The approval of spot bitcoin ETFs in January 2024 and the rise of digital asset treasury companies have given institutional investors more routes to bitcoin exposure than at any point in the asset's history. More routes mean more trade-offs.
This article breaks down what investors in each category actually own, what risks they are accepting, and how to evaluate the options against specific institutional goals. There are no simple answers here, only trade-offs that need to be understood before the first allocation.
by Alexander S. Blume
Co-Founder and CEO of Two Prime
The Options Available Today
After many years of regulatory resistance to Bitcoin, the asset has now gained approval to enter into mainstream capital markets. Starting with the approval of spot BTC ETFs to trade on January 11, 2024, various legal wrappers for BTC exposure have emerged.
Recently, a notable trend has emerged as public companies add BTC to their balance sheets. Many investors likely wonder how to get best involved with this complex set of options. There are no black-and-white answers to this, only trade-offs.
In this article, we will break down the pros and cons of each.
The Case for Direct Bitcoin
Owning actual Bitcoin, held in a personally controlled wallet of your own custody, is the original form of owning Bitcoin. Much like owning a bar of gold in your house, this offers complete control over the asset. This was the original intent of Bitcoin, an asset independent of government control or centralized authority. If custodied properly, it can not be seized or hacked or, potentially, even known that you own it.
Self-custody offers a double-edged sword for many. Properly custodying Bitcoin in cold storage can result in a complete loss of your investment if not done carefully. First, the private key can be lost and unrecoverable. This famously occurred to James Howells, who accidentally disposed of the private key to access 8000 BTC, worth over $850MM today. There is no backup for self-custody. Just as if you lost a bar of gold, it can be lost forever with no recourse. With great power comes great responsibility. In addition, ease of access to cold storage Bitcoin means that transacting may be slow. The process of accessing, transferring, or selling Bitcoin can take hours or days, which may pose a problem for some.
There are alternatives to this, but they essentially remove the benefit of owning BTC directly. This includes keeping your Bitcoin on an exchange, storing your private keys in a bank or with a lawyer, or using a private key device like a Ledger to store them. This decreases the odds of you losing your Bitcoin; it also removes the self-sovereign properties that make owning Bitcoin attractive and unique. You have to trust some other party or company to keep you secure.
"There are no black-and-white answers to this, only trade-offs."
Bitcoin ETFs: What They Remove
Bitcoin ETFs are legal wrappers that allow people to gain exposure to the price of Bitcoin. They create a legal entity that holds the Bitcoin in custody on your behalf. The ETFs are regulated by the SEC and must abide by strict compliance, reporting, and security standards to be approved. This allows regular investors to make an investment in Bitcoin without having to deal with the technological peculiarities the asset poses. These ETFs are trading on major stock exchanges and can also be accessed by retirement accounts and large financial institutions that must abide by strict investment and regulatory policies.
Though ETFs simplify ownership, they also neuter much of the unique protections Bitcoin can provide. You are depending on a large set of human beings to protect you. This includes the ETF creator, a firm like BlackRock or Fidelity, for example, the custodian, which is almost always Coinbase, the regulators, and market-making firms. Though all of these groups are regulated and legitimate, their incentives are not exactly aligned with every individual who wants to own bitcoin. Changes to policy, technical errors, hacks, and fraud can all arise when so many counterparties get involved.
Treasury Companies: Leverage and Risk
The latest wave of BTC exposure has come in the form of so-called Bitcoin Treasury Companies. These are public companies that hold Bitcoin rather than only USD. These vehicles offer many of the regulated protections and mainstream accessibility of an ETF and can be traded on exchanges, but add a variety of strategies and financial engineering approaches to aim to generate greater returns.
These approaches can vary widely depending on the company. It can include selling more shares of stock into the market to raise more money, selling convertible debt, offering exposure across different jurisdictions in order to tap into untouched markets, trading the bitcoin using derivatives, taking out loans with the bitcoin to buy more bitcoin, and much more. For some jurisdictions, no ETF exists, and so a simple company that just buys and holds Bitcoin for shareholders may be the best option available. All of this adds another layer of human involvement to the risk of the investment. It can also mean much greater upside if chosen properly. Some of these companies trade at 10 times the value of the actual Bitcoin they hold.
Though investors may be able to make more upside with BTC treasury companies, gaining exposure to intelligent strategies and retail buying momentum, they also have more risk. The same factors that can create outsized gains can create outsized losses. These are very sophisticated financial products that leverage aspects of retail speculation, debt instruments, marketing, and legal and jurisdictional arbitrage to, hopefully, outperform Bitcoin. Some of these strategies suffer from black swan-type risk, in which they will look to be doing very well until they suddenly fail. Others will be successful far out into the future.
One important aspect to consider with BTC Treasury Companies is whether they are pure-play Bitcoin holding companies or whether Bitcoin complements other business activities and income. Companies that have real income may be better positioned in the long run for stability and risk management during times when the price of BTC falters, since they have other ways to pay bills and stay in business. Companies that are pure-play vehicles may have greater upside and volatility.
In the end, all of these vehicles can make sense for different types of investors, from long-term individual holders to pension funds to day traders. It’s important to truly understand what the company does to generate a return for you so that you can evaluate risk with a clear perspective.
This article originally appeared in Forbes.
