Navigating Digital Asset Investment Solutions with a Deep Dive into Investable Bitcoin Products - August 2021
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
August 2021 Navigating Digital Asset Investment Solutions with a Deep Dive into Investable Bitcoin Products Joy Yang, Global Head of Index Product Management
Evaluating Digital Asset Investment Solutions August 2021
Navigating Digital Asset Investment Solutions with a Deep
Dive into Investable Bitcoin Products
A major trend that has accelerated sharply during the Covid-19 Pandemic has been the rise in demand for digital
assets. In April 2021, the market capitalization of digital assets topped US$2 trillion, gaining mainstream support
from institutions and institutional quality infrastructure. As demand continues to increase, so too does
investment opportunity — investors have never had such optionality in accessing digital assets. Understanding
the potential advantages and considerations for the different investment vehicles available can help investors
determine which option best delivers their investment solutions. Industry standard benchmarks, such as those
offered by MV Index Solutions (MVIS®), can help investors evaluate their different options and assess the
solution for their specific investment goals.
Exhibit 1: Digital Asset Growth
$ 2,000mn 7000
MarketCap Top 100 Assets (USD)
$ 1,500mn 5250
Count of Assets
$ 1,000mn 3500
$ 500mn 1750
$ 0mn 0
07/10 07/11 07/12 07/13 07/14 07/15 07/16 07/17 07/18 07/19 07/20 07/21
Market Cap Top 100 Assets Cumulative Monthly Coins
Source: MV Index Solutions, data as of 30 June 2021
The growing appetite for digital assets coupled with new ways to invest in digital asset growth have resulted in
the increase of digital asset indices and index-linked investment products. Digital asset indices are created by
index providers, such as MVIS, to benchmark the performance of the digital asset market by tracking a specific
digital asset, a basket of digital assets, or digital asset investment strategies. Investors cannot invest directly
in an index, but they can invest in an index-linked product. Choosing the right index-linked product starts with
understanding the underlying index. The MVIS CryptoCompare Indices are designed to help investors make
better investment choices and are actively used in underlying investable digital asset products.
mvis-indices.com 2Evaluating Digital Asset Investment Solutions August 2021
Exhibit 2: Digital Asset Performance
Top 100 DA Top 5 DA Top 10 DA BTC ETH
RETURN 301.49% 334.93% 332.65% 479.34% 426.80% The MVIS CryptoCompare Indices are
designed to help investors make better
MO STDEV 22.14% 25.26% 25.41% 23.47% 31.30%
investment choices and are actively
ANN RETURN 58.9% 63.2% 62.9% 79.6% 74.0% used in underlying investable digital
asset products. They track a specific
ANN STDEV 76.70% 87.50% 88.03% 81.29% 108.42%
digital asset, a basket of digital assets
MAX RETURN 51.32% 65.99% 59.94% 56.54% 89.66% or digital asset investment strategies.
MIN RETURN -36.01% -34.02% -34.17% -36.13% -41.86%
Source: MV Index Solutions, data as of 30 June 2021
mvis-indices.com 3Investable Solutions for BTC
Investors interested in digital assets have over 7,000 assets to choose from and a variety of investment options
to access digital asset investment returns. Given its maturity and wide acceptance, bitcoin still dominates the
market opportunity set, as measured by market capitalization. While purchasing bitcoin directly remains the
most obvious way for investors to participate in the performance of bitcoin, due to a range of complexities and
costs, the direct purchase approach may not be the most optimal approach for many investors.
Direct investment
Bitcoin can be purchased on an exchange or marketplace where digital assets are traded, either directly
or through a broker. Investors need to make decisions around exchanges and safe custody. Investors
also need to manage AML/KYC fees, software upgrades, hacking risks, and privacy issues. Full-service
payment platforms offer additional services to manage the above at a fee, but may have restrictions
around platform transferability. By owning bitcoin, investors will gain access to the asset’s price
performance and can use it as a currency to make limited transactions.
