What the US can learn from Sweden about how to launch a bitcoin fund

Many Americans are tired of hearing about how Scandinavian societies have figured out how to do everything better than us, but here’s one more: how to launch a bitcoin fund.

The Securities and Exchange Commission and ETF companies can’t agree on how to bring a bitcoin exchange-traded fund to market. Just last week four prospective bitcoin ETF issuers withdrew their filings for new funds tracking the digital currency after the SEC shot them down, citing concerns about trading liquidity and valuation of underlying bitcoin futures.

But a Swedish company has proved how it can be done. It has successfully run a bitcoin exchange-traded product for the last two years that can be accessed by European investors in multiple countries, and the products have attracted more than $1 billion.

Stockholm-based XBT Providers launched its CoinShares series in 2015. The XBT Bitcoin Tracker One (COINXBT) trades in Swedish krona, while the XBT Bitcoin Tracker Euro (COINXBE) — they launched on the Nasdaq Stockholm in 2015. XBT also issued versions in Denmark, Finland, Estonia and Latvia. In the Swedish krona version, 200 shares equal the price of one bitcoin, and in the euro version 20 shares equal the price of one bitcoin.

The big difference between the successful Swedish launch and the impasse in the United States is the type of exchange-traded product: the XBT portfolios are exchange-traded notes (ETN), not exchange-traded funds.

An ETN is an unsecured debt instrument that promises to pay the pattern of returns of the bitcoin price. Ironically, despite being an unsecure instrument, the XBT product tracks the spot price of bitcoin by holding the actual currency and forward contracts in case of a liquidity shortfall.

“At that point in time, the ETN structure was the best route to bring the products to market,” said Laurent Kssis, chief executive officer of XBT Provider. “As a result of using this structure to bring the product to market, investors have been able to gain exposure to the price movement of bitcoin since 2015. This stands opposed to the U.S., where most investors are still waiting for access to bitcoin exposure via their normal brokerage account.”

There are three ways to construct a bitcoin portfolio

There are three different ways in which a firm could create a bitcoin exchange-traded product. It could create an exchange-traded fund that owns and stores actual bitcoins, similar to the SPDR Gold Shares ETF (GLD). GLD tracks the spot price of gold by holding physical gold bricks in bank vaults in London. The second way is a bitcoin futures ETF, which approximates the price of bitcoin by owning bitcoin futures products. That’s been the dominant paradigm for SEC filings, including the ones recently pulled, due to the recent uptick in bitcoin futures contracts offered by major U.S. exchanges and securities firms.

“I think using the ETN structure to launch a bitcoin product was a good fit,” said Arlene Reyes, chief operating officer of Exchangetradedfunds.com, a website that reports on global ETFs. “ETNs are unsecured instruments backed by the credit of the issuer, and it tracks the performance of the underlying asset. … XBT Provider holds bitcoins equal to the value of ETN shares issued and tracks the performance of the price of bitcoin. I can see how this structure would be attractive to regulators.”

“I don’t know why an ETN hasn’t been done yet. We know other people are in discussions to make one, but it’s not us. We know it’s being talked about.” -Garrett Stevens, chief executive officer of Exchange Traded Concepts

This past October, XBT came out with two more ETPs to track the second most highly used cryptocurrency, ether, in both Swedish krona and euros: Ether Tracker One (COINETH) and Ether Tracker euro (COINETHE). These also are listed on the Nasdaq Stockholm for European investors.

One of the ETF companies that filed for a bitcoin ETF has looked at the ETN route and says others have been talking about it as well.

“We have considered notes with regards to bitcoin, but we have not had the opportunity,” said Garrett Stevens, the chief executive officer of Exchange Traded Concepts, which worked with REX ETF on a rejected bitcoin futures fund. “But we are a white-label company and we do what someone else wants. That’s what the REX guys wanted, so that’s what we created. I don’t know why an ETN hasn’t been done yet. We know other people are in discussions to make one, but it’s not us. We know it’s being talked about.”

There is one product that currently gives U.S. investors access to the bitcoin market — the Bitcoin Investment Trust (GBTC), managed by Grayscale Investments. However, GBTC is not an ETF, despite press reports. It’s not SEC-registered, and it trades on the Nasdaq over-the-counter markets. It’s highly volatile and can trade at an extreme premium to the price of bitcoin. Some brokers, including Merrill Lynch, are refusing to sell GBTC and other bitcoin-related securities to their clients.

Because they trade on an exchange, products like ETFs and ETNs are not only priced using a net asset value (NAV) — the value of securities held minus liabilities and divided by shares outstanding — that is calculated at the end of each day and by intraday NAV (iNAV) throughout the day. They also have a current market price, which can be more (a premium) or less (a discount) to actual value. The more volatile a market, the more likely there is to be a premium/discount issue.

“The [XBT] products are very well designed for what they do. They deliver, unlike GBTC,” said Matt Hougan, the chief executive of Inside ETFs, an ETF education company. “They give exposure to the returns of bitcoin and ether pretty well. I think they were well executed and they’ve done their job.”

