21Shares Research Newsletter - Issue 58

Market Outlook

While Europe has the benefit of having professional-grade products for investing and getting exposure to cryptoassets — namely 21Shares’ suite of exchange-traded products (ETPs). The situation in the United States is starkly different.

For several years, there have been sustained efforts by the likes of Bitwise and Gemini to launch a Bitcoin exchange-traded fund (ETF) in the United States to no avail. In the absence of any ETP or ETF option for investors to get exposure to Bitcoin, an alternative but inferior product by Grayscale Investments has come to prominence within the US. However, as we will explain today, investors are getting ripped off due to issues with its structure and a lack of understanding from those who have bought it. Retail investors who buy Bitcoin or Ether through Grayscale's investment trusts are paying a lot more to get exposure to the assets compared to what they would be paying if they had access to ETPs such as ours.

The two products in question are the Grayscale Bitcoin Trust (GBTC) and the Grayscale Ethereum Trust (ETHE) which, between them, have accrued around $3.85B in AUM. It’s important to note that neither product is an ETF nor an ETP but instead a private, open-ended trust.

Institutional and accredited investors are able to create new shares of the product in two ways. Firstly, at the defined Net Asset Value (NAV) with a $50,000 minimum investment — during a periodic private placement round — which is used to buy Bitcoin, if the creation happens, with US dollars. While the second way lets investors create new shares in-kind at NAV using an investor's existing Bitcoin holdings. These shares are then ‘locked’ with the investor for typically 1 year before they are able to sell their shares on OTC markets. This time period has recently been reduced to six months for Grayscale’s Bitcoin Trust following the news that it had become an SEC reporting company. However, such a reduction is also contingent on “the other requirements under Rule 144 of the Securities Act of 1933, as amended (the “Securities Act”) [being] satisfied”.

Importantly, these shares cannot be redeemed for the underlying Bitcoin at any point. The source of the issue with Grayscale’s products, when compared to ETPs or ETFs, is the lack of the create/redeem functionality. As many will know with our exchange traded products, we are able to keep the price of the 21Shares Bitcoin ETP (ABTC) close to its NAV thanks to the presence of our independent market makers (or authorized participants) Flow Traders and Jane Street who create and redeem ETP shares if they are at a premium or discount to NAV.

Grayscale’s investment trust cannot be redeemed and therefore pure arbitrage is not possible on them. This is what has led to, at times, huge premiums on both GBTC and ETHE which are paid by retail investors who cannot create shares at NAV and can only buy on the open market.

The premiums for GBTC have reached as high as 43.21% historically with a mean of 23.75% and the premium for ETHE has reached as high as 2,022.19% with a mean of 247.61% — using data from June 20, 2019 to yesterday. The chart below compares the premium/discount for GBTC with the 21Shares Bitcoin ETP — the difference is staggering.

One can understand the difference between the benefits of such an investment trust and an ETP when we look at the premium/discount on Grayscale’s Ethereum Trust (ETHE) compared to the 21Shares Ethereum ETP (AETH).

Both ABTC and AETH have historically traded as a slight discount to NAV — -0.21% and 0.20% — at much lower magnitudes than the premiums of GBTC and ETHE — 23.75% and 247.61%.

While the premiums for GBTC and ETHE have typically been understood as a good thing for the industry as they ostensibly signal institutional demand, this is simply not the case. Rather the premium is simply a function of the lack of redemption mechanism and the poor education about it among the retail investors who likely make up a great deal of demand for the product on secondary markets.

Given the premium of these products, it is unlikely that savvy or institutional investors are buying these products on the secondary market. Rather, it is likely the case that retail investors are buying the products in order to get exposure to Bitcoin through their brokerage accounts or 401Ks and the institutional and accredited investors that create GBTC are able to resell at large markups.

As we can see, creations of Grayscale’s products are mostly driven by institutional investors according to Grayscale. Given this fact, it’s likely that some of the inflows into Grayscale’s products are both a view on the premium — as investors can then sell at a premium on OTC markets after their lockup — and a way to benefit from some of the tax advantages, given that the products can be held in IRAs and 401ks.

However, the vast majority of inflows into Grayscale’s products are in-kind which means that existing Bitcoin holders are creating shares using their own holdings to take advantage of the premium and tax advantages. Only between 20-30% of inflows are cash-based, which are then used to buy cryptoassets such as Bitcoin from the market.

