BlackRock Bitcoin Trust Mixed Good and Bad

Author: Jesse Myers, onrampbitcoin; Compiler: Jinse Finance xiaozou

On June 15, BlackRock filed an S-1 with the U.S. Securities and Exchange Commission (SEC), a registration report detailing its proposed Bitcoin Trust product. The product is not technically an ETF, but it is functionally equivalent to an ETF in that it supports daily subscriptions and redemptions.

The development is notable in part because BlackRock has close ties to regulators and insiders who tend not to act without certainty about the outcome. In fact, the SEC has approved 575 of BlackRock's 576 ETF applications over the years. So, we have reason to be excited.

The SEC has yet to support a bitcoin ETF based on spot (rather than futures). "Spot" bitcoin products hold actual bitcoin products on behalf of investors; while "futures" bitcoin products hold derivative contracts (bets on the future price of bitcoin) without holding the actual asset. The "spot" product creates demand for actual bitcoins in limited supply and is therefore inherently bullish on bitcoin; the same is not true for the "futures" product, which is inherently neutral, although it is bullish for retail investors during bull markets Taking a contrarian bet against investor euphoria (and dampening that euphoria through selling pressure) is particularly useful.

Because of these facts, it is widely believed that the SEC’s rejection of spot-based ETFs while allowing futures-based ETFs demonstrates the U.S. government’s reluctance to help Bitcoin become a competitor to the U.S. dollar.

But that hasn't stopped demand for bitcoin, and Wall Street firms have been sitting on the sidelines.

Clearly, these big players don't want to miss out on the next bull run.

1. Optimization of Grayscale

BlackRock has specifically designed the new Bitcoin Trust/ETF to improve upon Grayscale's existing Bitcoin exposure vehicle, the Grayscale Bitcoin Trust (GBTC). The biggest problem with GBTC is that the trust does not allow in-kind redemptions. In other words, investors can buy shares in the trust and own a representative share of the underlying spot bitcoins, but they can never withdraw those bitcoins. All they can do is sell their shares to someone else and take the money to buy spot bitcoins.

Such a transaction creates a taxable event that may be subject to a 30% tax. It's brutal. But it doesn't have to be.

There is nothing strictly prohibiting Grayscale from supporting in-kind redemptions, and maintaining this structure—allowing dollars to flow into GBTC, turning into bitcoins, and never allowing bitcoins to flow out—is very much in the interests of Grayscale founder Barry Silbert.

In this way, Barry can collect 2% management fee every year. Since GBTC has absorbed 600,000 bitcoins in nearly ten years of operation, that means Barry collects 12,000 bitcoins ($300 million) per year. What a goose that lays golden eggs. That's great for Barry, but terrible for the client.

2**, BlackRock’s Bitcoin ETF product**

BlackRock probably understands the ETF business better than anyone, so they almost must have realized that the settlor trust model worked for them as well. Regardless, the Bitcoin Trust proposed by BlackRock is the second of its kind.

In some ways, BlackRock's new trust is a good product for bullish bitcoin prices. (BlackRock manages about $10 trillion in assets, 20 times the $500 billion worth of bitcoin. Some of BlackRock’s assets under management may soon be used to buy bitcoin.)

In other ways, it's a poor product that seriously undermines the rights of customers and threatens the core value of Bitcoin.

The BlackRock Bitcoin Trust is an investment vehicle whose overall quality to investors depends on two basic components: the trust mechanism and the custody and governance of the trust. Like the two wheels of a bicycle, these two vital components can be evaluated on their own merits, but must be properly combined to serve the interests of the user.

The following is the BlackRock Bitcoin Trust as an investment vehicle:

(1) Advantages: grantor trust model

In short, the settlor trust model is very much in the client's interest. BlackRock highlights two key benefits for investors:

· Tax Considerations

• "For U.S. federal income tax purposes, stock owners will be deemed to own a corresponding share of the trust assets."