But Michael Sonnenshein, managing director of Grayscale Investments, remains positive. “We are thrilled about the response of the market to the Bitcoin Investment Trust since it became publicly quoted in 2015,” he said. “My team is looking forward to bringing our second vehicle, the Ethereum Classic Investment Trust, to the OTCQX market in second quarter of 2018.”

Some ETF experts believe the chances remain good for a bitcoin ETF to be approved this year.

Before the crash, ETNs were more popular in the US

ETNs were once among regular exchange-traded product launches in the United States, though never at the level of exchange-traded funds in number of portfolios or assets raised. They were more popular with banks as issuers — which had the existing debt businesses to structure the credit side of the investment — than with standalone asset-management companies.

Before the financial crash, there were dozens of ETNs that covered commodities sectors, and many still exist today. But ETNs became less popular after the financial crash, based on the theoretical risk that a failure like Lehman Brothers could expose ETN investors to severe credit risk. While the theoretical risks did not play out, ETNs waned in popularity among new launches.

At the end of 2008, near the depths of the fiscal crisis, there were 74 ETNs, totaling $3.6 billion in assets under management. By the end of 2017, there were 204 ETNs, with combined assets of $24.9 billion, according to ETF.com

ETF companies that have filed for bitcoin ETFs, including REX, Proshares, Van Eck and Direxion declined to comment. Gemini, the investment company of the Winklevoss twins, did not respond to a request for comment.

Like the U.S.-based GBTC, the XBT bitcoin ETNs typically trade at a premium or discount to the actual price of bitcoin, but the range has been much smaller than in the case of GBTC, between 1 percent and 3 percent.

According to Bloomberg, the 52-week average percent premium is 0.46 percent, but it has been as high as 21 percent and as low as negative 16 percent. Still that’s a far cry from the 65 percent premium seen on GBTC.

“What Laurent has proven is the ETN structure has worked and been able to deliver that pattern of returns that’s different from the two paradigms filed with the SEC, which is the physical and the bitcoin futures products,” Hougan said. He also thinks the premium/discount issue is being handled fairly well in the case of XBT’s bitcoin portfolios.

“Bitcoin is an expensive product to trade, custody, store and service at this point. So I don’t think a 3 percent premium in the ETN is absurd,” he said. “That makes the ETN a viable approach.”

Currently, the two Bitcoin Trackers combined (krona and euro) have total assets of $900.8 million, and the two Ether Trackers have total assets of $439.3 million.

—By Lawrence Carrel, special to CNBC.com

Advertisement

WisdomTree Wins ETF of Year at ETF.com Awards As ProShares Walks Away With 4 Statues

It’s award time again.

Much like Spring follows Winter, although reports of more snow this weekend are leading some to question that, the ETF industry starts its period of self-congratulations on the heels of the Oscars, Grammys and Golden Globes.

ETF.com, the self-proclaimed world’s leading authority on exchange-traded funds, started the season off with their second annual awards banquet.

“Our awards try to recognize the products that make a difference to investors,” said Matt Hougan, president of ETF.com. “The ones finding new areas to put money to work.” The awards are determined by a panel of experts chosen by ETF.com.

Held at The Lighthouse restaurant at New York’s Chelsea Piers March 19, ETF.com wins the prize for best party location. With picture windows overlooking the Hudson River, guests of the cocktail hour took in the sunset over New Jersey before the ceremony started.

The WisdomTree Europe Hedged Equity (HEDJ) was the big winner, grabbing the prize for ETF of the Year, while the Market Vectors ChinaAMC China Bond (CBON) won Best New ETF. Not quite sure what the difference is between those two awards, but obviously both funds stand out from the crowd of 117 ETFs issued in 2014.

However, ProShares swept the evening, as the single provider that won the most awards. The twin funds ProShares CDS North American HY Credit (TYTE) and CDS Short North American HY Credit (WYDE) claimed the awards for both Most Innovative New ETF and Best New Fixed-Income ETF.

“We designed these ETFs for investors who want high yield credit exposure that is isolated from interest rate risk,” said Steve Cohen, ProShares managing director.

The fund was also nominated for Best Ticker of the Year with its homophones for “tight” and “wide”. However, the awards announcer had a chuckle by claiming they really were pronounced “tighty whitey”, a reference to his jockey shorts. Best Ticker was awarded to HACK, the PureFunds ISE Cyber Security ETF.

ProShares also won Best New Alternative ETF for the ProShares Morningstar Alternative Solution (ALTS) and Most Innovative ETF Issuer of the Year.

“We are always striving to deliver new and innovative products to allow investors to build better portfolios,” said ProShares Chief Executive Michael Sapir.

Lee Kranefuss, the man who created the iShares brand of ETFs and built them into the largest ETF issuer in the world won the 2014 Lifetime Achievement Award.

