Bitcoin, the SEC, and ETFs
Bitcoin, the SEC, and ETFs
Be careful - very careful - what you wish for
If you follow the news on Bitcoin and crypto, you know the Securities and Exchange Commission (SEC) recently approved a Bitcoin Exchange Traded Fund (ETF). Those who follow this subject closely know what this is. But for others - I liken them to people interested enough to listen in to a conversation when “overhearing” the subject of Bitcoin - this simply means a financial institution can set up a “company” of sorts to own Bitcoin and then sell “shares” of that company that you can buy in your investment/retirement account. I know this is probably rough and inexact. I do that on purpose in this blog. My audience is those interested enough to “overhear” but otherwise passively follow the conversation from the sidelines.
Also, in the news is some background on what seemed to be odd price activity in Bitcoin roughly corresponding to this SEC decision. FTX - the whole Sam Bankman-Fried (SBF) fiasco - is having its assets sold off to satisfy the debts it owes. That selling pressure on BTC is apparently the reason for the disconnect between the news out of the SEC (which it seems would have provoked buying) and the recent selling and the related downward price pressure.
The coinciding of all of this creates a teachable moment we must not let pass us by. There are some essential lessons here.
What, exactly, is an ETF?
The SEC’s website says this: “Exchange-traded funds (ETFs) are SEC-registered investment companies that offer investors a way to pool their money in a fund that invests in stocks, bonds, or other assets. In return, investors receive an interest in the fund.” (See here). Typically, there will be a separate corporate entity formed for each ETF. So, by saying “an interest in the fund,” I understand the SEC to be saying you are buying fractional ownership in the company.
This is extremely important. If you buy shares in a Bitcoin ETF, you are not buying Bitcoin. You are buying a company that has been created for the sole purpose of buying and selling Bitcoin in a manner that tracks the buying and selling of the ETF shares. Before the SEC’s approval, something similar - a “trust” - was the primary way to expose yourself to crypto as an investment without actually owning the “coin.” “GBTC” is the best-known, but the ticker can be misleading. “BTC” is the common shorthand for Bitcoin. But GBTC means “Greyscale Bitcoin Trust.”
GBTC is a wholly owned Digital Currency Group, Inc. (DCG) subsidiary. In an upcoming article, I’ll dig into this more, but suffice it to say here - merely as my opinion - that DCG is trying to build out a parallel financial system. A more detailed explanation will have to wait for that article, but a “Stablecoin” is a crypto unit managed to serve as a proxy for the U.S. Dollar by which money is moved between the legacy USD financial system and a parallel crypto financial system. The main reason for this is transactional friction arising from regulations in the legacy USD system. Move money from USD into a Stablecoin once, bear the regulatory burden once. Now, you can move in and out of crypto positions using a USD proxy rather than the USD - and be freed from the regulatory friction.
Never forget: You are buying a company…
Please take careful note of an SEC filing for GBTC found here (emphases added by me).
“Grayscale Bitcoin Trust (BTC) (the “Trust”) is a Delaware Statutory Trust that was formed on September 13, 2013 and commenced operations on September 25, 2013. In general, the Trust holds Bitcoin (“BTC”) and, from time to time, issues common units of fractional undivided beneficial interest (“Shares”) (in minimum baskets of 100 Shares, referred to as “Baskets”) in exchange for Bitcoin. The redemption of Shares is not currently contemplated and the Trust does not currently operate a redemption program.” […] The Trust currently has no intention of seeking regulatory approval to operate an ongoing redemption program. The investment objective of the Trust is for the Shares to reflect the value of Bitcoin held by the Trust, less the Trust’s expenses and other liabilities. […]
Roughly speaking, this means GBTC owns and holds Bitcoin in trust on behalf of the trust’s owners - who would be its shareholders. But note that last part: There is no “redemption program.” That is another way of saying you cannot “redeem” your shares for Bitcoin. Not even in this “trust” vehicle do you actually “own” Bitcoin. You “own” shares in “a Delaware Statutory Trust.” And that means you own shares in that company’s assets and liabilities.
…wholly owned by another company…
Continuing on from the above SEC filing, again with emphases added by me:
“Grayscale Investments LLC (“Grayscale” or the “Sponsor”) acts as the Sponsor of the Trust and is a wholly owned subsidiary of Digital Currency Group, Inc. (“DCG”). […] The Sponsor also acts as the sponsor and manager of other investment products including Grayscale Bitcoin Cash Trust (BCH) (Symbol: BCHG), Grayscale Ethereum Trust (ETH) (OTCQX: ETHE), Grayscale Ethereum Classic Trust (ETC) (OTCQX: ETCG), Grayscale Horizen Trust (ZEN), Grayscale Litecoin Trust (LTC) (Symbol: LTCN), Grayscale Stellar Lumens Trust (XLM), Grayscale XRP Trust (XRP), Grayscale Zcash Trust (ZEC) and Grayscale Digital Large Cap Fund LLC (OTCQX: GDLC), each of which is an affiliate of the Trust.”
… which is, in turn, owned by…
Continuing on, with emphases added:
“Authorized Participants of the Trust are the only entities who may place orders to create or, if permitted, redeem Baskets. Genesis Global Trading, Inc. (“Genesis” or the “Authorized Participant”), a registered broker-dealer and wholly owned subsidiary of DCG, is the only Authorized Participant and is party to a participant agreement with the Sponsor and the Trust. Additional Authorized Participants may be added at any time, subject to the discretion of the Sponsor.”
I’ll explain in my upcoming article why I believe Genesis Global Trading, Inc. is intended to be the crypto-system equivalent of a “Primary Dealer” like JP Morgan Chase (or any of the other twenty-or-so Primary Dealers).
