft, and hacking. These are issues that have been pervasive in the bitcoin market.
As a sort of an experienced participant in this space I have to say that I think many of those risks have been ameliorated, counteracted, and addressed by things like the NYDFS regulatory regime, by the anti-money laundering provisions that pretty much every decent exchange now has in place which are in some cases rise to the level of opening a bank account in terms of identification in the security protocols that are in place in the new hardware security modules, for example, that Gemini’s using to perform cold storage.
All these things are really high-quality solutions to some of the issues that bitcoin has had, so you know, I personally think bitcoin will change the world. I think it’s matured enough and I think there are enough really serious people, banks, regulators, technology companies, all sorts of different players now in the space doing sensible things and I do think that the SEC should take a view on that, and I do think that they should let it go.
Laura Shin:
And Spencer, what about you?
Spencer Bogart:
Yeah, I guess to answer your specific question about whether or not it’s a kind of foregone conclusion that the SEC that bitcoin is an asset that is itself worthy of an ETF, you know, they posed some questions for public comment and I think if we comb through those we can get an idea of the things that are perhaps top of mind at the SEC. Again, I don’t have any special information other than that otherwise publically available info, but you know, the very first question that they posed to the public is that there has never been a purely digital asset in an ETF before and so I mean, this is something that unlike a commodity it doesn’t have a physical form, and unlike a security or derivative, it’s not registered with any regulatory body, and so you know, I guess another concern that they posed in there as well is that ownership of bitcoin could in theory be changed by a coordination of a majority of the networks hashing rate.
Now, I mean, within the bitcoin industry we know that this risk is always evident but quite low, but that’s just one of myriad factors that the SEC is really looking at here. I mean, other things are really just general broader market concerns, so whether or not the bitcoin market is somewhat stable, if it’s resilient, if it’s fair, if it’s efficient, and whether or not, you know, the liquidity and transparency of some of the exchanges could enable any kind of market manipulation.
And then there’s also concerns just more broadly about the risk of loss from something like hacking, and of course I think in the specific filings that we’ve seen put forth, especially the Winklevoss filing, you know, I think that these risks are highly mitigated but you know, it’s anybody’s guess whether or not they’re enough to kind of appease the concerns of the SEC.
Laura Shin:
Okay. Those are some really great points right there and I actually want to circle back to, you know, your opinion because you did write about this, but let’s pause things right here to bring in an important word from our sponsor, Onramp.
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I’m speaking with Daniel Masters of Global Advisors and Spencer Bogart of Needham & Company about the prospects for SEC approval of a bitcoin ETF, and Spencer, you, you know, kind of laid out some general thoughts on what the SEC looks at in its decision-making process, but you actually recently put out a report saying that you think the chances of approval are 25 percent or less? So why do you think it’s likely not to be approved?
Spencer Bogart:
Yeah, again, so I mean, I’ll come back to you know, the way we divided up some of the concerns of the SEC before which was those things specific to the Winklevoss filing, and then there’s the things that are related to bitcoin, and then there’s kind of broader concerns as well. So I think that we really need to take a heavy consideration of the general conservativeness with the SEC.
I mean, if you think about just that’s just from kind of a game theory aspect, if I work at the SEC and I approve this ETF and a lot of money flows into it and something goes wrong, you know, there’s a very good chance that I could lose my job over that. If I do approve the SEC and it goes extremely well, it’s very unlikely that someone comes around to pat me on the back or give me a promotion, right?
So there’s one just that game theory aspect, and then there’s also the SEC’s mission statement, right? So the very first task mentioned in the SEC’s mission statement is to protect investors. The very last thing they mention is to facilitate capital formation. So I mean, when we think about it like that, a lot of the low probability that we put out of this ETF being approved is just a general conservativeness with the SEC that maybe this is an asset that’s too early.
Now, you know, for us when we look at the specific filing and we look at the concerns, we do not see any reason to disapprove the ETF, but again our analysis is not going to be the same as the SEC’s and we generally think that conservativeness will prevail here.
