by Maya Ortiz de Montellano, CFA, Senior Investment Analyst
Reading: Wells fargo bitcoin
- The digital asset ecosystem has made several quantum leaps since bitcoin’s inception in 2009, and the cryptocurrency is now widely regarded as a viable investable asset. new utilities associated with the technology have been discovered, the global cryptocurrency market capitalization has soared, and there have been marked changes in the quality of digital asset offerings and institutional participation.
- this thematic report is endeavors to first discuss the essential factors that investors should contemplate when seeking exposure to cryptocurrencies. it will then explore the various entities through which institutional investors can gain access to digital assets, while also highlighting the main differentiators and drawbacks of each method.
- without an exchange-traded fund ( etf) us approved uu. Securities and Exchange Commission (SEC), investors seeking exposure to digital assets can make a direct purchase through a crypto exchange or gain indirect access through mutual fund derivatives, a grantor trust, or placement fund private.
main investment criteria
When weighing whether to make a bitcoin investment directly or through a registered fund that uses derivatives such as futures, a grantor trust, or a private placement vehicle, investors should keep a few considerations in mind:
- ability to closely follow the price of the underlying asset
- impact of the premium/discount on the investment result
- protection against hacking/cyber theft
- fees and operating expenses
investment offers in digital assets
This segment of the report aims to analyze the various institutional cryptocurrency products mentioned above, with an emphasis on the first four main criteria for investment. liquidity, the fifth key component when evaluating such vehicles, will be compared between the different methods in the next section.
Coinbase’s direct listing in April represented the first time a digital exchange went public in the US. uu. its market cap, currently over $59 billion (as of 9/30/2021), underscores the disruptive potential of such platforms and illustrates investor appetite for the space. investing directly in bitcoin through cryptocurrency exchanges provides investors with the purest form of ownership among the aforementioned mechanisms.
however, it also presents numerous potential risks. such exchanges have proven to be vulnerable to hacking and cyber theft. For example, between 2011 and 2014, 650,000 bitcoins were stolen from mt. gox, a Japanese cryptocurrency exchange that was then the largest in the world. More recently, hackers were able to withdraw more than 7,000 bitcoins from Binance, currently the world’s largest cryptocurrency exchange. Such attacks highlight the importance of cold storage, discussed later in the report, and the susceptibility of digital exchanges to breaches.
Even when digital exchanges successfully evade attacks, investors can lose access to their cryptocurrencies if they do not properly store or remember the public and private keys associated with their wallet. given the decentralized nature of the platforms and their cryptographic security features, password recovery infrastructure is often not feasible. According to the New York Times, around 20% of the existing bitcoin supply appears to have been lost or stranded in wallets. To further exacerbate this risk, many platforms have very limited or nonexistent customer service capabilities, delaying responses in the event of a crisis. For example, the Federal Trade Commission and the Bureau of Consumer Financial Protection have received 11,000 customer complaints against Coinbase since 2016, most of which relate to customer service.
Finally, these platforms have substantial frictional costs associated with transactions and transferring assets.
mutual funds, grantor trusts and private placement funds are vehicles through which investors can indirectly access the digital asset sphere. while certain attributes differ significantly between the approaches, there are also some commonalities. in particular, each structure seems to solve most of the accessibility-related problems that are present in digital wallets: individual investors do not need to manage public and private keys. furthermore, the mechanisms are familiar to most investors, do not require the creation of an additional wallet, and tend to have broader customer service capabilities. these factors have the potential to allay many of the initial fears people have when considering an allocation to this new asset class.
liquidity… it depends.
If the definition of a liquid asset is that it can be easily converted to cash in a short period of time, research from global managers would suggest that bitcoin falls into the relatively liquid category. Bitcoin transactions through digital exchanges can be executed in a constantly trading market, while mutual funds are open vehicles. however, foreign exchange markets remain fragmented and can make accurate pricing difficult. Additionally, there are concerns about the depth and reliability of BTC futures, the products used by mutual funds. Next, indirect investments in cryptocurrencies through grantor trusts and private placement funds typically have restrictions around redemptions and subscriptions. Ultimately, more liquid markets may come at the cost of poor price accuracy and transparency. By contrast, private placement funds face liquidity constraints that prevent continuous trading in and out of the underlying assets.
rapidly evolving landscape
Looking ahead, Global Managers Research expects that cryptocurrency assets will no longer be the domain of technologists, with the number of investment offerings on the rise, including passive and actively managed options. the floodgate for this will likely require further development of a regulatory framework coming from the us. uu. regulators and increased cooperation among industry participants. With that view, a bitcoin etf is inevitable, in our opinion, but the timing is highly uncertain. Absent changes to the current Internal Revenue Service (IRS) tax guidance, we hope to eventually see a path to transition interest from a private placement fund to an ETF in a tax-efficient manner.
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