Grayscale, Bitwise, ETF, SMA or DTAMP – A Comparison for Financial Advisors

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Introduction

With interest in cryptocurrencies at an all-time high, financial advisors are facing significant pressure from their clients to provide exposure to this new asset class. Many advisors discover the Grayscale Bitcoin Trust in their research, but there are many other choices available. In this article I review and compare the different options that investment advisors have available to them to offer cryptocurrency and other digital asset exposure:

  • Investment Trusts (e.g. Grayscale)
  • Index Funds (e.g. Bitwise)
  • Exchange Traded Funds (ETFs)
  • Own the underlying asset (Digital Asset TAMP or SMA)

Investment Trusts (e.g. Grayscale)

The easiest and perhaps most common way to offer client exposure to digital assets is through the Grayscale investment trusts. Grayscale has a handful of assets available in this format, including:

  • Bitcoin (GBTC)
  • Ethereum (ETHE)
  • Bitcoin Cash (BCHG)
  • Litecoin (LTCN)
  • Ethereum Classic (ETCG)

Investment trusts are the simplest because they can be purchased just as you would an equity. The downside of these vehicles however is that the net asset value (NAV) of the fund is not flexible. This means that the amount of the underlying cryptocurrency that is held in these vehicles does not adjust frequently to the value of the shares, resulting in a divergence between the market price of one share of the trust and the value of the assets being held in the trust.

The figure below presents a chart from Grayscale Bitcoin Trust that shows the historical comparison between the market price of the shares and the value of bitcoin backing a share of GBTC.

Chart Source: Grayscale

The premium fluctuates significantly over time, with the highest being in 2017 where it was greater than 100%. The variance as of 11/6/2020 is shown below.

Chart Source: Grayscale

This data shows that if you were to purchase a share of GTBC, you would be paying roughly ~18% more for an equivalent amount of bitcoin than if you purchased the underlying asset.

The implication of this in practice is that not only are you getting exposure to bitcoin, but also to the premium. This means that if bitcoin goes up by 10%, but the premium drops by 10%, then your returns are 0%. However, it should also be mentioned that this can work in the reverse: If bitcoin were to rise 10% and the premium increased by 10%, the return would be up 20%.

The premium can be hard to predict, which means that buying GBTC significantly amplifies the risk of buying bitcoin, and with bitcoin already a relatively risky asset, this is not ideal.

The analysis above is for GBTC. The premium is even more pronounced for ETHE, as shown in the chart below.

Chart Source: Grayscale

This data illustrates that the premium for ETHE has been even more volatile than that of GTBC. A purchase of ETHE today would result in a 69% premium over the underlying Ethereum held by the trust.

To summarize, the investment trust option is a risky option for digital asset investors not necessarily due to the premium itself, but due to the volatility of the premium, which adds additional risk.

Index Funds

A second option for advisors is an index fund, the most popular being Bitwise. Bitwise offers a variety of index funds, each offering market cap weighted portfolios of digital assets. The funds are rebalanced to maintain their allocations, and some tokens are staked to provide yield.

There are downsides to the index fund approach however. First, there is a minimum investment of $25,000, so an investor would need to have a net worth of at least $2.5 million to maintain a one percent allocation to digital assets. As a result, clients with lower net worth must accept a significantly higher level of digital asset allocation in their portfolio, or forego exposure. It is unclear at this time if an advisor could lump their clients together in an omnibus style investment, and if this was possible it would produce substantially higher regulatory burden.

From a cost perspective, the Bitwise funds charge a 2.5% management fee, which is relatively high compared with the other options available. There is also a 12 month lockup period, which greatly restricts the ability to rebalance assets into and out of digital assets.

Finally, owning the Index fund gives the investor a basket of digital asset holdings that are passively invested, which does not allow much room for portfolio customization. Being such a nascent industry, there is ample opportunity for smart allocations of customized portfolios that could dramatically outperform (e.g.) a frequently rebalanced portfolio of the top 50 assets.

Exchange Traded Funds (ETFs)

Currently the SEC has yet to approve any of the multiple applications for a bitcoin ETF that have been submitted over several years, but this is expected to change. ETFs don’t experience divergence between the shares and the NAV because the underlying can be arbitraged on a daily basis. This means that ETFs trade much closer to NAV. As an example, the chart below shows the premium (or discount) of a share of GLD relative to the underlying gold holdings.