Bitcoin mining
Bitcoin miners solve complex problems to validate bitcoin payments in return for bitcoins as reward
for their contributions. Although miners do not pay for the bitcoins they receive as rewards, the costs
of running the hardware and energy to mine bitcoins can be costly, and rewards decrease as the number
of bitcoins paid out is predetermined to halve roughly every four years. To redeem bitcoins and realize
payment for cash, bitcoin miners must deal with the same issues as direct bitcoin investors, as noted
above.
Futures
Bitcoin futures enable investors to gain exposure to bitcoin without having to hold the underlying asset
by taking cash instead of physical delivery upon settlement of the futures contract. Like futures
contracts for commodity or stock indices, they allow investors to leverage and require margin accounts.
Because bitcoin is a risky asset, regulated exchanges generally require higher margin amounts
compared to other assets. And because bitcoin is a volatile asset, investors can face unexpected, forced
liquidations when they are unable to fulfill the margin requirements. Long-term investors using bitcoin
futures must manage costly futures rolls as contracts expire or they can now invest in perpetual futures
— contracts with no expiry or settlement — to keep their position. The bitcoin futures price is based on
bitcoin spot prices as well as the cost of carry — creating opportunities for price deviation from the
underlying bitcoin price. Equities
Publicly listed companies that generate a significant portion of their revenues from the bitcoin
ecosystem can provide correlated exposure to bitcoin performance. There are several alternatives,
such as investing in companies that provide services, products or technology for digital exchanges,
payment gateways, mining operations, infrastructure, commerce, software, equipment, and hardware
for the digital asset ecosystem. Investors can buy a portfolio of these companies directly or find funds
and ETFs that have exposure to digital asset-related companies to provide an indirect exposure to
bitcoin performance. They provide investors relevant exposure to bitcoin to the extent these listed
companies, in aggregate, are directly impacted by bitcoin’s performance and are highly correlated to
bitcoin price movements.
Funds
Funds pool the investment costs and participation of owning bitcoins. They can be open ended (can
issue/redeem an unlimited number of shares to investors) or closed-ended (capping the number of
shares it sells at inception). Open-ended funds are bought and sold at their net asset value (NAV), which
is defined as a fund’s total assets minus its total liabilities and closed-ended funds can trade at a
premium or discount to NAV depending on supply/demand interest. Investors pay a additional fees to
manage the operations of holding and trading bitcoin. Funds provide investors the performance of
bitcoin less the management fees, trading costs and or platform fees where investors access fund
shares. Investors own shares of the fund, not the underlying bitcoins.
Exchange Traded Funds (ETFs)
ETFs combine the ease of stock trading with the benefits and cost efficiencies of pooled funds. As
regulated funds, they provide all the options listed above under Funds, with the additional benefits of
regulated securities trading, including the ability to short positions. Additionally, the capital gain tax
triggered by fund trading can be minimized through the in-kind mechanisms of an ETF1. While several
companies have filed to issue U.S. bitcoin ETFs, there currently are no U.S. ETFs offering bitcoins or any
other digital assets, however, there are various regulated ETF bitcoin products in other jurisdictions
outside of the U.S., such as those listed and regulated in Canada and Europe.
1
Funds are subject to capital gains tax. Trading within a fund, either related to rebalances or redemptions can trigger a taxable event and
subject investors to capital gains. Redemptions of shares from a fund triggers capital gains for all shareholders, even for shareholders
who did not redeem or may have an unrealized loss on the overall fund. ETFs can accommodate share creation and redemptions by
delivering a basket of securities “in-kind” instead of trading to match the shares required for creations and redemptions. As a result, no
capital gains tax is triggered for fund shareholders. Alternative Investment Vehicles
Qualified sophisticated investors can make direct as well as indirect plays on the bitcoin price through
alternative investment vehicles, such as hedge funds or venture capital funds. These often require
minimum initial investments that are far higher than what mutual funds may require with higher fees
and potential lock-in periods. They can also be subject to minimum accredited investor standards under
different regulatory regimes.
