by Maya Ortiz de Montellano, CFA, Senior Investment analyst
Key takeaways
- The digital asset ecosystem has taken several quantum leaps forward since the creation of bitcoin in 2009, and cryptocurrency is now widely considered a viable investable asset. Novel utilities associated with the technology have been discovered, the global cryptocurrency market capitalization has skyrocketed, and there have been marked changes in the quality of digital asset offerings and institutional participation.
- This topical report endeavors to first discuss the essential factors that investors should contemplate while seeking exposure to cryptocurrencies. It will then explore the various entities through which institutional investors may gain access to digital assets, while also highlighting the primary differentiators and drawbacks of each method.
- Without an exchange-traded fund (ETF) approved by the U.S. Securities and Exchange Commission (SEC), investors seeking exposure to digital assets may either make a direct purchase through a crypto exchange or gain indirect access via mutual fund derivatives, a grantor trust, or a private placement fund.
Principal criteria for investment
In weighing whether to make an investment in bitcoin directly, or through a read fund that uses derivatives such as futures, a grantor believe, or a secret placement fomite, investors should keep a few considerations exceed of mind :
- Ability to closely track the price of the underlying asset
- Impact of premium / discount on investment outcome
- Protection against hacking/cyber-theft
- Fees and operating expenses
- Liquidity
Digital asset investment offerings
This segment of the composition aims to analyze the respective institutional cryptocurrency products mentioned above, with an emphasis on the inaugural four principal criteria for investment. Liquidity, the fifth key component when evaluating such vehicles, will then be compared across the unlike methods in the stick to segment .
Direct exposure
Coinbase ’ s direct list in April represented the first time a digital exchange went public in the U.S. Its market capitalization, which presently exceeds $ 59 billion ( as of 9/30/2021 ), underscores the disruptive potential of such platforms and illustrates investor appetite for the quad. Investing directly in bitcoin through cryptocurrency exchanges provides investors with the purest imprint of ownership among the aforesaid mechanisms .
however, it besides introduces numerous likely risks. such exchanges have proven vulnerable to hacking and cyber-theft. For example, between 2011 and 2014, 650,000 bitcoins were stolen from Mt. Gox, a japanese cryptocurrency central that was then the largest in the worldly concern. More recently, hackers were able to withdraw over 7,000 bitcoins from Binance, presently the populace ’ sulfur largest cryptocurrency exchange. such attacks highlight the importance of cold storehouse, discussed late in the report, and the susceptibility of digital exchanges to breaches .
even when digital exchanges successfully evade hacks, investors can lose access to their cryptocurrencies if they do not by rights storehouse or remember the public and private keys associated with their wallet. Given the decentralize nature of the platforms and their cryptanalytic security features, password recovery infrastructure is often impracticable. According to The New York Times, around 20 % of the existing bitcoin supply appears to be lost or differently stranded in wallets. far exacerbating this gamble, many platforms either have very limited or wholly nonexistent customer service capabilities — delaying responses in the event of crises. For exemplar, the Federal Trade Commission and Consumer Financial Protection Bureau have received 11,000 customer complaints against Coinbase since 2016, the majority of which associate to customer service .
last, these platforms have substantial frictional costs associated with transactions and transfer of assets .
Indirect exposure
common funds, grantor trusts, and private placement funds are all vehicles through which investors can indirectly access the digital asset sphere. While certain attributes differ meaningfully across the approaches, a few commonalities besides exist. notably, each structure appears to solve most of the issues surrounding handiness that are present in digital wallets – individual investors do not need to manage public and private keys. additionally, the mechanisms are conversant to most investors, don ’ thyroxine require the creation of an extra wallet, and tend to have more extensive customer service capabilities. These factors have the potential to mitigate many of the initial fears individuals have when considering an allotment to this brand-new asset classify .