Laura Shin:
And there has been a development since you put out that report which is that the Chinese government began taking a more active approach to regulating exchanges in China, and for a long time the largest exchanges in China had no trading fees and so bitcoin trading there was just through the roof and by most estimates, although it was difficult to get an exact figure on it, a lot of people would say that trading in China accounted for 95 percent of all bitcoin trading worldwide, however since then the three biggest exchanges, BTCC, OKCoin, and Huobi? I’m not sure if I’m pronouncing that correctly, have imposed trading fees and now trading there is down by like 80 to 90 percent, so you know, since that development happened after your report came out, how do you think that that you know, affects your assessment?
Spencer Bogart:
Yeah, so obviously it’s been really interesting watching the developments come out of China. Overall I think they’re probably not a major factor for this specific filing. I think that, you know, they could help slightly on the margin, only really in the sense that there’s been a misperception that China just dominates everything related to bitcoin and you know, that’s true in some respects, especially in mining, but there’s not nearly the same dominance in trading as has been kind of widely discussed in the media.
And so you know, historically we’ve looked at it and you can see a lot of reports that the top _____ 00:28:13 have 95 to 98 percent of trading volume has been out of China historically just until the last week when trading fees kind of came in, but that was never really true, it was never really an apples to apples comparison of volume. Anytime you have completely no fee trading, I mean, I myself could sit there and swap a thousand bitcoin back and forth myself. That pumps up trading volume very, very significantly, but the question is whether or not that volume is very meaningful.
And so in general comparing the volume on those Chinese exchanges historically to other exchanges around the world was just not at all an apples to apples comparison and we’ve always pushed back on this notion that 98 percent of trading volume comes out of China, and today we see probably a better representation of what that actually looks like.
Laura Shin:
Yeah, well now it looks like nearly all the big exchanges are somewhat roughly even, at least that’s my reading on Bitcoinity, so when you say that you used to push back on that is it because you felt like the trading wasn’t meaningful and therefore it wasn’t like necessarily really having much of an impact on the price? Is that kind of what you meant by that?
Spencer Bogart:
You know, impact on price is debatable, but just that the volume, just that it certainly wasn’t an apples to apples comparison to compare the volume across these no fee exchanges and then the rest of the world that did charge trading fees.
Laura Shin:
Okay.
Daniel Masters:
I mean, I would jump in there if I can, Laura.
Laura Shin:
Yeah.
Daniel Masters:
I think we need to be a little bit more precise about exactly what did go on in China and it’s Huobi, just so you know.
Laura Shin:
Oh, okay.
Daniel Masters:
Look, the changes that were made were made specifically to the Chinese yuan denominated physical bitcoin market which up until that point had been enjoying leverage, you know, leverage capability so you could buy, you know, five bitcoin if you only had one bitcoin worth of capital, and there were as Spencer correctly pointed out, no trading fees. So that’s changed. The leverage has disappeared after the People’s Bank of China walked into those three exchanges and started asking questions about investor protection, marketing policies specifically with respect to dissing the Chinese yuan as a currency, anti money laundering provisions, and so on, and it certainly had a dramatic effect. The timing was perfect because it was at the top of a very strong run. The timing was perfect because it was just ahead of the Chinese holidays, New Year which is still going on, and so as is often the case when a central bank or a government gets involved in a marketplace, they do pick extraordinarily good moments and they do have a very dramatic effect.
And if you look at what other central banks and regulation governments have done in the past, whether it’s you know, it’s states releasing the strategic petroleum reserve during price spikes for oil, or the UK intervening at some currency in ’92 to shored up in the exchange rate mechanism, or Alan Greenspan’s irrational exuberance, comments, the activities by you know, that these big people tend to be somewhat dramatic in the short term, effective in the short term, but are usually always _____ 00:31:19 victories because these markets normally go right back to where they were.
Now in this Chinese case, the Chinese domestic yuan market was not the only market going on. OKCoin for example had a very, very active futures market, it’s a dollar-based market, and even post the clamp down on some of the excessive factors as in China, we still see 100 million dollars in open interest on their contracts, we’re seeing 100 million dollars a day in volume, we’re seeing a billion dollars a day on a big day of volume, and that’s real. That is you know, that is not a free market to trade, you know, you have to put down your margin and you have to pay fees in order to trade that.
