Why is Bitcoin Trust becoming more and more popular among traditional investors?

Original title: "IDEG 丨 Bitcoin Trust is increasingly favored by traditional investors"
Written by: Kevin Yang, IDEG CEO

Bridgewater Associates is the world's largest hedge fund. Ray Dalio, the founder of Bridgewater Associates, mentioned in his article "Paradigm Shifts": "A big question worth thinking about now is which investments will have good returns in an environment of reflation, when huge debts are due and there are major internal and external conflicts among believers in various systems. At a time when many central banks are flooding the market with money and legal currencies are depreciating, we should think about what the next best currency or store of value will be." [1] Bitcoin seems to be a powerful answer to Dalio's question.

Bitcoin is the best performing asset in 2019-2020

In the past two years, Bitcoin, as a new asset class, has attracted strong attention from many traditional institutional investors. There are three main reasons for this: First, the scale of the Bitcoin trading market continues to expand, and the current average daily trading volume remains at US$80 billion, providing the necessary market foundation for larger amounts of funds to participate in Bitcoin investment. Second, there is no obvious correlation between the volatility of Bitcoin and various traditional assets, which meets the asset allocation requirements of macro funds. Third, Bitcoin has always performed very well in the past.

Figure 1: Performance of major macro asset classes in 2020, data source: JP Morgan, Messari [2]

According to IDEG statistics, the Bloomberg Galaxy Digital Asset Index rose by about 265.36% in 2020, significantly outperforming gold and far exceeding the returns of stocks, bonds and commodities.

Figure 2: Comparison of performance of major Bloomberg financial indices in 2020, data source: Bloomberg, IDEG

Trust has become the largest compliant channel for Bitcoin investment

Although Bitcoin has outstanding returns, how to invest in Bitcoin safely and legally is affected by many factors. In order to meet the compliance and security requirements of traditional institutions for Bitcoin investment, trusts, as a traditional investment tool, have become the best channel for the current Bitcoin investment market and have gained the favor of more and more traditional investors.

Grayscale Investment LLC is the sponsor of GBTC, the world's largest Bitcoin Trust. The Trust is a passively managed Bitcoin index tracking fund. GBTC opens private placements to qualified investors and institutional clients from time to time, allowing them to subscribe to trust shares in cash or Bitcoin. Grayscale's management fee is 2% per year, and the minimum single subscription amount is $50,000. According to data disclosed by Grayscale, 80% of its customers are institutional investors, 16% are family offices and high-net-worth individuals, and another 2% are pension funds. Currently, the main way for European and American investment institutions to enter the Bitcoin market is through the GBTC Trust.

According to Grayscale's 2020 third quarter report, more than $2.4 billion was raised in the first three quarters. Among them, the quarterly capital inflows from the first to the third quarters reached $504 million, $906 million, and $1.05 billion, respectively. The fundraising scale in the three quarters has continuously set new historical records, which shows that people's enthusiasm for investing in digital assets continues to rise against the backdrop of global economic uncertainty. So far, the cumulative investment scale of various digital asset trust funds issued by Grayscale has reached $3.6 billion.

Figure 3: Cumulative capital inflows into Grayscale’s various digital asset trust funds, data as of September 30, 2020[3]

After the Bitcoin block reward was halved in May this year, the amount of funds flowing into GBTC once exceeded the output value of Bitcoin mining in the same period. Relative to the number of newly produced Bitcoins, the amount of funds flowing into GBTC is so large that the supply and demand relationship in the Bitcoin market has changed. This phenomenon may be a positive signal for the further appreciation of Bitcoin in the future.

Figure 4: Comparison of GBTC inflows and Bitcoin mining output during the same period, data as of September 30, 2020[4]

According to public data, as of December 31, 2020, the GBTC Trust Fund held a total of 607,037 bitcoins (about 2.89% of the total amount of bitcoins), an increase of 57% from the end of June. According to market data on January 9, 2021, the size of the trust fund has reached US$24.155 billion.

Figure 5: GBTC Trust Fund Holdings, data as of December 31, 2020[5]

Why Bitcoin Trusts are Popular with Traditional Investors

According to a survey of the US financial advisory industry by Bitwise and ETF Trends, 76% of financial advisors said they had received investment advice from clients about digital assets in the past 12 months, and 72% of financial advisors believed that their clients may have invested in digital assets. 54% of financial advisors said that the most attractive factor for them to allocate digital assets is its overall weak correlation with traditional assets[6]. Since 2019, mainstream media and Wall Street analysts have continued to discuss the "digital gold" attribute of Bitcoin. This point has also resonated in the US financial advisory industry.

The survey also revealed the main reasons that prevent traditional investors from participating in digital asset investments include:

1. 53% - Regulatory reasons

2. 41% - Don’t know how to value digital assets

3. 39% - Lack of convenient investment tools

4. 34% - Concerns about not being able to keep it safe

From the above survey data, we can see that traditional investors are very interested in investing in Bitcoin, but they lack compliant and safe investment channels. As a traditional investment tool, Bitcoin Trust Fund has well solved many concerns of traditional investors:

Trust solves the compliance problem of bank funds channels. Private channels for buying and selling Bitcoin face the credit risk of the main body; and private channels are small in size and cannot deposit a large amount of funds, so they are not suitable for institutional customers. By subscribing to trust shares, institutional investors can conduct public-to-public transfers through trust accounts and realize legal and compliant purchase and holding of Bitcoin assets.

The trust solves the security problem of Bitcoin custody for customers. Bitcoin is a purely digital asset type, facing multiple security risks such as network security, storage device security, and key custody. The total number of Bitcoins is 21 million, and the current circulation in the market is about 18 million. Among them, the number of Bitcoins that have been confirmed to be lost is close to 1.7 million. At the current price, the lost Bitcoin is worth nearly $60 billion. Bitcoin trust funds generally cooperate with custodians to ensure the custody security of Bitcoin assets.

