✌️ Welcome to the latest issue of The Informationist, the newsletter that makes you smarter in just a few minutes each week.
🙌 The Informationist takes one current event or complicated concept and simplifies it for you in bullet points and easy to understand text.
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- What’s an Index Mutual Fund?
- What’s an Index ETF?
- Spot ETFs and Futures ETFs are not equal!
- Then what’s the GBTC Trust?
- Why do investors want a Bitcoin spot ETF?
💥Grayscale has launched a campaign urging investors to push the SEC to approve a spot #Bitcoin ETF.
The time has come! 💪
— Bitcoin Archive 🗄🚀🌔 (@BTC_Archive) February 22, 2022
With the SEC having denied approval for all Bitcoin spot ETFs to date, some people see the conversion of Grayscale’s GBTC Bitcoin Trust into an ETF as investors’ best near-term chance of getting a Bitcoin spot ETF.
If none of that makes sense to you, don’t worry, we’ll get you all sorted below.
📈 What’s an Index Mutual Fund?
To understand what an index mutual fund is, you first have to understand what an index is, and contrary to popular belief, an index is not an average of an entire market. For instance, the S&P 500 Index is a collection of 500 of mainly the largest companies listed on US stock exchanges, selected by Standard and Poor’s to be most representative of the US stock markets as a whole.
An index mutual fund is exactly what it sounds like, a mutual fund that owns the securities of an index. The manager of the fund (an automated computer program, these days) will ensure the holdings are appropriately weighted to ensure the fund properly tracks the index it is emulating.
One key characteristics of an index mutual fund is the fund’s Net Asset Value (NAV) is calculated daily, and so investors can only buy or sell at the close of the market each day.
📌 What’s an Index ETF?
Not too different from an index mutual fund, an index ETF also seeks to track the performance of the index it is emulating by owning the appropriately weighted holdings of the index. One of the most recognizable of these is the SPY, an S&P 500 ETF, known as “spiders”.
That said, an ETF is a security listed on an exchange, and so the price will fluctuate throughout the day, according to the performance of the underlying index, and investors can buy or sell throughout the day as they wish. This can be helpful for investors seeking to capitalize on market moves without needing to wait for the close of the market to make a trade.
Also, because ETFs are listed securities, they can be borrowed and hence, shorted. This is the key reason that index ETFs are a favorite tool for investors to use when seeking to hedge out beta risk.
If you need a primer on beta, The Informationist newsletter covered that here: The Difference Between Correlation & Beta
And that brings us to the next section, as all ETFs are not made equal, especially when shorting is considered…
⚖️ Spot ETFs and Futures ETFs are not equal!
As you may already know, while there are currently a handful of Bitcoin futures ETFs available and trading, we are still waiting for the SEC to approve the spot version of a Bitcoin ETF. To note, there are various Bitcoin spot ETFs that trade outside of the US, such as the Fidelity Bitcoin Spot ETF in Canada.
But an ETF is an ETF, right? After all, they are both seeking to track the price of the underlying asset or assets, so what’s the difference?
Turns out, the difference, while seemingly simple, is quite significant.
See, a spot ETF (as shown in the above example of the SPY ETF version the S&P 500) actually owns the underlying asset it is seeking to emulate. In the case of the Bitcoin ETF, the manager would actually buy and sell BTC, according to inflows and outflows of capital, and maintain the storage and keys of the underlying BTC thereafter.
A futures ETF, however, owns no assets other than paper futures (contracts to buy and sell BTC at a given price on a future date). Because futures contracts expire at the end of each month, a futures ETF like Valkyrie’s BITO must sell its position before expiration and then purchase contracts for the next month. As a result, the price of the underlying asset, BTC here, can be much different than the futures contracts that are trading, and the buying and selling of the contracts can be costly (estimated at ~10% annual currently).
Most importantly from all this, because institutional investors understand the poor price tracking and expensive proxy for actual Bitcoin, they are reluctant to use a BTC futures ETF to gain exposure to Bitcoin. Rather, the futures ETF has become a way for institutions to short exposure to Bitcoin in an, albeit sloppy and inefficient, attempt to hedge out volatility in their portfolio instead.
🔐 Then what’s the GBTC Trust?
In simple terms, Grayscale launched the Bitcoin Investment Trust (BIT) to accredited investors. The trust itself owns Bitcoin. An accredited investor can buy shares of the trust in daily private placements. After a 6-month lockup period, the investor can then sell their shares in the form of GBTC on the secondary market to retail investors.
You see the problem, right? The 6-month lockup means there is a disconnect between price and liquidity. For this reason, GBTC is a poor proxy for actual Bitcoin.
This is a main reason that Grayscale is seeking to convert the trust into an ETF. The thinking is that the disparity between GBTC and the Bitcoin price will collapse as GBTC would become an efficient way to own BTC. One thing that is unclear though, is the amount of immediate liquidity current holders of BIT (the underlying trust), who have been locked up, would be seeking. And hence, would the GBTC form of an ETF have an immediate and sharp selloff before it eventually finds parity?
This is something to be aware of, and I would personally study before buying GBTC on the premise that it will collapse to parity if GBTC is approved to convert to a spot BTC ETF.
🤩 Why do investors want a Bitcoin spot ETF?
As we saw above, institutions are not overly excited about owning a futures ETF for Bitcoin exposure. So, then why don’t they just buy actual Bitcoin themselves? It sounds obvious and simple, except it is truly far more complicated for institutions to own Bitcoin than individuals. This primarily has to do with internal policies, investment mandates, regulatory and compliance issues, as well as logistics such as settlement, pricing, and custody of an asset like Bitcoin.
This is not to say institutions like hedge funds, pension funds and endowments are not actively working toward solutions, but individual Registered Investment Advisors (RIAs) and smaller family offices will simply not have the comfort and/or capability to own Bitcoin outright for quite some time.
Bottom line, many institutions are just waiting for an SEC-approved US-based spot ETF to gain their exposure to Bitcoin.
For more on the specific challenges for institutions, I wrote a simple but information-packed thread on that:
Why it is taking so long for Institutional Investors to buy $BTC?
Answer: Institutional Alice (IA) must venture down the crypto Rabbit Hole[🧵👇]
— James Lavish (@jameslavish) September 14, 2021
That’s it. I hope you feel a little bit smarter knowing about indexes, ETFs and their roles in Bitcoin ownership, and have a good understanding how they work and trade.
As always, feel free to respond to this newsletter with questions or future topics of interest!