So you know, the total eradication of volume in China and the sort of fakeness of it is only partially true and it’s been localized to that domestic market. The rest of the Chinese market is actually quite healthy. That tends not to be reported on the sort of sites you just mentioned like _____ 00:32:22 because it’s not physical bitcoin, it’s derivative but it’s still a very significant market.
Now in relation to the Winklevoss ETF and other ETFs, one of the push backs that the SEC could possibly have had is that it’s unusual for a US ETF to be based on an asset which trades primarily outside the United States. It’s not that it never happens, you know, there was a copper ETF for example and everybody would tell you that you know, China is the most important market for copper, but there is a small copper market on the CME and there are ETFs that sort of trade off of that.
So it’s not unusual…it’s unusual but it’s not you know, completely never the case that a market for an ETF can be based on something which trades perhaps or was influenced by a foreign market and that would be true in the case of copper.
So in some funny way, you know, if you go back a year you might have said well, there’s not enough bitcoin trading to support an ETF. Now along comes China and it gets very, very active, possibly too active, corrects to a more sensible level of activity but still a significant market. But indeed these markets have come more back into line, so you sort of have to pick your poison here. Are you concerned that there’s not enough bitcoin trading to support a bitcoin ETF because you know, some of that’s in China, or are we now happy that the volume is much less in China and therefore it’s more evenly balanced across the West? You kind of can’t have your cake and eat it in that respect.
Laura Shin:
Great. Well, so but I do want to know, you know, now what it seemed…do you guys think that it would seem to the SEC that there isn’t enough trading?
Daniel Masters:
I personally think…I mean look, we’re quite active in the markets on a day-by-day basis both for our exchange trade and notes. We have people coming in to buy and sell those every day. Our fund is a sort of a monthly liquidity vehicle so we have you know, periods where we’re taking subscriptions there and then we do actively manage that fund as well, so we’re in the markets every single day. As I mentioned, our assets around 40 million under management, we have no problem whatsoever moving those kind of volumes around to suit our clients’ needs and to affect our hedging strategies.
So I think there is enough volume to do an ETF.
Laura Shin:
Spencer, what do you think?
Spencer Bogart:
Yeah, I mean, there are certainly ETFs whose underlying asset is less liquid than bitcoin, so you know, I mean, depending on the actual volume of assets that flow into this ETF, I mean, certainly you know, it could be challenging to source enough liquidity to be able to acquire the bitcoins for the ETF, but again, I mean, there are significantly less open markets, underlying assets that do have an ETF.
Laura Shin:
And Spencer, Daniel did you know, give his opinion on what he thinks the SEC should do but we didn’t actually get that from you. What do you think the SEC should do, should it approve a bitcoin ETF?
Spencer Bogart:
Yeah. I mean, you know, certainly as I mentioned, we don’t see any specific reason to disapprove the ETF. I mean, if you were rooting for bitcoin in the long term I think that there is both puts and takes here, right? I mean, I think that the approval of an ETF certainly, at least on the margin, improves regulatory risk slightly. There would certainly be an associated positive shift in perception, so again kind of this historical association of bitcoin with illicit activity and instead if you get an ETF with kind of the SEC stamp of approval on it, you know, I think that certainly in the broader public’s mindset that’s a positive shift.
I think that there’s also at least some level of risk if you’re hoping for bitcoin to be successful in the long term and just that an ETF could be very, very popular, a bitcoin ETF. Now that’s certainly not a reason to disapprove and I certainly hope the SEC does not make any decisions according to, you know, that particular metric. I mean, if so we would never approve things that the investing public wants. But you know, I think that a very significant sum of assets would likely flow into this ETF. I think it would be very difficult in that type of environment to source the underlying bitcoin without drastically pushing up price, and so I think that you know, we would have a very significant bull run if an ETF were approved, and again, I mean, that’s not necessarily bad for bitcoin but you know, too much too soon can certainly be a bit destabilizing. We saw that in the 2013 run and then the subsequent Mt. Gox implosion and you know, certainly an ETF could have a similar price action. I hope not.
Laura Shin:
But then wouldn’t that problem simply get worse if they waited longer to approve it, meaning you know, if they approved it now then that would be kind of the minimal amount of you know, disruption it would cause…
Spencer Bogart:
Right.
Laura Shin:
…whereas…
Daniel Masters:
I think that there’s another…
Spencer Bogart:
Yeah, there’s two…oh sorry, go ahead. Jump in, Daniel.