• This means that, for tax purposes, owning shares in the BlackRock Bitcoin Trust is equivalent to owning the underlying asset - Bitcoin.

· Redeem in kind

• Several parts of the BlackRock Trust Proposal describe policies and procedures for redemption in kind.

• In-kind redemption ensures that any premium or discount to NAV can be arbitraged, thereby removing a major pain point once suffered by GBTC investors.

Overall, the terms are better than Grayscale and similar funds, especially since the settlor trust model allows bitcoin to be withdrawn without paying taxes.

This is on the plus side and is a normal round wheel. And underneath is a rickety square wheel...

(2) Cons: BlackRock Hosting and Governance

The main problem with BlackRock's proposed Bitcoin Trust is that it is managed by BlackRock. In particular, it meant that the trust was managed in a manner typical of the traditional asset landscape and BlackRock's well-known brand of politicized licensed finance.

· Redeem in kind——Trap:

• There is a specific description in the S-1 document: "The trustee will deliver to the redemption authorized participants the amount of bitcoins corresponding to the redemption basket...The stock can only be used for redemption (whole bitcoin)" . Only registered brokers who have entered into a separate contract with BlackRock are designated as "Authorized Participants". In other words, the privilege of being able to withdraw bitcoin from the trust is reserved for investment firms favored by BlackRock, a list that is subject to change at any time. In-kind redemptions of Bitcoins can only be submitted (by "Authorized Participants") for whole Bitcoin redemptions, partial Bitcoins cannot be withdrawn from the Trust.

· Remortgage

• In the field of traditional assets, the operating practice of ETFs is to lend the assets in the asset pool they are responsible for to market participants (such as short positions). BlackRock would naturally extend this practice to its Bitcoin Trust, as there is nothing in the proposal document prohibiting rehypothecation.

• Obviously, the problem here is that investors in the BlackRock Bitcoin Trust will have ownership of the Bitcoins that are supposed to be in BlackRock's custody but have actually been loaned out. In this case, trust investors only have claims on Bitcoins that BlackRock no longer holds.

• This means that BlackRock's Bitcoin Trust will be a huge source of paper Bitcoin creation. When FTX went bankrupt, they owed customers $1.4 billion in paper Bitcoin claims, but had no Bitcoin to distribute to those accounts.

• I'm not sure about you, but I'd rather invest in bitcoin trusts that don't support bitcoin rehypothecation, because assets are still held in on-chain vaults.

· Fork

• BlackRock's documentation clearly states: "In the event of a fork, (BlackRock) will...determine which network is generally accepted as the Bitcoin network and should be considered the appropriate network and the underlying asset to be considered Bitcoin, in order to meet the fiduciary objectives."

• To be fair, this is a language that can be used to address the possibility of a fork (i.e., when a splintering group changes the Bitcoin code and tries to convince enough people to follow the modified version of the code to see it as "true "Bitcoin").

• However, this language also allows BlackRock to impose its own views on what is "real" Bitcoin.

• This is especially worrisome given Bitcoin's history of corporate-led forks and BlackRock's history of politicized finance. In 2017, the Bitcoin Cash fork was driven by large interest groups in the Bitcoin space — some speculating government interests. Likewise, BlackRock is the originator of the “ESG Score,” a corporate social credit score developed and promoted no doubt in partnership with government interests.

• Altogether, this creates a plausible scenario: BlackRock's ETF could become a very successful investment vehicle, allowing institutions to gain exposure to Bitcoin and scale to capture a significant portion of the total Bitcoin supply. BlackRock may suddenly decide that it will support a new ESG fork of Bitcoin and will disregard the existing Bitcoin network as not "real" Bitcoin.

• While I don't think this attack will be enough to convince well-informed, hawkish Bitcoin investors to align with BlackRock's political goals, it could mean that countless clients of the BlackRock Bitcoin Trust will unknowingly become players in BlackRock's power game hostage. Ultimately, BlakcRock's customers may suffer the same fate as Bitcoin Cash investors.