What Investors Get Wrong About Bitcoin


Bitcoin’s price might have peaked in 2018, but as an investment, the digital currency is having its moment in the sun.

One of the most-talked-about investment themes of the Wealth/Stack conference this month was digital currencies, such as bitcoin, Ethereum and others. Conversations went well beyond “what is bitcoin?” and instead dug into the nitty-gritty: how much advisors should allocate to digital assets; how to efficiently trade crypto instruments; and where to access digital currencies, when so many online brokerage platforms still don’t carry them.

Grayscale Investments offered answers. As the largest digital currency asset manager worldwide, Grayscale has more than $2.7 billion in assets invested across 10 products, including the Grayscale Bitcoin Trust (GBTC).

While at Wealth/Stack, ETF.com sat down with Michael Sonnenshein, managing director for Grayscale Investments, to get his take on how advisors who don’t know their Ethereum from their Ethereum Classic can quickly get up to speed with digital currency investing.

ETF.com: What do you see as the biggest potential of digital currencies, like bitcoin?

Michael Sonnenshein: It’s the promise of digital currency to create financial inclusion. It hasn’t done so yet. But it could.

When I think about the different areas of the world I’ve traveled to, many of these economies are rooted in cash. A lot of folks don’t have access to bank accounts or lending, and they can’t finance a business or an education.

Often, too, they’re living in a place where the government is ruining their currency, with inflation or debasement or whatever it is. So digital assets are a new technology that could be used as an exchange of value for money that could really help advance people’s lives.

ETF.com: However, the “conventional” wisdom, as much as there is any, is that you shouldn’t look at crypto assets as a way to exchange money: They’re an asset, an investment.

Sonnenshein: I’d say advisors and investors aren’t really thinking about allocating to digital currencies, because they just don’t have enough knowledge about them. Advisors look at the investable universe, and the options available to them in a brokerage account, and they see stocks, bonds, ETFs, mutual funds. At the moment, digital currency falls outside that infrastructure.

However, you’re seeing a lot of legacy players getting involved in digital assets. They see the potential to eliminate middlemen and fees, and to scale things faster.

ETF.com: A lot of investors liken bitcoin to digital gold. Is that fair?

Sonnenshein: Absolutely. Gold was perhaps the right store of value for the physical world, but [investors] have realized that the world is moving digitally, and we need a digital store of value.

Bitcoin has a lot of the same attributes, but a few additional positive ones that make it a better store of value than gold. It’s verifiably scarce. It’s more portable. It’s more divisible.

ETF.com: It’s more volatile, though.

Sonnenshein: No question about that. But you have to look at it against the backdrop of this: Is the world we live in a physical one, or is it digital?

Digital asset exposure is certainly not for everyone. It’s risky and volatile, and it’s early days for the asset class. But if you’re not at least thinking about digital assets when putting together a portfolio, you’re doing yourself or your investors a disservice.

ETF.com: The Grayscale products have significant institutional ownership. Why do you think that is?

Sonnenshein: In fact, 84% of asset inflows during the second quarter of 2019 probably came from institutions. And what’s been interesting for us is that, last year, at a time when digital asset prices did nothing but decline, we actually saw the strongest inflows we’ve ever experienced. We raised $360 million last year. This year, we’re already on pace to beat that.

If you’re an institution, buying and holding digital assets directly doesn’t fit within your operational framework. But if you could get passive, long exposure to bitcoin—with no cash, no leverage, and through a security that has a CUSIP and an offering memorandum and tax statements, etc.—well, now suddenly you have a product that looks and feels like all the other products that institutions use.

ETF.com: What do you think the vast majority of the financial industry misunderstands about digital currency?

Sonnenshein: There are no shortage of articles about hacking and theft within the bitcoin space, but a very misunderstood aspect of those incidents is that the hackings/thefts were associated [not with bitcoin, but] with a company providing a product or service around bitcoin. The bitcoin [protocol] itself wasn’t hacked.

In the same way that a bank can get robbed and cash can be stolen, that indicates a flaw in the bank’s security model; it doesn’t mean the U.S. dollar is flawed.

In that regard, it’s really important that investors do due diligence over which types of providers they’re using in the space, and they understand the risks around that.

