Making Cents Of The Bitcoin ETF

The ink on the filing documents for the Winklevoss twins’ bitcoin ETF barely even had a chance to dry and we here at IndexUniverse had already exchanged nearly 50 emails on the subject. The following morning we had a near-20-minute debate about the merits of the product.

Suffice it to say, this thing has captured our imaginations.

While that type of hype may be a public relations firm’s dream, it will eventually pass, and what the market will be left with is the nuts and bolts of a product that has no precedent.

Sure, the Winklevoss twins may point in interviews to the gold fund SPDR Gold Shares (GLD) and its physically backed structure as a template, but the reality is that gold and bitcoins are about as similar as a manatee and a peregrine falcon.

To be fair, the Winklevoss twins, who were part of the Harvard beginnings of Facebook, seem to be doing and saying all of the right things with regard to their planned product. They have meticulously mapped out a list of risks—18 in all—and hired perhaps the most famous ETF lawyer around:Kathleen Moriarty.

Anyone with any knowledge of the ETF industry knows Moriarty as “SPDR Woman” thanks to her role in writing the prospectus to the first and still largest ETF:the SPDR S'P 500 ETF (SPY).

Despite what seems like an honest commitment to getting this filing and a possible launch right, I’m left wondering exactly what this product seeks to achieve. Heck, I’m not even sure most people know what the attraction of bitcoin is moving forward.

First, a little background for the uninitiated:Bitcoin was created in 2008 as a virtual currency whose inflation rate and issuance are dictated not by fat-cat central bankers or central planners, but by a complex algorithm.

The goal is to decrease issuance every year until 2140, when the amount of bitcoins in circulation will reach 21 million. At that point, the currency will be subject entirely to the ebbs and flows of demand for the currency.

While the currency has attracted a tremendous amount of attention in the past five years, not all of that coverage has been positive. The virtual currency’s exchange rate has fluctuated—sometimes wildly—and there’s always the looming threat of some kind of intervention by the U.S. Treasury Department.

Both of these concerns are relevant, and both of them cause me to wonder just how likely it is that this ETF will come to market.

Ultimately, the question I’ve been asking anyone who will listen is, What is a bitcoin supposed to be, a currency or a store of wealth?

Beware Of Treasury

If it’s intended to be a currency, then I have little doubt the Treasury Department will eventually shut it down.

Sure there are other currencies than the U.S. dollar in circulation, but those are issued by foreign governments. Bitcoins, on the other hand, have no country of issuance and are designed to be used for e-commerce.

While the government has made it clear that users of the currency do not have anything to worry about from a legal standpoint, the Treasury has made it clear that it does have jurisdiction over domestic bitcoin “miners” and exchanges.

This may not mean bitcoins will be put out of business directly by the Treasury, but it does mean that the existence of the exchanges and providers hinges on their compliance with the complex and onerous regulations of being money transmitters.

In short, the Treasury is going to ensure that any nefarious users of bitcoins will have to navigate the same treacherous waters that someone dealing in greenbacks would.

None of this is to say that the Treasury won’t decide one day that bitcoins are a competing currency and should be shut down. It’s not like you have to go back that far to find a useful—albeit imperfect—precedent:the U.S. Liberty dollar whose creator was charged with “making, possessing, and selling his own currency.” That sure sounds familiar.

In his recent interview with Financial News, Tyler Winklevoss said he believed regulators are looking to bring “healthy and reasonable” regulations. He sure seems confident that the Treasury will exercise patience with bitcoins, but it remains to be seen if that confidence winds up being naivete instead.

A Dicey Store Of Value

Still, some argue that bitcoins are merely a store of value in the same way that gold has been used in recent years. If that’s true, then it’s not as much a currency as an investment vehicle. In my mind, that may be the most dangerous line of thinking yet.

Gold is a physical asset whose value over centuries has been dictated by the laws of supply and demand—and government intervention, of course.

Bitcoins may be a lot of things, but tangible is not one of them. The “storage” of bitcoins has to do with servers, not vaults, and the value of bitcoins has to do with algorithms, not production.

As such, anyone who’s banking on bitcoins to provide a store of wealth over the next 100 years is putting a tremendous amount of faith in not just a complex algorithm, but a network of servers and systems whose security is only as good as the piece of regulatory paperwork it’s written on.

Of course, that type of irony—relying on paper promises of security for a currency whose whole rationale for being is to avoid fiat, i.e., paper currency—is rich, even for the financial services industry.

In the end, it will be up to the market and regulators to decide whether a bitcoin ETF will come to market and survive. Maybe Tyler Winklevoss is right and pension funds and fiduciaries are lining up for “frictionless” bitcoin access.

And maybe Kathleen Moriarty, the SPDR Woman, will have another feather in her cap when all is said and done. Maybe I will pay for my son’s college tuition in bitcoins that I redeemed from the bitcoin ETF held in his 529 plan.

As always, time will tell. In the meantime, I hope someone can explain to me what a bitcoin is.

At the time this article was written, the author held no positions in the securities mentioned. Contact Paul Baiocchi at pbaiocchi@indexuniverse.com .

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