Bitcoin and digital assets in general are not currently regulated. Regulators are carefully monitoring this space
and the investment options investors have will differ and evolve as the ecosystem for the underlying asset
grows. In comparing options to a direct investment, investors must consider not just additional implementation
costs or management fees, but also how the regulatory framework constrains or supports each investment
solution.
Setting Benchmark Standards to Evaluate Investable Alternatives
A standard framework to evaluate the different investment alternatives is to measure them against a relevant
benchmark by reviewing the performance tracking difference and tracking error2 between the various options
and the benchmark, net of all costs. Digital assets have several distinct characteristics which make it harder to
index and price. The fact that they are highly volatile, global, 24/7 markets create complexities not typically seen
in traditional asset classes or their benchmarks. Digital assets based on public blockchains are described as
decentralized because it is not possible to limit their exchange and transactions to a specific location. For
example, bitcoin is traded on over 100 exchanges worldwide and in peer-to-peer locations, therefore measuring
liquidity is another challenge. Getting the pricing right is critical in evaluating an investment solution based on
digital assets and what slippage may incur in any investable approach. Having investment industry
benchmarking for an index can help the investors consider the trade-offs for cost, risk, implementation,
performance, and investment goals across different investable alternatives.
MVIS is the first regulated benchmark provider to meet investment industry benchmarking standards for digital
assets by providing a public digital asset methodology rulebook for fork treatments and other events, industry-
wide data distribution, proper identifiers, and further standard index governance requirements that are
expected from a regulated, unaffiliated, major benchmark provider. MVIS Digital Assets Indices are the first and
definitive family of benchmarks for the digital assets market. These indices provide institutional-grade access
to the largest and most liquid digital assets.
In 2017, MVIS, in partnership with CryptoCompare —a global leader in digital asset data providing institutional
and retail investors with high-quality real-time historical data — launched a series of digital asset indices
designed to track the performance of the otherwise fragmented global digital assets markets more accurately.
CryptoCompare offers the most complete pricing and transaction data collected from digital asset exchanges.
Their exchange leadership reports, analytics, and exchange reviews offer objective insights and sets the
2
Tracking difference is the simple mathematical difference between the investment performance and benchmark performance. Tracking
error is the annualized standard deviation of daily return differences between the investment performance and the benchmark performance.Evaluating Digital Asset Investment Solutions August 2021
standard for the digital asset industry. MVIS is proud to have worked together with CryptoCompare for more
than four years.
The MVIS CryptoCompare Bitcoin Benchmark Rate (BBR) is designed to be a robust price for bitcoin in USD.
BBR is a one-hour median-weighted index based on CryptoCompare’s CCCAGG pricing methodology3 which
uses a weighted average of the latest available trading price of each eligible exchange. Eligible exchanges are
chosen from top-ranked exchanges based on CryptoCompare Exchange Benchmark ranking table4. Using a
rigorous approach that combines both quantitative and qualitative assessment to exchange selection can help
solve risks around price manipulation, fake liquidity, regulation penalties, data quality, and specific risk events
to provide more robust reference prices for digital assets.
MVIS Digital Asset Index Solutions
Digital assets will continue to be a growing resource for many investors seeking alternative sources of return
and risk to diversify their existing holdings. Though the specific vehicle an investor chooses is less important
than the underlying assets within it, all investment decisions should be carefully deliberated. The MVIS
CryptoCompare Indices are designed to help investors make better investment choices and are actively used in
underlying investable products. The MVIS CryptoCompare Bitcoin Benchmark Rate (BBR) leads the way with
over $2 billion USD in assets under management (as of 30 June 2021) licensed to underlie financial various
products. It is available with real-time, 24/7 data with historical data going back to 2016. MVIS indices serves as
a reference rate for funds, asset managers, and exchanges who wish to build financial products in the digital
asset space, such as derivatives and ETFs/ETPs, using a proven, robust index as their underlying benchmark.