And now, for the punchline:
“The custodian of the Trust is Coinbase Custody Trust Company, LLC (the “Custodian”), a third-party service provider. The Custodian is responsible for safeguarding the Bitcoin, Incidental Rights, and IR Virtual Currency held by the Trust, and holding the private key(s) that provide access to the Trust’s digital wallets and vaults. The Custodian Agreement is for an initial term of three years.”
And here is why FTX matters
Here is the lede on the Zero Hedge story; this time emphasis is in the original, except at the very end (where I add italics):
“Earlier this week we reported that the primary reason why bitcoin has been sliding ever since the arrival of bitcoin ETFs on Jan 10 - an event that had been lauded as very bullish for the crypto space but instead promptly sparked a bear market... has been the relentless liquidation of residual bitcoins by the bankrupt FTX estate which has been aggressively building up cash - and selling bitcoin into every market meltup - to maximize recoveries for stakeholders.”
You must not fail to ask: “building up cash” in what? “[S]elling bitcoin into every market meltup…” for what? “[T]o maximize recoveries [of what???] for stakeholders.”
Hang on - what, exactly, are “stakeholders?” Are these “shareholders?” Simply put: No. In a bankruptcy, the owners are left with nothing. The stakeholders are the creditors - those who lent money to FTX - not those who bought shares in FTX.
If you are well-read in this arena, you know what I mean (you’re probably saying: Well, duh!). Thank you for subscribing or reading, but you’re not who I write for. It is for those whose ears might perk up overhearing a conversation about crypto but who are not immersed in this world. This is a crucial teachable moment for them: You can buy shares (and be an owner) or bonds (and be a creditor) in a company like FTX. And when you buy bonds, you are not lending crypto - you are lending USD.
FTX’s Bitcoin holdings have primarily been sold into this recent upswing to build up the biggest possible USD cash position and then distribute that cash to FTX’s creditors. Again - the shareholder gets nothing!
But even more importantly, this is a lesson in legal tender. To, once again, oversimplify in the interest of clarity and to avoid specialty language, FTX went under because its interest obligations on its debts outstripped its income and assets. These debts are all contracts, and the obligations in these contracts are all measured in U.S. Dollars. The bankruptcy court cannot award the creditors a portion of these Bitcoins because Bitcoin is not recognized as legal tender for private debts. Consider Article I, Section 10 of the United States Constitution:
“No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title …”
Now I will write for the market/finance pro AND the passively interested!!! PEASE PAY ATTENTION: This teachable moment simply cannot be allowed to pass us by!
The United States Constitution was born from a civil tumult known as the Daniel Shays Rebellion. During the Revolutionary War, two things happened: The money issued to pay for the war effort caused inflation, and in many cases, the men who left their farms to fight were not paid their rightful salary (for which that extra money had been issued). Many went into debt trying to keep their farms and were victimized by unscrupulous debt collectors. These were the men - like Daniel Shays - who actually took up arms against several state governments.
Two things were missing here: One, there was no uniform set of bankruptcy laws that applied across the states. Two, there was no uniform manner in which payment of a debt was legally recognized as extinguishing that debt. There were other areas for improvement in the Articles of Confederation. Still, these weaknesses drove the then-Confederation known as the United States to the brink - and gave rise to the desire to “…ensure domestic Tranquility.”
FTX is a lesson in Legal Tender
This constitutional restriction on legal tender for payment of debts was initially designed to protect debtors and provide the foundation for uniform bankruptcy laws. And as long as the U.S. Dollar had a price in silver (not the other way around - please read my book for more detail), this worked exactly as designed. But when we decided to live in an economic Alice in Wonderland world where everything is upside down (e.g., silver and gold having a floating price in U.S. Dollars), we sowed the seeds for today’s crisis: This has now become an obstacle to those of us who have concluded the U.S. Dollar is bad money. The heart of the case I make in Liberty’s Silver Bullet: The Digital Liberties Amendment to the United States Constitution is crypto cannot ever be an alternative to the USD until and unless the USD loses its monopoly on legal tender for private debts. It must be understood that a state accepting Bitcoin for payment of state taxes is a public debt and is merely a token gesture with no real meaning.
Crypto is and will remain nothing more than a stateless, digital, foreign exchange play as long as we are not allowed to enter into a contract in which the obligation to pay is both measured in a cryptocurrency of our choice and adjudicated by the courts in that same crypto unit! At the end of the day, we are only free once we are free to decide we no longer accept USD as the tender by which our wages are paid!
As for Bitcoin ETFs: Buyer Beware!
Before you put money into a Bitcoin ETF, you must ask how the coins are held. Will it be like GBTC, where the coins are in the custody of a publicly traded exchange (e.g., Coinbase)? If so, make absolutely sure you follow the news on FTX. Toward the end of the Zero Hedge article, we learn (emphases added):
“The good news for bitcoin bulls is that FTX has almost nothing left to liquidate (not that its customers will even benefit: as a reminder, dozens of FTX customers are challenging a company proposal that would peg the value of their digital assets at the time the company filed bankruptcy, meaning they’d miss-out on a yearlong Bitcoin rally and rebound for other tokens.) FTX also doesn’t expect customers will be fully repaid, which means that almost all of the "cashing out" has been concluded.”
Once again, in the event of bankruptcy (or any other dispute that might end up in court), there is no other unit in which a court can award damages other than a unit recognized as a “Tender in Payment of Debts.” FTX is proposing to calculate its USD liabilities to its customers based on the value of its crypto assets on the date it declared bankruptcy. As long as the USD enjoys its monopoly on legal tender for payment of private debts, any contract in which obligations are measured in a crypto unit will simply not be adjudicated in that unit. The court will have to determine an exchange rate in USD and then order the debt to be extinguished by the tendering of payment in that amount of USD.