In the only speech of the night — thank goodness — Kranefuss said, “ETFs allow people to take control.” He likened ETFs to iTunes, saying “no longer are you limited to what the record company puts out.” He said he’s often been asked if he thought the ETF industry would take off like it has in the 15 years since iShares launched.

“Not really,” said Kranefuss, “we just put out the best products we could put out.”

The other award winners:

Best New U.S. Equity ETF – iShares Core Dividend Growth (DGRO)
Best New International/Global Equity ETF – Deutsche X-trackers Harvest MSCI All China Equity (CN)
Best New Commodity ETF – AdvisorShares Gartman Gold/Euro (GEUR) and AdvisorShares Gartman Gold/Yen (GYEN).
Best New Asset Allocation ETF – Global X /JPMorgan Efficiente (EFFE)
ETF Issuer of the Year – First Trust
New ETF Issuer of the Year – Reality Shares
Index Provider of the Year – MSCI
Index of the Year – Bloomberg Dollar Index
Best Online Broker for ETF-Focused Investors – TD Ameritrade
Best ETF Offering for RIAs – Charles Schwab
Best ETF Issuer Website – BlackRock

Webinar to Teach How to Evaluate Corporate Bond ETFs

Matt Hougan, IndexUniverse’s President of ETF Analytics, and Jason Bloom of Guggenheim Partners will lead a webinar on how to evaluate corporate bond ETFs and what special risks and opportunities should you be aware of? It will teach tactical approaches to corporate bonds such as managing the yield curve to enhance yield and evaluating credit spreads, duration and other key fixed-income metrics.

It will be held at 2 pm EST on Thursday, February 23.

Hougan Calls Out Vanguard on Transparency

Matt Hougan of IndexUniverse.com recently wrote that ETFs Are Not Really Transparent. He calls out ProShares and Vanguard as the worst offenders, although the accusations against Vanguard are much worse. ProShares lack of transparency is more a matter of degrees, while Vanguard pretty much gives investors a poke in the eye.

In fact, Hougan says ETF firms are lying when they say they’re “fully transparent.” It’s a pretty scandalous statement to make about the ETF industry. Transparency is part of the mantra ETF providers chant when trying to convince investors to abandon mutual funds for their products. For those who haven’t heard the mantra it goes something like this: “ETFs are better than mutual funds because they’re cheaper, more tax-efficient, more flexible and more transparent.”

This famed transparency is a direct result of the creation unit process in which the Authorized Participants receive ETF shares directly from the firm. The creation process is what’s known as an in-kind trade. The AP buys a basket of all the securities in the ETF portfolio and trades them for an equal number of ETF shares, which it then sells on the stock exchange. For instance, trading all 500 stocks in the S&P 500 Index for shares of the SPDR (SPY). In order for the AP to buy the correct basket, the ETF needs to publish its portfolio every night. This compares to the mutual fund, which only needs to publish its portfolio every three months.

Hougan says there’s “actually no rule requiring index-based ETFs to disclose their portfolios any more frequently than traditional mutual funds. And for many ETFs, portfolio disclosure is either incomplete or significantly delayed. And the problem is getting worse.”

ETF firms do say if you can’t find the portfolio listings then look at the index. But many ETFs optimize their portfolios, because some securities are so illiquid or small that if the ETF purchased them it would significantly affect the market. So they don’t hold the exact same holdings as the index. This can create a disparity between the index return and the ETF’s return, a situation called tracking error. He adds that some portfolios and creation units differ too, though I lost him on this part.

Still, it’s a bit of a head fake, because as Hougan admits, almost all ETF families do provide the entire portfolios of their ETFs on a daily basis on their Web sites. He also acknowledges that almost all ETF creation units can be found on Bloomberg or if you directly contact the ETF sponsor. However, that’s not great for retail investors without an expensive Bloomberg machine.

However a few firms are taking advantage of the right to not disclose. Hougan calls ProShares a worse case scenario. For most of its short and leveraged funds, ProShares uses equity swaps to achieve their daily return. The swaps and their amounts are listed, but not the counter parties who hold the swaps. This becomes an issue if the counter party can’t fulfill its obligation, which happened in 2008. Lehman Brothers held some swaps for ProShares on the day it went bankrupt, causing problems with the portfolio. However, transparency is a big issue within the entire swaps market, so this might not necessarily be ProShares fault. Rydex SGI and Direxion (click on direct holdings), which also sell short and leveraged funds, list the swaps but not the counter parties.

Most surprising is Vanguard, which Hougan calls the worst offender even as it promotes transparency of holdings on its sites, but only gives them out every three months, like their mutual funds. The latest being Dec. 31, 2009. I’m surprised by this because Vanguard is definitely the ethical standard by which to measure mutual funds. So I figured they would be on the forefront with ETFs.

Ironically, Hougan points out the actively managed ETFs must be totally transparent every day, sort of beating the index ETFs at their own game.

While the few exceptions are troubling, overall I think the window on transparency remains pretty clear, especially considering the alternatives, mutual and especially hedge funds, where you hardly ever know what you own.