Why An ETF When You Can Buy The Currency Directly?

Seasoned ETF investors might be aware of the ‘weird’ ETFs launched in the past, trying to capitalize on the ever increasing popularity of ETFs, from Guggenheim Ocean Tomo Patent ETF to Global X Farming ETF. Even though the Bitcoin ETF can’t be exactly classified under ‘weird’, but one question it definitely raises is – Why will anyone buy an ETF (and thereby pay fees) when they can buy the underlying asset (in this case Bitcoin) rather easily.

The whole idea of the ‘Bitcoin’ is based on a cryptographic currency which is peer-to-peer i.e. users don’t need an intermediary to do the transactions as is the case with conventional banking transaction. By buying an ETF, one actually deals with the asset management company that launched the ETF and owns the underlying assets hence an intermediary.

The Winklevoss twins seem to have thought about that question beforehand as in their recent media interactions they emphasized on how the ETF will ease the process of owning and storing Bitcoin for an average investor. Another purpose that ETF will solve, according to them, is it will give institutional investors (hedge funds and the likes) to gain an exposure to Bitcoins, especially those who are forbidden by their subscription agreements to own the currency directly. The twins also drew comparison with Gold ETFs arguing that the Bitcoin ETF will work in the same manner that gold ETF does i.e. it will ‘ease out the friction’ of owning and securing the asset for investors.

Though the twins are answering all the concerns that investors might have regarding the ETF, they are also working towards creating a new Bitcoin exchange ‘Gemini’, proclaiming that it will be the NASDAQ or Google Inc(NASDAQ:GOOGL) of Bitcoin, which begs the question that if they are so sure that the Bitcoin ETF will be the safest option for investors to get exposed to Bitcoins, what purpose will Gemini solve?

The Bitcoin Index – Winkdex

The twins also filed an amendment to their original SEC filing on February 19, 2013, which included a notification of a Bitcoin index proposed by them, called the Winkdex (short for Winklevoss Index). The Winkdex is run by Winklevoss twins’ Math-Based Asset Services LLC and is based on a proprietary formula. The index calculates the price of a Bitcoin by ‘blending’ the last two hour U.S. dollar prices of a Bitcoin from three ‘qualified’ Bitcoin exchanges using a volume-weighed exponential moving average. Out of a set of five qualified exchanges, the three exchanges would be selected on the basis of the volume of transaction they process in the previous 24 hour period.

The Real Concern

Whether it is the ETF or the Gemini exchange that the twins are working on, it might help in pushing Bitcoins from the fringes to the mainstream, but it really doesn’t take away the inherent issues and concerns related to Bitcoin as an asset.

In 2014, the price of Bitcoin denominated in U.S. Dollars fell by more than 60%, which might not be astonishing when one starts comparing it to the price of a volatile commodity like oil, which itself saw a slump of 50% during the last six months of the year. However, to put things in perspective oil is a commodity, but Bitcoin is a currency and such a significant drop in any conventional currency used in any country across the world today would have surely created mayhem. The ETF might help in making it relatively easy for people to invest in Bitcoins, but it won’t take away the inherent risk of volatility that Bitcoins carry.

Bitcoins also received huge amount of negative publicity when one of the most well known Bitcoin exchange MtGox collapsed and Bitcoins worth millions of dollars went missing. Although the twins have answered the concerns regarding safety of Bitcoin kept under the control of their asset management firm and chances of something like MtGox happening are rare, one can’t completely ignore the risk of Bitocins being hacked and stolen owing to them being a digital currency.

In a recent interview with Bloomberg, the twins tried to answer some of these real concerns, but their answers can’t be exactly called convincing.

“I think, like any new technology, it’s going through its growing pains right now, but we don’t look at the price day-to-day. I think, we look at it in a 5, 10- year time horizon and the critical piece of infrastructure like a U.S.-based exchange are being built as we speak. So, I think that’s going to long-term build a very interesting situation for Bitcoin,” Cameron Winklevoss said.

Buy/ Sell/ Sit On the Sidelines?

As of now, the Winlevoss Bitcoin ETF is on track to debut on the NASDAQ in the first-quarter of this year and the Winklevoss twins are busy promoting it to the investor community, particularly those who invest in Gold ETFs.

If as an investor, you have followed the Bitcoin evolution in the last few years, one thing is for sure that this digital currency has attracted a lot of attention and is perhaps the most well-known crypto currency out there. However, ‘hype’ of a product or good doesn’t necessarily make it an attractive investment.

If you are someone who doesn’t know anything at all about this new digital currency, it would be better to first study them in detail even before thinking about investing in the ETF. However, if you are someone who knows what Bitcoins are and have followed its evolution, the two questions you must ask yourself before thinking about investing in this ETF is –

1) Are you of Bitcoins becoming a more mainstream currency in the future?

2) Can your portfolio withstand the volatility that is inherent to Bitcoins and a significant drop in value if it were to happen?

If the answer to any of these two questions is a ‘no’, perhaps Bitcoins aren’t adiversification that your portfolio needs at this time, otherwise taking a small exposure to the Bitcoins can be worthwhile, even if only from a diversification point of view.