GBTC - ProShares Bitcoin Strategy ETF: Why To Hold

2023-11-30 09:37:48 ET

Summary

• I believe owning Bitcoin through a vehicle like the Bitwise Bitcoin ETF is attractive due to its lower fee and simplicity.
• There are potential bearish factors like the Mt. Gox repayment and the conversion of the Grayscale Trust into an ETF.
• I believe the upcoming Bitcoin halving and the launch of spot Bitcoin ETFs are likely to remain dominant forces and the price trajectory continues.

ProShares Bitcoin Strategy (BITO) is a Bitcoin ETF that' gives investors exposure to Bitcoin futures. For people that don't want to bother with setting up their personal wallets, it is a fine way to gain simple Bitcoin exposure. The ETF charges a fee of around 0.95% per annum.

The runup in Bitcoin this year, however you own it, is, of course, great.

But occasionally, when I see it, I get the urge to decrease my position when faced with negative news or price action. Although not without risk, I believe it is quite important to hold Bitcoin here.

Trained as a value investor, these are the toughest situations for me. I'm used to buying at a discount, sitting through deep bear markets, and tolerating my companies going nowhere. Flipping them as they achieve fair value or something close. I'm not as well trained to let investments run. There are several reasons why I want to do just that and I'll get into these in this article.

Bitcoin went through quite a bear market. It could have been worse, but it had major and widespread consequences. Big and small names disappeared, fortunes were lost, and the industry disappeared from the front pages for a long time.

This year's Bitcoin surge seems driven by the possibility of spot Bitcoin ETF launches and the Bitcoin halving, which is expected in April 2024. These events are exactly why I've been fairly bullish on Bitcoin. In addition, I think the collapse of the SPAC market and venture funding in general is also helping a lot.

Bitcoin mining firms were receiving funding on very favorable terms. People were throwing money at these with little regard for the likelihood of a realistic return. A flood of mining machines got hooked up and started humming. When Bitcoin was going up, all these mining firms were hoarding coins. When Bitcoin started falling AND funding dried up, they started selling more and more. All part of a pretty standard boom-and-bust mechanics.

There are a few near-term bearish arguments that I think deserve consideration. The top one is the Mt. Gox repayment , which I now expect next month or early 2024.

J.P. Morgan (JPM) made the second one, which is the conversion of Grayscale, leading to a potential avalanche of sales.

I think the Grayscale trust trade is still very good. This trade is based on a typical closed-end fund arbitrage. A closed-end fund typically trades at a discount to NAV (net asset value). When converted into an ETF that discount disappears because ETFs have a creation/redemption mechanism. If a trader wants to profit from the discount to net asset value disappearing, he or she goes long the CEF and shorts the portfolio of the CEF in the market. Sometimes, shorting the exact portfolio of the CEF is impossible. For example, if it holds private assets. In cases like that, you short a proxy. If the CEF contains private debt, for example, you could short the high yield bond ETF ( HYG ) against it.

It may seem better to forgo the short. Why not just go long, and you'll pick up the discount and the underlying beta? Doing that is the approach that will lead to higher average returns on the position. But it is considered considerably worse by most players engaging in stuff like this.

If you take the long/short position, you effectively tie up little or no capital. Your return on equity is sort of limitless. It isn't in practice because it will eat into your margin, and you have to risk control even if there are no margin limits. However, earning an 8% discount in what could be a matter of weeks or a few months is a fantastic return with almost no capital down.

Second, the long/short position adds almost no volatility to your portfolio. This depends on the specifics of the exact trade. In practice, very little volatility will be added to your portfolio while you do add significant returns. Adding a lot of return and no volatility is beautiful to hedge funds and professional traders. If you have building blocks like that in your portfolio, it allows you to maintain risk elsewhere. You can take any beta you like elsewhere. You don't have to take this exact beta.

The bottom line is that for professional arbs; it is very unattractive to go long the underlying outright. I think many will have hedged themselves through various means. When GBTC funds are finally freed up, this doesn't cause them to be net sellers. They are buying as much as they're selling. Their activity will essentially be neutral.

Furthermore, some funds/institutions have undoubtedly used Grayscale as their preferred source of Bitcoin exposure. They're just long. But they have chosen to be long Bitcoin. Sure, they may decide to own Bitcoin differently. If six Bitcoin ETFs are coming to market, they may select another one or spread their allocation. But this shouldn't impact the price of Bitcoin either. Why would they suddenly start unloading Bitcoin just as many more institutional and retail investors get access to the space?

Then there is the Mt. Gox argument. This is the bankruptcy estate of what was, once upon a time, the largest Bitcoin exchange in the world. FTX 1.0 if you will. First of all, Mt. Gox trustee holds 137890.981186 BTC on all known addresses. The total amount held by the Mt. Gox trustee amounts to around two days of Bitcoin volume.

I think it will be a drawn-out process for the Japanese trustee to send these Bitcoins to the original owners. Returning these funds to its owners will take a lot of time. I don't think it will be a 1-day batch and be done with it.

Second, the recipients are primarily early-day crypto investors and didn't sell their claims at any time before. They may like the exposure.

Third, the narrative around Bitcoin is pretty bullish, which may increase the likelihood they don't liquidate their assets. If the Mt. Gox selling temporarily pushes the market down, it may be a buying opportunity. Sellers want liquidity, and the market will provide it at a return. It will be clear that the wave of selling will be temporary.

I genuinely feel uncomfortable when some asset I'm long has been surging upwards. To make things worse, Bitcoin's implied volatility has been picking up lately. That's not always a great sign for things to come. At the same time, several firms are in the race to launch ETFs.

All these ETFs will likely be pre-seeded. Just think about it. When many people pick an ETF, they google "best gold ETF" or "lowest fee cybersecurity ETF" or something like that. They look at the list of the available ETFs. If they are longer-term traders or investors, they may compare costs and do some other applicable due diligence.

Shorter-term traders may opt for the largest one because of the liquidity. In terms of options markets, often only the largest ETF has a lot of volume. Volume begets volume in ETFs. All these firms compete hard to get one across the finish line first. That's why GBTC wants to convert a high-fee product with an eternal lock-up into a lower-fee product with constant exit liquidity. It is the race to become the $100 billion or $200 billion Bitcoin ETF. Will these firms put $10 - $20 or $100 - $200 million in these ETFs? I'd think so. Perhaps they will hedge that risk with futures, but I'm unsure. There's some support out of this corner even ahead of the launches.

I still believe that getting an ETF approved will catalyze additional flows into Bitcoin. I also think the halving is a natural tailwind. Finally, we're going into a holiday season with bullish, solid crypto narratives and matching price action. It is a simple indicator, but the ETF trades well above its moving averages, which is a positive and something many traders keep an eye on. It could end up a year with much crypto talk at the dinner table.

While the potential impacts of the Mt. Gox repayment and the conversion of Grayscale into an ETF present potential bearish considerations for investors, I doubt these factors will do more than stall Bitcoin's ascent. The upcoming Bitcoin halving and the launch of spot Bitcoin ETFs are pivotal fundamental events that are likely helping to drive the current price ascend. As we approach and go through the holiday season with bullish, solid narratives for crypto, it seems fitting to me to hold on, even if Bitcoin surges a little faster and harder than I think is ideal.

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