While Grayscale’s products do seem to be a driver of retail interest in Bitcoin and other assets, the structure allows institutional investors to lock-up their existing holdings and see tax benefits when they then sell at a premium. While this may be good for investors who can benefit from trading the premium, retail investors are losing out and it is obvious that such a situation is less than ideal. Key to fixing such issues is the availability of exchange-traded products for cryptoassets in the United States with a create/redeem functionality — the likes of which are available to investors across Europe currently with 21Shares.

We can view shares in Grayscale’s Bitcoin product, for an institutional investor, as a call option on a Bitcoin ETP or ETF not being approved in the United States. As such, growth in these products can be quite decoupled from the actual fundamental institutional interest in Bitcoin. Institutional investors obviously are taking a view on the long term existence of the premium rather than necessarily on the long term price of Bitcoin.

The market had a noticeably quiet week, following the month of May which saw an extended period of volatility following the Halving, as the crypto asset market continue to decouple from wider capital markets once again — BTC (2.70%), ETH (3.70%), XRP (0.691%), BCH (1.60%), and BSV (-2.03%).

The Adoption Life Cycle of Bitcoin

For those of you who have not had a chance to listen to our researcher Eliezer Ndinga’s breakdown of Bitcoin’s adoption lifecycle, have a listen here!

News - 66% of Coinbase Users Would Delete Their Account | Bitcoin.com

What Happened?

Last week, the renowned crypto exchange, Coinbase, shook up the community as The Block reported that the exchange would sell its Blockchain Analytics software to US government agencies — the U.S. Drug Enforcement Administration (DEA) and the Internal Revenue Service (IRS). The news has raised privacy concerns for crypto investors and traders that use Coinbase. A poll was carried out on Twitter to quantify the market sentiment towards Coinbase’s company-wide decision. The poll gathered more than 5,000 responses and, unsurprisingly, 65% of the respondents said they would be willing to delete or stop using Coinbase services while the remaining 33% confessed they would keep their Coinbase account active.

Why Does It Matter?

The results of this poll are an expression of the general market sentiment towards Coinbase and, as a result, paves the way for other service providers to better serve these users. In fact, earlier last week, infamous essayist, scholar and mathematical statistician - Nassim Taleb publicly expressed his frustration due to the inefficient and non-responsive customer support of the exchange after the Coinbase’s website went down several times this year. As many confused customers have done, Nassim Taleb also deleted his Coinbase account.

Coinbase shouldn’t underestimate the power of word-of-mouth on social media as the user traction and retention of crypto exchanges will always emanate primarily from user trust. Investors and traders alike are looking for the best and safest user experience when it comes to investing in cryptoassets, and this new wave of customer churn will benefit alternative service providers that meet their expectations such as 21Shares’ fully-collateralized Exchange Traded Products (ETPs) for European-based customers.

As traditional crypto exchanges are still not immune to sophisticated hacks, the 21Shares research team anticipates our suite of ETPs will continue to be among the most reliable investment vehicles for investing in Bitcoin and other cryptoassets in the foreseeable future. As a matter of fact, recently, Bitwise surveyed more than 500 financial advisors in the US who overwhelmingly, by 65%, would prefer to buy cryptoassets in an ETF-like package compared with all other options.

Learn more here.

News - Coronavirus Accelerates Shift Away from Cash | The Financial Times

What Happened?

Turkish government has joined Europe’s largest and Belgian settlement house, Euroclear, after almost decade-long negotiations. With record low foreign investments in Turkey, Euroclear which holds over $30 trillion of assets under custody on behalf of banks, asset managers, and pension funds, could be a driver of much-needed investment in the country. This will allow investors to settle trades in Turkey’s government bonds paving the way for a new wave of cautious international institutional investors investing in Turkish markets in agreement with Euroclear.

Why Does It Matter?

The general investor sentiment in traditional financial markets is quite negative as reported by the Financial Times. Viktor Szabo, a fund manager at Aberdeen Standard Investments confessed to the FT: “We think it’s best not to have a position in Turkey at all.”

Additionally, the Gold reserves held by the central bank of Turkey have significantly increased, doubling over the past two years from 200 tonnes to around 485 tonnes as you can see in the chart below.

While institutional investors in Turkey are trying to stay afloat and diversify their portfolios, on the retail side of the spectrum, Turkey is among the leading countries in terms of cryptoasset adoption with a reported 1 million investors, chiefly retail investors, owning Bitcoin and other cryptoassets. The 21Shares research team will look closely at what the future holds for the more professional investors based out of Turkey but with the rising demand for gold from the central bank, Bitcoin and other cryptoassets could start to be part of small portfolio allocations going forward.

Learn more here.