Daniel Masters:
Yeah. No, I just wanted to just chime in with one extra point as we’re talking about this before we move somewhere else, but I think you’ve got to look at for example one of the pivotal developments in the commodity ETF world which was the launch of GLD in 2000, the US gold ETF. I was very active in the gold market prior to that ETF and if you’d have told me that that ETF could grow to 80 billion dollars, which it did, I would have said the gold market couldn’t possibly sustain an ETF of that size.
But what happens in practice, and this is not just with GLD, it’s with USO and the natural gas ETF and some other metal ETFs, the fact is that these ETFs in some way create more liquidity in the market, and the gold market today, the underlying futures and cash market for gold is far more active than it was prior to the issue of the ETF, and indeed in terms of sourcing, then that gold ETF started from zero and peaked at around 14 hundred tons of gold, a number which I think back in the day, you know, and one percent of all gold in the world above ground, you know, you take out Central Bank reserves and country-wide reserves, it is actually a very significant number. You add to that some other ETFs in other locations, you can double or triple it.
That was a number that people didn’t really think could happen, so in some ways this has sort of become self fulfilling. The liquidity that people may be worried about isn’t there, actually becomes created when these instruments appear.
Laura Shin:
Spencer, I actually also wanted to bring up something that you had written about in your report which is that you estimated that 300 million dollars would flow into bitcoin in its first week if a bitcoin ETF were approved. How did you come up with that figure?
Spencer Bogart:
Yeah, sure, so I mean, it’s a ballpark figure. I mean, there’s no precise quantitative way to arrive at exactly what the assets would be, but I mean, what we did is we looked at some of the most successful ETF launches out there, so I think you know, for example to put it in perspective, I think GLD attracted somewhere in the order of 800 million dollars in its first week, something like 1.3 billion in its first month. I think EFA which is a developed market ex-US ETF also attracted something like 800 million also in its first week.
So I mean, this gives us some ballpark of what a highly successful ETF launch looks like, and then I think the next question you have to ask is why would you assume that a bitcoin ETF would be on the highly successful end of that spectrum, and I think the main reason is because it would be the first vehicle that is really widely available to institutional investors in the US. So again, we kind of did an overview of some of the vehicles that are available in the US today. It’s mostly a smattering of relatively small hedge funds, and then the bitcoin investment trust which trades on OTCQX as ticker GBTC and you know, that is the best vehicle that is available for institutional investors that need a US-listed product today.
But it’s not without its warts, right? I mean, this is a product that either you pay a 25 to 30 percent premium on if you want to buy it on the exchange, or if you had previously wanted to get into the private placement into the bitcoin investment trust was only available to accredited investors and came with a one-year lockup period. Now since the Bitcoin Investment Trust has filed for their S1, they’ve closed private placement and so you can no longer subscribe to the Bitcoin Investment Trust and your only option is to buy it on the exchange.
But so I mean, when we look at what does a full-fledged ETF looks like where the creation and redemption of shares is very fluid, I mean, again, that’s the first time that large sums of institutional capital could really flow into the space and I think that that asset gathering would really be aided by kind of a perfect storm for bitcoin, right? So we’d have this first kind of investable vehicle for many, and then again the things that I talked about before which is that perception would be improved, regulatory risk could be down, and price would be rallying, which is going to drive incremental news flow and a lot of additional interest in bitcoin.
So I think that it’s very easy to get to a 300 million dollar number within the first week. I mean, and we think that’s conservative.
Laura Shin:
So you mentioned the Grayscale filing and I actually just want to talk, you know, about pretty much all the other filings with the SEC for bitcoin ETFs because there’s also one by a blockchain company called SolidX, and so I just want to hear from you guys, you know, do you have any reason to believe that any of the other filings have a better chance with the SEC and just to generally sort of compare you know, these proposals?