3
CCCAGG is CryptoCompare's proprietary index calculation methodology for digital assets, based on 24-hour volume weighted average
calculation, time-penalty factor and outlier methodology. It aggregates transaction data of more than 250 exchanges, with the purpose to
show the best price estimation for cryptocurrency traders and investors to value their portfolio at any time.
https://data.cryptocompare.com/reports/cryptocompare-aggregate-index-methodology-jan-2021
4
CryptoCompare Exchange Benchmark was established in 2019 as a tool to bring clarity to the cryptoasset exchange sector by providing a
framework for assessing risk, bringing transparency and accountability to a complex and rapidly evolving market. It has since become an
industry standard for evaluating exchanges. The methodology has since expanded and is now approached in several dimensions using a
comprehensive data set, covering more than 160 exchanges across 8 categories of evaluation:
• Legal/Regulation
• KYC/Transaction Risk
• Data Provision
• Security
• Team/Exchange
• Asset Quality/Diversity
• Market Quality
• Negative Events Penalty
Adopting an innovative ranking methodology that utilizes a combination of qualitative and quantitative metrics, the methodology assigns a
grade to each exchange which helps identify the lowest risk exchanges in the industry.
https://www.cryptocompare.com/exchanges/#/overview
mvis-indices.com 7Evaluating Digital Asset Investment Solutions August 2021 August 2021 Case Study Case Study: 3iQ BTC ETF, an investable bitcoin solution using MVIS CryptoCompare Bitcoin Benchmark Rate (BBR) In April 2021, MV Index Solutions GmbH (MVIS®), in partnership with CryptoCompare, licensed the MVIS CryptoCompare Bitcoin Benchmark Rate (BBR) to 3iQ Corp. for their 3iQ CoinShares Bitcoin ETF (TSX: BTCQ.U) which trades on the Toronto Stock Exchange (TSX). BTICQ (the ‘Fund’) is a regulated fund structure that trades as a security (the ‘ETF’) on a regulated exchange. The fund issuer, 3iQ, is Canada's largest digital asset investment fund manager with more than C$3.5 billion in assets under management (AUM). With several options for bitcoin ETFs in Canada, BTCQ was one of the fastest bitcoin ETFs in Canada to reach $1 billion USD in AUM. The ETF's investment objectives are to provide holders of units of the ETF with: (a) exposure to digital currency, bitcoin, and the daily price movements of the U.S. dollar price of bitcoin, and (b) the opportunity for long-term capital appreciation. Launched during the bitcoin price high of around $60K USD in April 2021, BTCQ survived the turbulent ride of the May 2021 crash in bitcoin prices. As bitcoin prices tumbled below $30K USD, a fall in BTCQ AUM followed suit. Remarkably, BTCQ had minimal redemptions in Fund shares as investors stayed put in the Fund with overall net inflows for the month of May. Instead, investor activity carried on by trading the ETF shares through the exchange, As trading volume spiked during May, the ETF shares trading on the exchange provided continuous liquidity for investors, minimizing underlying bitcoin trading activity in the Fund (Exhibit A). By limiting trading in the underlying bitcoins held by the Fund, investors were protected from potential taxable events as well as further price pressure on bitcoin and potential price deviation to bitcoin. By trading continuously, BTCQ provided bitcoin liquidity, even when underlying bitcoin exchanges halted. mvis-indices.com 8
Evaluating Digital Asset Investment Solutions August 2021
Exhibit A: Investor Trading Activity in BTCQ during May 2021
$60,000 315,000
$45,000 230,000
BTCUSD
Shares
$30,000 145,000
$15,000 60,000
$- (25,000)
05/06 05/09 05/12 05/15 05/18 05/21 05/24 05/27 05/30
ETF (Daily Shares Traded) Fund (Shares created/redeemed) BTCUSD Spot Price
Source: MV Index Solutions, 3iQ, Bloomberg
With minimal trading in the underlying bitcoins held by the Fund, we expect that the Fund would perform in line
with its direct holding in bitcoin. A review of the tracking difference between BTQC and its underlying benchmark
BBR shows that despite the price volatility in May 2021, the Fund did indeed track closely to both its benchmark
as well as the BTCUSD spot price, providing performance in line with bitcoin (Exhibit B). Furthermore, despite
the active trading in the ETF shares, a review of the ETF price showed that the ETF stayed in line to the Fund
NAV, trading within a narrow premium/discount range of +/-2% (Exhibit B). The ETF structure held well during
the crises and protected investors from both price dislocation and forced sales in the underlying assets, while
delivering its aim to provide exposure to bitcoin and the daily price movements of the U.S. dollar price of bitcoin.