Trust solves the compliance problem of financial audit. Trust funds are subject to strict audit by third parties, and Bitcoin trust assets can be reliably incorporated into the financial statements of listed companies and large investment institutions, avoiding the problem of inability to consolidate due to different financial audit systems in different regions.

It is these advantages that make trust funds the most popular compliant investment channel in the Bitcoin market. GBTC’s successful operation over the years has fully verified the reliability of trust channels.

The limitations of GBTC and the development of trust funds

Although GBTC is the most successful Bitcoin trust fund on the market, its terms and conditions have certain limitations. First, GBTC is a passively managed trust fund, which means that Bitcoin is held after purchase, and the income is completely linked to the rise and fall of Bitcoin itself. Secondly, GBTC shares do not support redemption, and investors can only choose to sell them on the open market after the lock-up period. The setting of this clause has made the premium rate of GBTC shares over the actual price of Bitcoin remain high. The highest premium rate has reached 140%, and currently it remains at around 20%. This means that investors must pay a higher cost to purchase GBTC shares.

Figure 6: Historical premium rate of GBTC shares, data as of January 8, 2021[7]

Due to the success of GBTC and its obvious clause defects, some strong upstarts have emerged in the field of Bitcoin trust funds. On June 12, 2020, Wilshire Phoenix Funds LLC submitted an S-1 registration statement to the US Securities and Exchange Commission for approval of its Bitcoin trust product. The trust hired Fidelity Digital Assets as a custodian to custody Bitcoin assets, with a management fee of 0.9%, much lower than the 2% of the GBTC trust. But these trusts are mainly aimed at the US market.

In the Asia-Pacific region, this field is also attracting more and more attention from investors. In November 2019, IDEG took the lead in launching Asia's first Bitcoin Trust, Asia Digital Trust , in Hong Kong, which includes two sub-trusts, Asia Bitcoin Trust (ABT) and Atlas Mining Trust (AMT) . The core members of IDEG have been focusing on quantitative trading in the field of digital assets since 2013, and their strategies are known for their stability. The management scale of IDEG's quantitative trading ranks among the best in the Asia-Pacific region. In addition, IDEG's parent company is a world-leading professional blockchain investment institution. IDEG's parent company has deeply cultivated important tracks such as blockchain infrastructure, underlying public chains and applications, and has invested in many star projects including Canaan Creative and Polkadot worldwide, with excellent investment returns. The custodian of ABT and AMT trusts is Coinbase Custody, the world's largest digital asset custodian. Coinbase Custody currently has digital assets under custody worth more than US$10 billion, and has not had a single security incident since its inception.

ABT is a trust fund focused on Bitcoin trading. Different from the passive management strategy of GBTC, ABT adopts an active yield enhancement strategy. The advantages of the enhanced strategy are mainly reflected in two aspects: earning more Bitcoins through low-risk arbitrage strategies and optimizing the dividends brought by Bitcoin appreciation to the greatest extent; on the other hand, effectively controlling drawdowns through hedging strategies to avoid extreme market risks. Therefore, the trust income using the enhanced strategy will be higher than that of the passively managed trust.

AMT is the world's first Bitcoin mining trust fund, providing traditional investors with a compliant channel to participate in Bitcoin mining. Bitcoin mining is a capital-intensive industry, and retail or small institutional miners lack the necessary competitiveness in the face of large capital. Trust funds can form capital advantages and scale effects, thereby providing investors with more reliable mining returns. In addition, Bitcoin mining has high industry and operational barriers. Trusts can use their brand and financial advantages to maintain competitive advantages in mining machine procurement, power procurement, mine site selection and design, mine operation, daily maintenance and security, and reduce operating costs.

Through the analysis of the Bitcoin trust market, we can see that the field is gradually developing from monopoly to competition and evolution. Compared with exchanges and OTC dealers, GBTC has quickly gained the favor of many traditional investors in a short period of time due to its compliance and security advantages, and thus achieved great success. However, due to its own limitations, it leads to low efficiency in capital utilization. Investors began to seek better investment tools to participate in the Bitcoin market. It is in such a market environment that trust fund products that are more in line with local market needs and have better terms and conditions have emerged, providing traditional investors with a compliant, safe and convenient investment channel.

Reference:

1. Ray Dalio,"Paradigm Shifts",LinkedIn,
https://www.linkedin.com/pulse/paradigm-shifts-ray-dalio/

2. Mira Christanto, Twitter,
https://twitter.com/asiahodl/status/1344529644721061889

3."Grayscale Digital Asset Investment Report Q2 2020", page 5, Grayscale,
https://grayscale.co/wp-content/uploads/2020/10/Grayscale-Digital-Asset-Investment-Investment-Report-Q3-2020.pdf

4."Grayscale Digital Asset Investment Report Q2 2020", page 7, Grayscale,
https://grayscale.co/wp-content/uploads/2020/10/Grayscale-Digital-Asset-Investment-Investment-Report-Q3-2020.pdf

5."Grayscale Investments BTC Holdings", bybt,
https://www.bybt.com/Grayscale

6."The Bitwise/ETF Trends 2020 Benchmark Survey of Financial Advisor Attitudes Toward Cryptoassets", Bitwise,
https://static.bitwiseinvestments.com/Research/Bitwise-Research-ETF-Trends-2020.pdf

7."GBTC Discount or Premium to NAV", Ycharts,
https://ycharts.com/companies/GBTC/discount_or_premium_to_nav