Daniel Masters:
Yeah. I think the Winklevoss ETF is the best in class and that’s the bottom line. The SolidX S1 filing doesn’t defer…none of these filings differ meaningfully from each other, so happens the SolidX trust is a New York state trust as opposed to a Delaware trust, no big deal, but just like with the Winklevoss trust, you know, Bank of New York and as far as the S1 is currently constituted, Bank of New York is the trustee, the administrator, and the custodian, and there’s a comment there saying the sponsor will provide custody services related to the custody of trust bitcoin, so i.e., looks like SolidX have got their own custody solution, just the same way as the Winklevoss’s do, but I can guarantee you they don’t have the technical infrastructure that would match what the Winklevoss’s currently have.
With BIT, that’s a very interesting filing. The digital currency group who own Grayscale Investments, the sponsor, had some issues with the SEC back in July last year over the mechanics of distributing and marketing the shares in BIT. This filing will have, if it’s successful, the same effect as the other ones, is almost necessary because BIT’s been running into problems. You can read that filing, that was a judgement, a settlement between Grayscale and the SEC. It needs to do this in order to continue marketing units in BIT.
Once again, Bank of New York, trustee, agent, so a transfer agent of the trust and the administrator, and the custodian there is Xapo. Xapo is a great company, Wences Casares is a visionary in the bitcoin space. The custody solution there is not completely clear to me.
So you know, of these two other options, you know, BIT and SolidX, it would seem to me that not only is the Winklevoss trust definitely first to get to the decision line on March the 11th for better or for worse, I believe it’s a better product overall, and I would say that if it so happens that the SEC deny COIN, the Winklevoss ETF, I think there is zero prospect of the other ones happening _____ 00:44:32.
Laura Shin:
Spencer?
Spencer Bogart:
Yeah. I’m not sure that the odds are too different for any of the other filings other than the Winklevoss twins. Again, I think that the greater portion of concerns that the SEC might be considering are broader bitcoin related as opposed to something specific about the Winklevoss filing, but you know, when we really look at some of the differences between the filings, I mean, Daniel touched on custodian and that’s probably one of the most important factors there, of course, with SEC they’re going to be concerned is the bitcoin stored securely, but there are other factors that play here as well such as you know, what is the reference price for bitcoin?
So I mean, we talked about how the Winklevoss filing uses the Gemini spot price, so their own exchange there. The SolidX filing uses trade blocks XBX Index we referenced before. Again, that’s a volume-weighted index of US dollar denominated exchanges, and then there’s the Grayscale filing which uses the price from a particular exchange that they determine annually and review quarterly.
There’s been a couple other factors that could be important at play here as well and one of those is insurance. This comes up a lot in discussions that I have and generally the sentiment among people, at least when they’re first inquiring, is that because SolidX appears to have insurance on their filing that it might be more likely to get approved. I’m not sure that that’s really the case. I think that the first thing to note in regards to insurance here is that it’s my understanding that there is not an efficient market for insuring custodianship of bitcoin, and we’ve seen this with a few companies that used to prior have insurance on their holdings and have since removed that, principally because their insurers one, kept rationing up the price, and two, simultaneously decreasing the amount of coverage so the exact situations under which the insurance would kick in.
I think that at this point it’s extremely difficult for any actuary out there to price in every risk aspect in the storage of bitcoin. You know, I’m quite confident that, you know, that what the Winklevoss twins have proposed here is secure and is sound, but I think that it’s very difficult for an insurance company to be comfortable with that with, you know, potentially hundreds of millions of dollars at risk, and so both the Winklevoss filing and the Grayscale filing have chosen to not put insurance with that ETF.
The SolidX one does, but according to the filing at least, it only covers 10 million dollars. It might just be because you know, that’s relative to the initial filing amount which I believe the SolidX filing was only for a million dollars. But again, this really comes down to a cost benefit analysis of whether or not the insurance makes sense here and I’m just not convinced that there is actually an efficient market here.
A couple of the other factors, just differentiating between the ETFs are the exchange, of course, right? So the Winklevoss twins filing for the _____ 00:47:32 Exchange. The other two filings are both for the New York Stock Exchange, and then there’s a difference in the creation and redemption process, so this is how new shares of the ETF are either created or redeemed, and it’s that process that actually keeps the price of the ETF in line with the value of the underlying assets that it represents, so that’s very important to again keeping the price of the ETF from trading at a premium or a discount relative to its value, and in this case it appears that all of the filings allow for in kind creations and redemptions, which means that to create new shares you have to literally submit the underlying bitcoin, and when I say you I actually mean an authorized participant because these are special traders out in the market that help facilitate this creation and redemption process.