Exhibit B: Bitcoin vs BTCQ ETF and Fund NAV Price during May 2021
110 2.00%
Price Levels (rebased o 100)
Price Prem/Dis (% Diff)
95 1.00%
80 0.00%
65 -1.00%
50 -2.00%
04/30 05/03 05/06 05/09 05/12 05/15 05/18 05/21 05/24 05/27 05/30
BTCQ Prem/Disc to NAV BBR Index BTCUSD Spot BTCQ ETF BTCQ NAV
Source: MV Index Solutions, 3iQ, Bloomberg
mvis-indices.com 9Evaluating Digital Asset Investment Solutions August 2021
As one of the most successful financial innovations in the last 25 years, ETFs have been attracting flows and
expanding beyond equity asset classes. But their appropriateness for assets that do not trade like equities
continues to be questioned. The concern around ETFs that trade on liquid stock exchanges holding illiquid
assets, centers around the mismatch in liquidity between the vehicle and the underlying assets. Specifically,
during volatile market crashes, panic selling of ETF shares combined with a lack of market makers can lead to
forced sales in the underlying fund holdings. This selling pressure drives prices further down and can trigger
trading halts in the underlying assets, ending in a liquidity trap with investors unable to withdraw their funds.
This is the “illiquidity doom loop” 5.
ETF performance, in general, over the last few market crashes, has proven that not only can ETFs withstand
market crashes, but they also offer alternative sources of liquidity to dampen market crashes as their initial
concept design intended6. They provide a mechanism for sellers and buyers to meet without triggering trading
in the underlying assets. Buyers and sellers can continue to trade even when markets in the underlying assets
are closed, providing powerful price discovery when markets in the underlying assets are unable to. However,
risks do exist with notable exceptions such as the suspension of trading of the United States Oil Fund ETF (USO)
in April 2020. USO aims to provide oil exposure by investing in oil futures and is one of the largest oil ETFs. The
unprecedented scale of oil price movements, as oil prices fell below zero, attracted investors into USO and
triggered Fund share creations. As the Fund increased positions in short-term oil futures, it hit regulated
futures position limits, causing USO to temporarily suspend Fund share creations and trading in the ETF shares.
USO was forced to change its structure to hold more expensive longer-term basket of futures, triggering a
sharp negative performance divergence between USO and the price of oil.
For any fund structure, investors must look underneath the wrapper. With an ETF structure, investors can
monitor, in real-time, how BTCQ fared against its underlying holdings in bitcoin. Using the index, BBR, as a
reference price, fund accountants, market makers, brokers, asset managers, and regulators have transparency
and data to manage rapidly evolving markets and complex scenarios for risk assessment. BBR uses multiple
exchanges to source bitcoin price in its pricing methodology. This enables BBR to provide continuous, quality
price data, even with outages in specific exchange, such as those that occurred in Binance and Coinbase during
May 2021. BBR’s price methodology dynamically follows liquidity, providing investors with a more accurate
reflection of bitcoin price for valuing BTCQ.
Confidence in understanding an investment product starts with confidence in understanding the underlying
asset valuation and having real-time data for transparency and clarity. MVIS delivers investable solutions for
high quality investment products.