ETF.com: One of the common criticisms of digital assets is that they’re incredibly energy intensive to mine. Global bitcoin mining activity is estimated to one day consume as much power as the country of Ireland. Given that we’re in the middle of a climate apocalypse, how can eco-conscious investors reconcile that?

Sonnenshein: Most digital asset mining around the world is in places where there is either hydroelectric power or renewable energy sources. Also, similar to gold mining—where if the price of gold doesn’t maintain a certain level, then it’s unprofitable for a mining company to go send machinery and humans into a mine—there’s also a cost/benefit analysis that digital asset miners must undertake. So I would argue that, actually, it’s kind of a misnomer that [mining] is an energy-wasteful process.

If you want to get morose, look at global fatalities associated with mining gold or other metals. You don’t have any of that associated with mining digital assets.

ETF.com: But you do have criminals using bitcoin as a way to hide their tracks.

Sonnenshein: You just hit on No. 2 of the most misunderstood things about digital currencies! Every digital currency transaction leaves behind a digital breadcrumb, and there’s always going to be some semblance of that transaction out there for everyone to see.

There’s always going to be a trail tied to you. It may not be right away. It may be several transactions down the line. But at some point, at the on-ramps and the off-ramps of digital currencies, names get revealed, bank accounts get associated with the transactions, and criminals are always, always caught. Using digital currencies to do anything nefarious is probably the worst possible method, if you didn’t want to get caught.

ETF.com: Another common criticism of bitcoin products—specifically GBTC—are their high trading premiums. Historically, trading premiums on GBTC have swung from 0% to 100%. Are these products efficient enough to trade safely?

Sonnenshein:  Grayscale Bitcoin Trust began its private placement offering to accredited investors in September 2013. In 2015, Grayscale obtained regulatory approval for the trust to trade on the public market [under the ticker “GBTC”].

Investors who participate in Grayscale’s private placement offerings purchase shares at a daily net asset value. In contrast, shares of Grayscale Bitcoin Trust’s public quotation trade at prices dictated by the market.

Unlike an ETF, the trust doesn’t operate a redemption program. Because there is currently no redemption program, there are no assurances that the value of the shares will approximate the value of the underlying assets held by the trust when traded on a secondary market. As such, shares of the public quotation may trade at substantial premiums or discounts to the value of the assets held by the trust.

ETF.com: For advisors who don’t know where to start with crypto assets, what questions should they be asking?

Sonnenshein: First, I implore advisors to read up on the asset class before speaking to clients. So often, we hear from clients that their advisors are not knowledgeable about digital assets, and as a result, they’re dismissive of it.

They say, “This isn’t something I can advise you on.” If that happens, though, advisors need to realize that clients will just find digital assets directly, tasking themselves with the storage, safekeeping and so on.

For those advisors with clients who have the appropriate risk appetite and who can afford to be patient,  they also need to think about portfolio sizing. Typically we see investors allocating 50 to 250 basis points to digital assets in their portfolio.

ETF.com: They should also consider regulation and taxation, right?

Sonnenshein: Sure. It’s important to remember how much progress has been made over the past 10 years: You’ve seen guidance from the SEC on digital currencies and guidance from the CFTC, as well as the approval of derivatives trading. Think about that. This is an asset that didn’t even exist a decade ago, and now there are derivatives traded on bitcoin, next to futures on other assets that have been traded for millennia.

You’ve also seen guidance from the IRS on the taxation of digital assets. You’ve seen state-by-state regulation. So I think there’s a growing impatience for more regulation or more clarity, but we think our regulators have been very proactive and thoughtful, and they have quite a bit of resources to understand and stay on top of this space.

ETF.com: What are Grayscale’s next steps?

Sonnenshein: In 2017, we looked to register our Grayscale bitcoin product into an NYSE-listed ETF. We made progress, but ultimately, we realized that between the regulatory environment and market conditions, it just wasn’t the right time. So we went back to continuing to develop our product family and raising more assets.

Ultimately, the hope is to turn our whole product family into ETFs. It’s more a matter of when, not a matter of if.

Contact Lara Crigger at lcrigger@etf.com

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