A Bitcoin ETF? Not Yet…

As we sit writing this note late Sunday afternoon, bitcoin is trading around $6,800 – less than half its levels at the start of the year ($13,860). Current prices are also right on top of our low estimate of fair value ($6,500). And we’re close to 3-month lows as well ($6,600 on April 6th).

The proximate cause of the current downdraft is news of a hack at South Korean crypto exchange Coinrail. While it is one of the smaller exchanges in the country, the thieves managed to steal $40 million of various Initial Coin Offering “tokens”. These are assets that mirror the basic structure of bitcoin/ethereum, but are intended for a specific use case.

Why does a hack of a third-tier exchange that steals non-bitcoin assets matter to bitcoin itself? The simple answer is investor confidence. Financial assets, whether they be shares of Apple or a bitcoin, rely on security to maintain faith in the system. That’s even truer of crypto assets, which are both newer than equities and remain largely unsupported by the traditional global financial system.

The larger, more important issue in the headlines about bitcoin: the Commodity Futures Trading Commission’s demand for extensive trading data from Bitstamp, Coinbase, itBit and Kraken. Prices from those exchanges go into the calculation of a current cash price, which then determines the value of bitcoin futures on the CME. The CFTC was frustrated by the exchanges’ lack of cooperation with the CME in an early investigation and so decided to subpoena them directly.

Why this matters (a lot): bitcoin and other crypto currencies trade all over the world, and at different prices simultaneously. In that way, they are similar to US stocks, which trade at dozens of different venues over the course of the day. The difference is that US stocks have an official close at 4pm as reported by the Consolidated Tape Association. That’s the price used, for example, to price the Net Asset Value of US mutual funds.

The bottom line is that bitcoin/other crypto currencies need something similar to the mechanism used by US stocks to determine a closing price if there is ever to be a ”real” bitcoin exchange traded fund listed here. The work-around used by bitcoin futures (the average prices of those 4 exchanges measured across an hour of trading) is now under scrutiny by the CFTC. Exchange operators don’t seem to appreciate the move. Kraken CEO Jesse Powell told the Wall Street Journal that the subpoena “has the spot exchanges questioning the value and cost of their index participation”.

So what to do with bitcoin here? We remain cautious, even as it approaches our low-end price target. First, we worry that the CFTC investigation pushes any bitcoin ETF off into 2019 at the earliest. An accurate and transparent closing price is a non-negotiable feature of any US listed exchange traded fund. Second, as we have recently noted, public interest in cryptos continues to wane. Bitcoin is a technology and requires rising adoption rates to see an increase in value.

Sources:

Bitcoin price: https://www.coindesk.com/price/

CFTC Investigation: https://cointelegraph.com/news/wsj-cme-and-btc-exchange-dispute-led-us-regulators-to-open-price-manipulation-probe

Coinrail hack: https://techcrunch.com/2018/06/10/korean-crypto-exchange-coinrail-loses-over-40m-in-tokens-following-a-hack/