But one of the filings, SolidX, also appears to be filing to allow for cash creates and redeems which would mean that instead of submitting the underlying bitcoin they submit the equivalent in cash and then it is up to kind of a party associated with the ETF to actually source the underlying bitcoin. I mean, these are just some of the factors that could weigh here in the consideration.
Laura Shin:
Well, but for that last one, is the SolidX way of doing it better or worse than the others?
Spencer Bogart:
Yeah, that’s fair. I’m not sure that it really improves the odds at all, in fact I don’t think it does.
Laura Shin:
Okay. Well, so far all of our discussion has been around these bitcoin ETFs that are being proposed by specialized issuers. How do you think this would play out differently if traditional ETF issuers got involved?
Daniel Masters:
Well, I’ve had some experience with that, Laura, you know. In addition to the exchange trade instruments that we currently list, we are going to issue some more. There’s definitely demand here in Europe amongst clients that we know and understand to take that further and to penetrate other regulatory pockets if you like, the _____ 00:49:39 market, the European market, even the Asian market, you know, Korea, Japan, there’s definitely strong interest to get access to these kind of products.
So you know, the question you’re asking, you know, where does that leave traditional ETF players? Now, you know, we can raffle through the names, I think they’re probably well known. Most of these companies that run ETFs run multiple ETFs, sometimes hundreds of them and you know, the bigger houses will have any number of offerings in different currencies to all different kinds of investors.
The issue is this. This is a ground-breaking product without a doubt. There is risk associated with it. I believe it offers investors something they really want and I think that there are risks involved that they’re prepared to take but are mitigated in a really solid way. That being said, if you think about a legacy player in the ETF space, why would you for the sake of one more ETF out of the sake of 200 ETFs choose one that had you know, lots of associated reputational risk, regulatory risk, even risk of potential, you know, hacking or something nasty like that, just to get one-two hundredth of your fee base on top? You know, you could really sort of potentially besmirch the reputation of a company and that’s why I think that, you know, legacy _____ 00:51:01 in the ETF space have to date not been interested in doing this.
Laura Shin:
Spencer, what about you?
Spencer Bogart:
Yeah, I really agree. I think that the large ETF issuers out there will kind of play a wait and see game, even if an ETF is approved for a while afterward. I think they’ll watch and see how successful is the ETF, you know, how much is this worth kind of our time and reputational risk here getting associated with bitcoin, you know, presuming that significant sum of assets flows in and it’s worth kind of the additional fee revenue.
I wouldn’t be surprised to see the traditional ETF issuers call the BlackRock or Vanguard or both of them kind of move into the space, and really when it comes down to it the ETF space is really a game of scale so when you have multiple ETFs that are out there that provide extremely similar coverage, it really comes down to the fees associated with it and how liquid the fund is, so you know, I could see like a BlackRock kind of coming out a while after a specialized issuer has a fund and after they’ve seen it, have success with gathering assets, and offer a fund at kind of a fraction of the price and just slowly over time kind of bleed away those assets into their own ETF.
Laura Shin:
Okay, great. Well, this has been such a fascinating discussion. Thank you both so much for coming on the show. Can you each tell me where people can learn more about your work and also get in touch with you?
Daniel Masters:
Sure. In my case our products are available on xbtprovider.com and that’s for our NASDAQ listings, and globaladvisors.co.uk, and that’s our private fund.
Laura Shin:
Spencer?
Spencer Bogart:
Yeah, most of our research, you can always access if you email me at Sbogart@needhamco.com. We can’t publically post that on a website or anything but feel free to shoot me an email and I’m happy to chat a little bit more.
Laura Shin:
Okay. Well, thank you both so much.
Daniel Masters:
You’re welcome, Laura.
Spencer Bogart:
Thank you for having us.
Laura Shin:
Thanks for joining us today. If you’re interested in learning more about Daniel and Spencer, check out the show notes which are available on my Forbes page, forbes.com/sites/laurashin. Thanks so much for tuning in, and check back in two weeks for the next episode, and if you enjoyed this discussion with Daniel and Spencer please review, rate, and subscribe to it in iTunes or your preferred platform. Thanks again for listening.
