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Bitcoin Investments: Institutional Investors stepping up, while small funds double down

Bitcoin has excelled as means of exchange and is slowly developing the characteristics of mainstream currencies.  But for it to go the distance, what Bitcoin would require is the backing of the institutional investors. The trends in Bitcoin investment can be analyzed from the direction of the flow of funds into the currency. The volumes of Bitcoin trading are increasing everyday and have been on continues uptrend. The volumes have gone up significantly in the face of global financial crises showing the growing faith in the currency. Let’s look into how various investment groups are adopting Bitcoin and how the investment trends have been:

Hedge funds leading in Bitcoin:

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Bitcoin has a total invested market of around $ 6.4 Billion. Majority of these investments (>50%) are held by near institutional funds at hedge funds and family offices. The largest fund holder to hold Bitcoin is the Panthera Bitcoin Fund with estimated holding of $ 160 million. The California based hedge fund founded in 2013 by Dan Morehead, is available to individuals with $50,000 or more to invest. A fund brochure indicates when the fund launched in July 2013, bitcoin BTC=BTSP traded at around $65. On Thursday, it traded at $418.80, marking a gain of more than 500 percent from July 2013.

Other Top Holders:

The Grayscale Bitcoin Investment Trust (GBTC) is the only publicly-traded U.S. security in the over-the-counter market invested in the cryptocurrency. It has assets of more than $60 million invested in cryptocurrency holdings with more than a 1000 shares trading daily.

The trust holders have certified that adding Bitcoin to their portfolio has improved fund performance significantly. Ledra capital specializes in allocating Bitcoin to the portfolio of the clients within the ranges of 1 to 3 percent. ARK Invest in New York holds GBTC in its $12 million Next Generation Internet ETF and the $7 million ARK Innovation ETF. The company manages four exchange-traded funds with $240 million in assets.

Results of the ETFs:

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It is estimated that GBTC has delivered 67 basis points to Next Generation Internet ETF’s return and 62 points to the ARK Innovation ETF since September 2015. Next Generation ETF experienced a 15.29 percent return in 2015 while the Innovation ETF posted a 3.76 percent gain. GBTC has been a great diversifier since it has had a low correlation with other asset classes. Kingsbridge Wealth has invested about $1.7 million in bitcoin and the blockchain and has been using GBTC as diversifier.

Why to Think Twice About Investing in Bitcoin ETFs

What are ETFs?

An ETF is a type of fund, traded on stock exchanges, that hold assets tracking the value of an index.  Authorized participants, which are generally large financial institutions, buy and sell large creation units of the ETF to break up and distribute in smaller quantities.  ETFs were created in 1993 as a tool for investors to track the value of market sectors, niches, and trading strategies.  

Why ETFs? Why Bitcoin?

ETFs can help reduce costs, improve liquidity, strategize against capital gains taxes,  diversify portfolios, and improve transparency for investors.

Financial professionals are racing to be first to market with an ETF for emerging market sectors.  Bitcoin has grown to the point of receiving this attention.  Leading the charge are the Winklevoss brothers, who introduced Bitcoin ETFs to the SEC in 2014.  If readers are interested in the prospectus, it’s available on the SEC website.

Drawbacks of a Bitcoin ETF

Although the benefits of ETFs have contributed to their rising popularity, ETFs have drawbacks that can be exaggerated in their developmental stages.  In 2011, Fidelity published a piece on the drawbacks of ETFs.  Of those that Fidelity listed, buying high and selling low, management fee creep, and tracking error seem as though they could be particularly pronounced when evaluating a Bitcoin ETF.

shutterstock_280312850Buying high and selling low describes the spread between bid and asking prices for ETFs.  If this spread is
high, the cost of purchasing (or the benefit of selling) may not accurately reflect the value of the ETF.  In an ETF with few transactions, it’s likely that the spread will be greater than in an ETF with regular, or practically constant transactions as the curve of people’s willingness to sell/buy will be smoother.

Management fee creep describes the administrative costs of ETFs.  In a developing fund, the costs of marketing could be reflected in the management fees.  Given the uncertainty and slow adoption of Bitcoin across traditional financial markets, marketing costs could be higher for a Bitcoin fund.

Tracking error describes the deviations in a fund’s investment performance from the index that it tracks.  Given the volatility of Bitcoin, it could prove difficult to accurately align with the indexes of choice.  This can be a cost to investors.

Broader Implications for Bitcoin

If the Winklevoss Bitcoin ETF is approved, it would signal faith in Bitcoin from the U.S. federal government.  This faith could improve investor confidence and the value of Bitcoin itself.  As a byproduct of a legitimizing a cryptocurrency investment vehicle, Bitcoin investment would likely be subject to a greater degree of scrutiny from the federal government and regulatory agencies.  This could incentivize greater transparency for other methods of Bitcoin investment, improving access to the Bitcoin market.