   Chart Source: YCHARTS

While there is still a premium/discount risk, it is significantly less than the investment trust. As a result, when a bitcoin ETF is approved in the future, there will be less reason to buy GBTC, and we can expect the premium to disappear as money flows out of GBTC and into the ETF.
But would an ETF be the panacea for owning digital assets?

While the ETF does not suffer from premium risk as much as the Investment trust, the downside is that there will be very limited options when it comes to cryptocurrencies approved for an ETF. It has taken years with still no results for even a bitcoin ETF to be approved, so we can expect any other cryptocurrencies to take even longer. If an investor wants to gain exposure to a basket of cryptocurrencies, it could be years before an ETF exists that could facilitate it.

To summarize, if and when ETFs become available for BTC, they will offer a significantly lower premium/discount risk than investment trusts. However, non-BTC ETFs will take significantly longer to be approved, limiting an advisor’s ability to expose their clients to the benefits of a diverse range of digital assets.

Own the Underlying Asset – Digital Asset TAMP or SMA

The fourth option allows the investment advisor to purchase digital assets on behalf of each client, in a segregated client account. In this scenario, each client retains ownership of their own digital assets. This involves creating an account on a cryptocurrency exchange and managing the assets through a Digital Turnkey Asset Management Platform (DTAMP).

The first benefit of this approach is that, by definition, there is zero premium risk because the asset being purchased is the underlying asset. Additionally, being able to purchase the assets at a cryptocurrency exchange allows the advisor to select from a significantly wider range of digital assets. Most US cryptocurrency exchanges offer more than 25 digital assets, with new ones being added frequently.

This raises the question of having the knowledge to invest in these assets. An important benefit of a DTAMP is that it doesn’t just allow access to these assets, but also enables the advisor to outsource the management of the portfolio to a third party on the platform in an SMA structure. This means that advisors can offer clients a wide range of digital assets with all the benefits of owning the underlying, even if they don’t have significant experience in the asset class themselves. This is illustrated in the figure below.

A broader array of assets also adds more customization flexibility into the types of portfolios that can be created. Bitcoin being the first and largest cryptocurrency, has a well-defined portfolio definition. It is a widely held view however that other digital assets will continue to develop and mature their own investment thesis as the entire digital asset class evolves. For this reason, a DTAMP or SMA with the ability to manage a diversified portfolio of digital assets has advantages over other managed-account options such as bitcoin-only SMAs.

Potentially the most valuable benefit of owning the underlying in the future is the ability for the advisor to leverage the innovations being implemented by cryptocurrency exchanges. One of these innovations is the ability to earn yield on digital asset holdings. This yield is derived from the staking or loaning of different digital assets on centralized or decentralized platforms. It is too soon to speculate on the full extent of this since a large portion of the infrastructure is still being built, but even today many exchanges offer yield for specific digital asset holdings.

With rates at historic lows, returns in the fixed income market have stagnated, creating opportunity for other asset classes to fill that role in a much more efficient manner. Lending and staking rewards on digital assets held on exchanges are methods of achieving passive income that have gained significant popularity over the last year.

Conclusion

While Investment Trusts are by far the easiest way for advisors to gain exposure to digital assets today, the premium risk adds additional risk to an already risky investment. And while an ETF would limit the premium risk, it is unclear when a bitcoin ETF will be approved, let alone ETFs for other digital assets, if ever. Index funds offer the benefits of broader exposure to a range of digital assets but suffer from higher costs and limited flexibility.

Owning and managing the underlying digital assets with a Digital Turnkey Asset Management Platform (DTAMP) requires a greater initial setup effort than an Investment Trust, ETF, or index fund. However this option allows the advisor to avoid all premium risk, while gaining access to the largest array of assets available, and offering clients all the benefits of full ownership. It also allows the advisor to leverage the exchanges’ ever expanding yield producing functions.

Finally, a Digital Asset SMA offers a sweet spot solution for many advisors – combining most of the advantages of a DTAMP without the setup effort or the need for experience managing digital assets.


Disclaimer: The views expressed in this article are solely opinions of the author and do not represent financial or legal advice whether to buy, sell or hold shares of a particular cryptocurrency, cryptographic asset, stock or other investment vehicle. Prior to trading, investing or purchasing any assets, individuals should consult with their own tax, financial or legal advisor. Past performance is no guarantee of future price appreciation.

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