The Damage a Bitcoin ETF Could Do to Individual Portfolios

Crypto enthusiasts who want the Bitcoin ETF to go through have not truly understood Bitcoin. It is very easy for someone to make the claim that they’re ‘in it for the technology’ and it is just as easy to see whether they’re telling the truth. The Bitcoin ETF is being proposed by Van Eck, an asset management firm with nearly $47 billion in Assets under Management (AUM). They are pushing hard to get regulatory approval for this ETF to be launched. Cryptocurrency investors worldwide view this as a game changer that will bring more liquidity to the market. While this may be true, institutional investment in Bitcoin may just be a catalyst for its demise.

The argument for the ETF is quite simple, so naturally it is agreeable and people view it in a positive light. Just like any other situation in the universe; every positive has a negative. With a Bitcoin ETF, the primary concern is security. As Andreas Antonopolous has famously said “Your keys, your Bitcoin; not your keys, not your Bitcoin”. With all of these investors putting their money into a passively managed portfolio with one asset, they are pooling their funds and putting it into a set of wallets controlled by Van Eck and its custodian. The Bitwise Asset Management index for Bitcoin and Ethereum are similar to this. The only advantage these particular funds hold is their potential to be included in a retirement plan such as a 401K.

Single Crypto Passive Funds Will Eat Into Your Gains

The concept of a passive fund that has only one asset makes no sense for cryptocurrency. When you look at a hedge fund, at least they’re offering you a service of diversification and professional management. But most of these hedge funds are run by amateurs who think their dominance of equity markets or knowledge of basic blockchain functions deems them fit to manage a cryptocurrency fund. There are some very good funds with extremely competent fund managers and research departments, but the majority, which are funds that are looking to establish a brand or make a quick buck by jumping into the newest financial fad, dominate the limelight.

Holding your own private keys is an essential part of Bitcoin. By investing in an ETF, you are essentially paying a 1.5–2% management fee for them buying your cryptocurrency. To put this in practical terms: you could invest $1,000 in one of these funds and 2% of this amount was annually given to the asset management company for holding the asset for you. This is two negatives in one go; you don’t get to hold your own asset and you have to pay them for it! 2% of $1,000 is just $20 so it doesn’t seem like that big of a deal. But to see the effect of this management fee, consider the following example.

You invest $1,000 in a Bitcoin ETF. The management fee is 2%. Bitcoin gains 10% every year for the next 5 years, so by default, so does the ETF. Parallel to this, you directly invest in Bitcoin; whether as an individual on an exchange like Binance and Coinbase Pro or as an institution on a platform like Coinbase Prime and Gemini. The results of your investment over 5 years sum up as below.

Outcome for above scenario

By avoiding the ETF and investing directly, you gain 12.9% more than an ETF investor. The management fee which increases as your investment value increases seriously erodes your profit margin. Under a similar case, imagine up till year 4 we have the same conditions (10% gain each year), but in the 5th year we suddenly see a 12% loss in Bitcoin’s price. What happens to the end of year value for the ETF investment and the direct investment?

Outcome for scenario with a loss in 5th year

While the direct investor sees the same 12% decline in his investment, the same drop as Bitcoin, the ETF investor witnesses a 13.76% decrease in their investment value.

The Logic behind the Argument

All of this boils down to one simple point: overcomplicating something simple. Buying Bitcoin or any cryptocurrency is easy; open an account on a reputable exchange that accepts the fiat currency of your country, add a card or your bank details, make an electronic transfer from bank-to-bank or from a debit card, buy the crypto of your choice. What is the need to overcomplicate this by having a third party start a fund that just buys and sell Bitcoin based on money coming in and out form investors? At its essence, this ETF is going onto an institutional exchange and purchasing or selling Bitcoin: something you can do yourself.

The fungible nature of Bitcoin and Cryptocurrency in general makes the concept of a single-asset ETF mindless. Gold ETF’s are logical because it cannot be broken down into one hundred millionth of a unit. Gold is sold as 1 ounce or 1–10 grams at minimum (depending on where you live). In India, they sell gold at a minimum of 1 gram which is roughly $48 or 3350 Indian Rupees. The Gross National Income per head is about 100,000 Indian Rupees which is $1400. Expecting almost 5% of yearly income to go into gold is definitely not feasible. While most people in the investing class of India make much more than this on a yearly basis, they still cannot make such a large allocation to gold. Gold is meant to be a minor player in an investment portfolio, not make up a huge allocation. Gold ETF’s give investors the ability to invest small amounts into gold, just like a regular stock index ETF or a mutual fund gives investors to ability to invest relatively small amounts with sector diversification that otherwise would’ve only been possible at an individual level with a large portfolio.

The Bitcoin ETF gives you no such benefit; it doesn’t offer you multi-asset diversification or the ability to invest a small amount into it. Bitcoin is currently divisible to the 8th decimal. When Bitcoin is worth $100,000,000 you can still buy .00000001 Bitcoin (1 Satoshi) for $1.

Where ETF Talks are Headed

As I was writing this I heard that CBOE is withdrawing the proposal for the VanEck ETF. This is all but the end for ETF tailwinds. Now that the idea has been planted into the minds of the many CIO’s and CEO’s of various asset management companies, we are bound to see one company after the other try to get ETF approval from the SEC. The entire finance industry is as bound together as a Colombian cartel. When they decide to come together to lobby for Bitcoin investment products to be regulated, the SEC will finally give in to their wishes. Right now, VanEck and few other lesser powerful players have made their attempts. When the real big boys of the investment management space decide they want to push out Bitcoin and other cryptocurrency based financial products, the SEC will at some point give in to their wishes. This may turn out to be a good thing just for the fact that the authorities will put down some guidelines and regulation for cryptocurrency. This will give individuals more clarity on just how they are expected to treat this new asset class. Regulation also means a lot more investors who have been skeptical thus far will enter the market with a sense of confidence that their trusty securities regulator has their back.

The ETF talks are going nowhere. They’re here to stay. The theory that these institutions are driving prices down seems downright nutty to some people. But you cannot deny that both of the following things are true: they have the power and resources to suppress the price of the cryptocurrency market and they would greatly benefit from doing so. There are honestly no clear signs of ‘institutional manipulation’, at the same time it cannot be ruled out because we cannot see exactly where cryptocurrency volatility stems from

Conclusion

A passively managed product for a single cryptocurrency will most definitely decrease the magnitude of your gains and increase the magnitude of your losses. But it does hold its own benefit. A Bitcoin ETF as a mainstream financial product would get more people interested in cryptocurrency and distributed ledger systems. It would have a ripple effect (pun not intended) and would end in more people learning about cryptocurrency, decentralization, and the ability to take back some degree of your power and privacy from large corporations (at least).

The only thing we can hope for is that an ETF product helps draw more attention to the space and as people learn more and more, they see the flaws of a passive single-crypto product and the importance of holding your private keys. From a slightly more pessimistic perspective, it can also lead to the bigger players in the space taking advantage of people by getting them to jump into their risky customized crypto based financial products and put individual savings and entire economies at risk. So I guess at the end of this anti ETF argument, we end on a note where it can either raise more heads toward cryptocurrency or turn it into another avenue for crony capitalism. Only time will tell where exactly we are headed; all we can do is hope for the best and continuously contribute to the decentralization revolution.