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A Look Under The Hood Of One Of The World's First Bitcoin ETFs

February 26, 2021 9:22 am
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A Look Under The Hood Of One Of The World's First Bitcoin ETFs

Last week marked another big milestone in the ever-evolving cryptocurrency story with the introduction of a pair of bitcoin ETFs to the Toronto Stock Exchange, the first of their kind to trade on a major North American exchange.

But while the approval of the funds caught some off-guard, the regulatory and logistical process of fine-tuning how a bitcoin ETF would be regulated, managed and priced was a years-long process.

Benzinga spoke with Raj Lala, President and CEO, and Elliot Johnson, Chief Investment Officer at Evolve ETFs, who are the key principals responsible for shaping the Evolve Bitcoin ETF (TSX:EBIT).

Launched for trading as unhedged (EBIT) or USD-unhedged (EBIT.U) on February 19, the mechanics of the funds were tailored to optimize traders’ direct exposure to bitcoin as an asset while also reducing costs and management fees as much as possible.

This was initially accomplished by tying the funds pricing structure to CF Benchmarks, a unique leader in the crypto space that offers a fully-regulated crypto benchmark to ensure the accuracy of the fund’s NAV. CF Benchmarks draws transparent real-time price from five publicly available bitcoin exchanges, whereas the other bitcoin ETF on the market, the Purpose Bitcoin ETF (TSX:BTCC), utilizes TradeBlock XBX which references just four. 

However, in their continued effort to reduce investment costs, Evolve ultimately decided, less than a week from their launch, to reduce those fees even further. Now both EBIT funds carry a management fee of just 0.75% from 1% on their initial release making the Evolve Bitcoin ETF the lowest-management fee bitcoin ETF currently available in the market, bringing a valuable opportunity for investors.

“We took the approach when constructing the fund to make sure all key levels of the structure were regulated and held to an institutional standard,” said Lala.  “The updated management structure is just bringing the fee to that level.”

See also: Is Bitcoin A Good Investment?

A Defining Fund

In describing how they crafted EBIT to best deliver direct exposure to bitcoin with as low of a cost barrier as possible, Johnson highlighted the existing financial infrastructure that had taken shape over the intervening five years, from the creation of closed-end fund like the Grayscale Bitcoin Trust (OTC:GBTC) to the CME Group’s launch of bitcoin futures.

“Our position going into discussing with regulators was that investors would be better served by an ETF than these closed-end funds that have high management expense ratios and pretty poor tracking to the underlying asset,” said Johnson. “If the job of a regulator is to be principally concerned with investor protection, the ETF model makes sense because it allows for the fund to grow and shrink in size based on investor demand.”

These initial investment frameworks not only established the standards and best practices that Evolve would work within, but also the gaps that existed in incorporating bitcoin into an investment portfolio.

Because valuation is one of the most pressing gaps in bitcoin trading, Evolve deferred to the CME’s CF Cryptocurrency Index, which has been used for over three hundred billion dollars of CME futures transactions and is derived from U.K.-based CF Benchmarks, one of the most scrupulously regulated indexing companies in existence.

“If you're going to buy a product, you should make sure that the price you're paying comes from some valid place that has a clear process for determining price. CF Benchmark’s process involves audit checks on five large bitcoin exchanges that are completely publicly available. If you want to find out how the price of EBIT is put together, you can walk through it yourself and check every last input into that price.”

Johnson also stressed that, because EBIT’s NAV is fully deployed in bitcoin at all times, the fund maintains a price continuity that traders can rely on to actively reflect changes in the price of bitcoin. A consequence of this is that Evolve ensured the process for buying and selling assets within EBIT was as streamlined and transparent as possible, beginning with quotes provided by market makers for the creation or redemption of new units that dictate whether the fund needs additional or fewer bitcoins.

“We then negotiate with a bitcoin counterparty to sell us the bitcoin at a predetermined price. Then we just wire our money to Gemini Trust, which is where we hold our bitcoin, the counterparty shows up with the bitcoin, the trade is matched and our bitcoin immediately goes to a cold wallet, which means it's encrypted with a set of keys that are never connected to the internet, and the fund has the bitcoin,” said Johnson. “We don't go anywhere else.”

See also: Gemini Review

Decrypting Bitcoin

These factors of value and transparency will without a doubt play a massive role in defining what a cryptocurrency ETF will look like as they become more common.

Having traded for less than a week EBIT, as well all current and future bitcoin ETFs hitting the market, will be competing for the attention and capital of retail traders who may have only dabbled in trading bitcoin, if they’ve held the asset at all.

Said Lala, “You've got the investors who bought bitcoin for themselves, those that identified a bitcoin exchange, set up an account, went through all of the background checks, that's one group. Another group is those who bought closed-end funds like GBTC and have been willing to pay very high fees and have the product trade at these volatile premiums relative to NAV. Then there’s the third category, which is who we’re trying to appeal to.”

Putting it in terms of the launch of the first ETF more than 30 years ago, which was also on the TSX, Lala explained that the ETFs for this new asset class will ultimately streamline the process for average retail investors to diversify their portfolio with an asset that has so far been generally uncorrelated to any other asset class.

“We’re hoping to appeal to those that are skeptical of buying bitcoin directly and who don't want to pay these volatile fees. This ETF is really good for retail traders because it's got great tracking and is overall more convenient, which should appeal to everyone. ETFs have the value add of having market makers who provide a quote for unit prices all day long at the NAV of the fund in real-time.”

This added convenience, as well as the entirely new class of trader likely to buy into EBIT, may well alter the trajectory of bitcoin and cryptocurrency as the asset takes another step toward widespread acceptance.

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