Independent, Fee-Only Financial Advisor

Independent, Fee-Only Financial Advisor

Friday, November 19, 2021

How and WHY are you buying Bitcoin?

Recently, a Bitcoin Futures ETF has been approved for trading on US stock markets. This represents just another way that you can get exposure to the price movement of Bitcoin as a US investor. Here are just a few:

The first and most "pure" way to access Bitcoin is to own and hold it directly. You can purchase through an exchange, like Coinbase or Gemini, who will hold it in an account, or "hot wallet." This wallet has a unique "address" and a private key which only you know. While anyone can see your address (so that they can send you more Bitcoin!) your private key is what makes it yours only. Keeping it in the hot wallet on an exchange is simplest, and most familiar to those who now brokerage accounts already. This is a little different from the "cold wallets" discussed later.

Maintaining a wallet can be difficult for some. As this is a new technology, most people will likely need a good bit of help getting started on this sort of system. Interacting with the broader crypto-economy will likely have more steps and complications than other methods. Much like buying stock directly from a transfer agent, you have direct ownership, but less convenience than using a broker.

A crypto broker or exchange will allow you to hold crypto in an account that they secure and monitor. This typically offers convenience and features that are not available for a wallet. Much like having a stock brokerage account, you can view your holdings in one place, buy, sell and transfer with ease. There are even regular stock custodians like Interactive Brokers or Robinhood that allow you to trade some crypto within a traditional stock brokerage account.

Stepping away from the actual coins, there are several ways to get exposure to the price swings of bitcoin without actually holding the coins yourself.

The new ETF from ProShares, BITO, tracks Bitcoin futures. Futures are contracts to buy a commodity, in this case, a digital commodity, at a later date. If a contract is only a few days or weeks away, the value of the contract will generally be very close to the value of the underlying commodity. This can be a way to get the same general exposure, but it isn't perfect. As new contracts are purchased, there will often be price discrepancies due to the dates of the contracts maturity, regulatory issues or supply and demand.

For short term trades, this is probably an acceptable way to get exposure to bitcoin price changes. Over time, however, the price discrepancies can add up to significant slippage.

In the US, there are no ETFs or Mutual Funds that own Bitcoin directly - yet. There is, however, a trust that trades over the counter that almost anyone can buy called the Grayscale Bitcoin Trust, ticker GBTC. Since the trust holds nothing but Bitcoin, the underlying value will accurately reflect the value of Bitcoin, less a fee. However, since the trust trades freely with no arbitrage mechanism, it can trade at a significant premium or discount to the value. As I write this, for example, Bitcoin trades at $60,264 and there are 0.00093361 Bitcoin per share of the trust. This implies a trust value of $56.26, yet it last traded at $47.07 - a discount of over 16%! While this means that you can buy Bitcoin on the cheap right now, there is no promise that you will ever be able to sell the trust for 100% of its value. Grayscale offers a series of trusts like this that offer exposure to many aspects of the crypto economy!

Another similar fund is the Bitwise Crypto "index fund" BITW. Accredited investors can buy this at intervals directly from Bitwise, allowing them to buy

Why can't Americans have a Bitcoin ETF - after all, Canadians have one! Each ETF has to be approved by the SEC, while I do not know their thinking, I suspect that the reliability of pricing and trading is a top concern, as ETFs must have an arbitrage mechanism to keep their price close to their value. As evidenced by the wild swings in the premium or discount of the existing funds, this may be a top concern.

We can step away from trying to get direct exposure to the price of the coin, and try to profit from the growing crypto economy instead. There are many companies that participate in mining, trading or using bitcoin in some way. You can even buy ETFs that specifically look for those companies. The idea is that as bitcoin becomes more important and more widely used, these companies should profit from that increased activity. There are even major companies like Square, PayPal or Robinhood that let users hold and trade Bitcoin. While they profit from other lines of business, they certainly are exposed to the crypto-economy.

Lastly, I would be remiss to not bring up the company Microstrategy, Ticker MSTR. This is a software and technology company that started buying Bitcoin to hold on their balance sheet. They currently have about $7 Billion of Bitcoin and the entire company is with $8 Billion. They still do carry on with their normal business and they have debt on the balance sheet, but there is interesting exposure to Bitcoin nonetheless.

Mechanically, the steps that you take to invest in bitcoin are still a little less familiar than investing in stocks. Some of this complexity may remain a feature of the crypto-economy as security and self-custody remain fundamental aspects of Bitcoin. Some of that will change, but just like investing in stocks, there will be many ways to gain exposure to the price movements of Bitcoin.

Importantly, if you want to invest in Bitcoin, you have to consider why, and what the best way to gain that exposure is. For instance, if you want to trade the price swings, the new Futures ETF may work well within your current trading account. If you believe in the long term transformational power of Bitcoin, maybe a self-custodied, cold wallet is most appropriate. Popular cold wallets like Tenor or Ledger keep your coins out of your "hot" exchange wallet for more security. If you think that the crypto economy will keep growing, but don't know what coin will be best, there are funds of crypto-adjacent companies you can invest in.

Bitcoin, the broader crypto-economy and it's derivatives are very new and changing very rapidly. Nothing in this post is or should be construed as a recommendation to purchase or invest in bitcoin or any related investments. If you have independently arrived at the conclusion that crypto investments are aligned with your values and goals, this may be a useful guide for determining how exactly to make that investment.