common Funds
reciprocal funds habit futures, which are cash settled, in an try to replicate the price action of cryptocurrencies. More specifically, these funds typically invest in front-end futures contracts. The vehicles then begin the roll process, whereby they exchange a buy run out contract for a newly longer-dated contract. frankincense, such offerings do not own the fundamental asset itself — in this case Bitcoin. however, this approach path can be ineffective from tax and transaction cost standpoints. additionally, these funds frequently have tracking error ( the extent to which a Fund ’ s returns differ from the Index ), and do not precisely mirror the monetary value of Bitcoin. The U.S. Securities and Exchange Commission ( SEC ) has expressed caution around these new funds, as there are outstanding questions about the depth and width of the Bitcoin ( BTC ) futures market, and its ability to accommodate casual liquid requirements of read common funds, or ETFs. finally, the volatility in the price of Bitcoin referenced by the futures contracts may introduce far impreciseness.
Grantor Trust
The first base period for many investors who want to buy digital assets such as Bitcoin is to invest in a grantor hope, which is a structure normally used to hold single commodities ( ex-wife. Gold, Silver ). Grantor trusts for cryptocurrency assets broadly trade in the over-the-counter ( OTC ) marketplace, and are a stream through structure like a limited partnership for tax purposes. additionally, grantor trusts are typically IRA eligible. These structures provide exposure to single commodities and are not registered under the Investment Company Act. A grantor hope net asset measure ( NAV ) for Bitcoin may at times trade at a bounty or discount rate to the underlying asset for hearty periods of time. For exercise, the Grayscale Bitcoin Trust ( GBTC ) reached a agio of 122.3 % on June, 2017, and a low of -17.9 % in May, 2021. While a premium or deduction could conceivably be beneficial, if timed absolutely, the reality is that it most likely makes buying a highly fickle asset like Bitcoin risker. ultimately, the fees associated with such vehicles have the potential to be prohibitive for many investors .
private placement
Unlike common funds and grantor trusts, a private placement for bitcoin offers qualified investors the opportunity to transact at a web asset value ( NAV ) of a fund that immediately corresponds to the price of bitcoin at a specific point in time ( for example, 4 p.m. ET ). Keeping in heed that digital assets actually trade 24 hours, 7 days a week, transacting at NAV inactive permits a strategy such as dollar price averaging to better reflect the true economic operation of the underlie asset. The traceability and accuracy associated with this type of fund served as identify differentiators during the vetting process of the cryptocurrency ecosystem.
Regarding security, the highest level of auspices against hacking for the time being is referred to as cold storage. This means the code private key data that permits transacting in bitcoin ( or any digital asset ) is stored on a hardware faculty which is never connected to a routable network. The most batten cold storage facilities are excess, geographically dispersed with forcible barriers to entry, electronic surveillance, and patrols. The private placement selected by Global Manager Research meets this standard .
Liquidity…it depends.
If the definition of a liquid asset is that it can well be converted into cash within a short menstruation of time, Global Manager Research would suggest that Bitcoin falls in the relatively liquid category. Transactions in Bitcoin through digital exchanges can be executed in a marketplace that trades constantly, while reciprocal funds are open-ended vehicles. however, exchange markets remain break up and can hinder accurate price discovery. additionally, there are concerns about the depth and dependability of BTC futures, the products used by common funds. Next, indirect investments in cryptocurrency through grantor trusts and private placement funds typically have restrictions surrounding redemptions and subscriptions. ultimately, the more liquid markets may come at the price of deficient price accuracy and foil. conversely, private placements funds face liquid restrictions that prevent seamlessly trade in and out of the underlie assets .
Rapidly Evolving Landscape
Looking to the future, Global Manager Research expects that cryptocurrency assets will no long be the knowledge domain of technologists, with the number of investment offerings growing, including passive and actively managed options. The sluicegate for this will probable require further development of a regulative model coming from U.S. regulators, and promote cooperation across diligence participants. With that watch, a Bitcoin ETF is inevitable, in our opinion, but timing is highly unsealed. Absent any changes in current Internal Revenue Service ( IRS ) tax guidance, we expect to finally see a pathway to transition interests from a private placement fund into an ETF in a taxefficient manner .
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