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The Cointucky Derby Begins!

January 10, 2024

The Starting Gate

In the world of finance, we are witnessing the start of a thrilling race – a race that is reminiscent of the prestigious Kentucky Derby, but with a digital twist. Welcome to what the cryptocurrency community is calling The Cointucky Derby, where the starting gates are filled with well-known asset managers launching spot Bitcoin ETFs. The race got off to a bit of a false start on Tuesday, as the X account @SECGov tweeted out approval of all the ETFs, while SEC chair Gary Gensler quickly followed up to inform everyone that the account was compromised, and no formal approval had been granted. The following day (today), the SEC officially approved the ETFs. 

Spot Bitcoin ETFs, as opposed to futures-based ETFs, track the actual price movements of Bitcoin itself. In simple terms, they hold the physical cryptocurrency rather than derivative futures contracts. Futures-based ETFs offer a way for traditional investors to dip their toes into the cryptocurrency market, they come with some inherent inefficiencies compared to spot ETFs. Futures-based ETFs for Bitcoin were first approved in 2021, and the SEC has just today reluctantly approved spot ETFs, which they had been opposed to doing, until a court ruling forced them to treat futures and spot ETFs the same. Spot ETFs are more efficient because as new shares are created, Bitcoins are purchased for the fund, which increases the buy pressure and tracks the performance of Bitcoin in a much tighter manner. This subtle, yet significant difference, has sparked considerable interest among investors looking for a more direct and authentic connection to the world of cryptocurrencies.  

Another popular option for cryptocurrency exposure has been the cryptocurrency trusts through Grayscale Investments. All the way back in 2013, Grayscale introduced Closed End Funds as an early attempt to provide exposure to digital assets. However, these funds have faced challenges, including persistent discounts and premiums to the net asset value (NAV). Investors often found themselves trapped with inefficiencies, as they do not have a way to redeem the shares for their underlying crypto, which is the key factor that allows an ordinary ETF to trade at its NAV. The crypto community has likened this to Hotel California, as coins were able to come in, but they could never leave. In other words, if you were a buyer of this fund, you would have to essentially be right on two things: 1.) buying at the right time in the crypto market cycle, and 2.) buying at the right time in the discount/premium cycle. This, along with the burden of high annual costs associated with Grayscale's products, makes them a very difficult product to own. That said, Grayscale is amongst the horses in this race, so assuming they convert to an ETF, the premium/discount issue should be resolved, as the ETF will return to trading close to NAV.

The Jockeys

The Contenders are as follows: BlackRock, Fidelity, Ark Invest, VanEck, Bitwise, Invesco, Franklin Templeton, Valkyrie, Hashdex, and Grayscale. 

The Cointucky Derby is certainly not short of star-studded contenders. Leading the pack is BlackRock, the world's largest asset manager, signaling a significant institutional embrace of the cryptocurrency market. If we were setting the betting lines, we would have them as the odds-on favorite to attract the most capital. Fidelity would be a close second, as they are the only firm that will handle the custodianship of the Bitcoin themselves (8 of the 11 are using Coinbase as custodian).  

Track Conditions

This may be just a matter of dumb luck, or perhaps some foresight on the end of ETF filers and the SEC. We’ve seen various bad actors reprimanded such as FTX, Three Arrows Capital, Celsius, and Binance. When the SEC chair, Gary Gensler, said the cryptocurrency community is “rife with fraud and scams” he was certainly not wrong. But alas, with those market manipulators out of the way, the cryptocurrency market is without a doubt, much healthier. On top of that, the Bitcoin halving is approaching, which happens once every four years in Bitcoin world and has had a strong correlation with the start of bull markets. The halving is simply a 50% reduction in block rewards for miners. One of the key reasons investors expect these events to lead to price increases in Bitcoin is because these miners typically convert their BTC rewards from mining to cash to cover their mining cost. When the halving occurs, these miners essentially get paid less Bitcoin, which in turn, means there should be less selling pressure. 

Cracking the Whip

We’ve already seen a fee compression battle, as these managers are racing to the bottom of who can offer the lowest fees. Fidelity, Ark Invest, BlackRock, and Invesco have slashed their fees from where they initially filed. Several of the managers have even waived their expense ratios for the first 6 months, to try to attract more capital. Bitwise comes in with the lowest fee of 0.2%, while Grayscale is the highest, at 1.5%. Grayscale has the benefit of having a head start in the race as they have roughly $27 billion Bitcoin in their fund as it stands today. 

(credit to @JSeyff on X - https://twitter.com/JSeyff/status/1745067027381780709/photo/1

As the race progresses, we expect to hear a lot of noise as we will likely have hundreds of millions of marketing dollars promoting them. We’ll see Larry Fink of BlackRock and Cathie Wood of Ark Invest making the rounds. We’ll see outlandish price targets while others call Bitcoin a fraud. We’ll see endless commercials that you can’t seem to get away from. And I’d bet good money we’ll even see a Superbowl commercial from one of these players. But just because you see all of this hype, does not make an investment in cryptocurrency right for you. Which leads us to the ultimate question... 

Should I Have a Horse in the Race?

These new entrants promise to offer a direct path to cryptocurrency ownership, eliminating some of the challenges faced by previous investment vehicles. The market is abuzz with speculation on how these ETFs will impact the broader crypto landscape and whether they will pave the way for greater institutional adoption. As an investment advisor who focuses on retirement planning, we have no horse in this race, but I am fascinated to see how it plays out. 

Remember, Bitcoin and other cryptocurrencies are off-the-chart risky. I mean this literally, see the chart below: 

(credit to @TimmerFidelity on X - https://x.com/TimmerFidelity/status/1720157959336919072?s=20

As you can see, over the past three years, Bitcoin has offered nearly 3x the returns of the S&P 500, with over 3x the volatility. The volatility is unlike anything we’ve ever seen before. In a retirement plan, generally we’d say having some equity risk exposure is enough. But, if your appetite calls for it, the outperformance has certainly justified the stomach-wrenching volatility for a potential minimal slice of your portfolio. This is an entirely new asset class, that’s what is so exciting about it, but that will also make financial advisors across the country hesitant to recommend it. Remember, Bitcoin is just 15 years old, it’s just a teenager and there are still a lot of unknowns: 

  • How fast will institutional adoption come? 
  • Can Bitcoin scale? 
  • Can the Bitcoin network generate enough fee revenue to offset declining miner revenues? 
  • Will more companies begin using Bitcoin as a store of value, similar to Microstrategy, when the FASB accounting changes go into effect at the end of 2024? 

In conclusion, the Cointucky Derby marks a significant moment in the evolution of cryptocurrency investments. With the arrival of spot Bitcoin ETFs from major financial players, the race for mainstream acceptance and integration has entered a new and exciting phase. As the contenders thunder down the track, investors eagerly await the outcome, hopeful that the finish line will bring a more accessible, efficient, and inclusive era for crypto enthusiasts around the world. I encourage you to talk to your financial advisor to determine if these vehicles are right for you.