5
“Illiquidity Doom Loop” is a phrase that first appeared in Bloomberg News to describe the price dislocation between equity ETFs and their
underlying bond assets. Bloomber.com, March 2020.
https://www.bloomberg.com/news/articles/2020-03-20/mizuho-charts-roadmap-for-an-illiquidity-doom-loop-in-etfs
6
In 1988, post Black Monday, Oct 1987 – the day the US stock market fell 22% in one single day, still the largest single one-day fall – the SEC
review of the crash, contained a recommendation for “an alternative approach be examined”. The report suggested the creation of a single
“product” – a baskets of stocks – that would provide the opportunity for well-capitalized specialists and supplementary market makers to
trade. This would create a liquidity buffer between the futures market and individual stocks, and have the potential to dampen market
volatility and possibly prevent a crash. Bloomberg.com, https://www.bloomberg.com/features/2016-etf-files/
mvis-indices.com 10Evaluating Digital Asset Investment Solutions August 2021 Contact info@mvis-indices.com Joy Yang Joy Yang is Global Head of Index Product Management at MV Index Solutions (MVIS). She is responsible for managing MVIS products and services to accelerate innovation in financial index design and adoption. Joy brings more than 25 years of investment experience to MVIS, having led teams delivering index and quantitative-active investment solutions at Arabesque Asset Management, Dimensional Fund Advisors, Vanguard, Aberdeen Standard Investments, AXA Rosenberg and Blackrock. Joy has an MBA from the University Of Chicago Booth School Of Business, and a BS in Electrical Engineering from Cooper Union’s Albert Nerken School of Engineering. mvis-indices.com 11
Evaluating Digital Asset Investment Solutions August 2021 IMPORTANT DEFINITIONS AND DISCLOSURES Copyright © 2021 by MV Index Solutions GmbH (“MVIS”). All rights reserved. MVIS is a registered trademark of Van Eck Associates Corporation that has been licensed to MV Index Solutions GmbH and BlueStar and BlueStar Indexes are registered trademarks of MV Index Solutions GmbH. Redistribution, reproduction and/or photocopying in whole or in part are prohibited without written permission. All information provided by MVIS is impersonal and not tailored to the needs of any person, entity or group of persons. MVIS receives compensation in connection with licensing its indices to third parties. You require a license from MVIS to launch any product that is linked to an MVIS index to use the index data for any business purpose and for all use of the MVIS name or name of the MVIS index. Past performance of an index is not a guarantee of future results. It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available through investable instruments based on that index. MVIS does not sponsor, endorse, sell, promote or manage any investment fund or other investment vehicle that is offered by third parties and that seeks to provide an investment return based on the performance of any index. MVIS makes no assurance that investment products based on the index will accurately track index performance or provide positive investment returns. MVIS is not an investment advisor, and it makes no representation regarding the advisability of investing in any such investment fund or other investment vehicle. A decision to invest in any such investment fund or other investment vehicle should not be made in reliance on any of the statements set forth in this document. Prospective investors are advised to make an investment in any such fund or other vehicle only after carefully considering the risks associated with investing in such funds, as detailed in an offering memorandum or similar document that is prepared by or on behalf of the issuer of the investment fund or other vehicle. Inclusion of a security within an index is not a recommendation by MVIS to buy, sell, or hold such security, nor is it considered to be investment advice. These materials have been prepared solely for informational purposes based upon information generally available to the public from sources believed to be reliable. No content contained in these materials (including index data, ratings, credit-related analyses and data, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse-engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of MVIS. The Content shall not be used for any unlawful or unauthorized purposes. MVIS and its third-party data providers and licensors (collectively “MVIS Indices Parties”) do not guarantee the accuracy, completeness, timeliness or availability of the Content. MVIS Indices Parties are not responsible for any errors or omissions, regardless of the cause, for the results obtained from the use of the Content. THE CONTENT IS PROVIDED ON AN “AS IS” BASIS. MVIS INDICES PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall MVIS Indices Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs) in connection with any use of the Content even if advised of the possibility of such damages. mvis-indices.com 12
You can also read
