BlackRock’s Bitcoin Trust: Mixed Feelings

Mixed feelings on BlackRock's Bitcoin Trust

Author: Jesse Myers, onrampbitcoin; Translation: Blockingxiaozou

On June 15, BlackRock submitted an S-1 filing to the U.S. Securities and Exchange Commission (SEC), detailing its proposed Bitcoin Trust product. Technically, the product is not an ETF, but it functions like one, as it supports daily subscriptions and redemptions.

The development is noteworthy in part because BlackRock has close relationships with regulators and insiders who often do not take action in uncertain circumstances. Indeed, of BlackRock’s 576 ETF applications over the years, the SEC has approved 575. So we have reason to be excited.

The SEC has yet to support a Bitcoin ETF based on spot (rather than futures) prices. “Spot” Bitcoin products represent actual Bitcoin holdings for investors, while “futures” Bitcoin products hold derivative contracts (bets on future Bitcoin prices) without the need to hold the actual asset. “Spot” products create demand for actual Bitcoins with limited supply, so they are essentially bullish on Bitcoin, while “futures” products are not, although they are particularly useful for betting against the frenzy of retail investors during bull markets (and suppressing that frenzy through selling pressure).

Given these facts, it is widely believed that the SEC’s rejection of a spot-based ETF while simultaneously allowing a futures-based ETF indicates that the U.S. government is not willing to help Bitcoin become a competitor to the dollar.

But this has not stopped demand for Bitcoin, and Wall Street firms have been watching closely.

Clearly, these big players don’t want to miss the next bull market.

1. Grayscale Optimization

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

Such a transaction creates a taxable event that may require a 30% tax payment. It’s cruel. But it doesn’t have to be that way.

There’s nothing strictly prohibiting Grayscale from supporting physical redemption, and maintaining this structure–allowing dollars to flow into GBTC and be turned into bitcoin, but never allowing bitcoin to flow out–is very much in the interest of Grayscale founder Barry Silbert.

That way, Barry can charge a 2% management fee every year. With GBTC having absorbed 600,000 bitcoins over the past decade, that means Barry is taking in 12,000 bitcoins a year ($300 million). It’s a goose that lays golden eggs. Good for Barry, bad for clients.

2 , BlackRock’s bitcoin ETF product

BlackRock may know ETF business better than anyone, so they almost certainly recognized that a grantor trust model would be viable for them too. In any case, BlackRock’s proposed bitcoin trust is the second of its kind.

In some respects, BlackRock’s new trust is a good product for betting on bitcoin’s price. (BlackRock manages about $10 trillion in assets, 20 times the total value of bitcoin at $500 billion. Some of BlackRock’s asset management scale may soon be used to buy bitcoin.)

In other respects, however, it’s a bad product that severely harms clients’ rights and threatens the core value of bitcoin.

BlackRock’s bitcoin trust is an investment tool whose overall quality for investors depends on two fundamental components: the trust mechanism and the custody and governance of the trust. Like the two wheels of a bicycle, these two important components can be evaluated based on their respective advantages, but must be properly combined to serve the interests of users.

Here is BlackRock’s bitcoin trust as an investment tool:

(1) Advantage: Grantor Trust Model

Simply put, the grantor trust model is very much in the interest of clients. BlackRock emphasizes two main benefits for investors:

· Tax considerations

– As far as US federal income tax is concerned, stock owners will be considered to own a corresponding share of trust assets.

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

· Physical redemption

– There are several parts of the BlackRock Trust proposal that describe physical redemption policies and procedures.

– Physical redemption ensures that any premium or discount to the net asset value of the asset can be arbitrated, eliminating a major pain point previously experienced by GBTC investors.

Overall, these terms are better than those of Grayscale and similar funds, especially since the grantor trust structure allows for tax-free withdrawals of Bitcoin.

This is the good side, a normal circular wheel. The following is a wobbly square wheel…

(2) Disadvantages: Black Rock Custody and Governance

The main problem with the Bitcoin trust proposed by BlackRock is that it is managed by BlackRock. Specifically, this means that the trust is managed in the typical traditional asset pattern and the well-known politicized licensed financial brand of BlackRock.

· Physical redemption – trap:

– There is a specific description in the S-1 document: “The trustee will deliver the number of bitcoins corresponding to the redemption basket to the redemption authorized participant…Stocks can only be used for redemption (the whole bitcoin).” Only registered brokers who sign an exclusive agreement with BlackRock are designated as “authorized participants”. In other words, the privilege of extracting Bitcoin from the trust is reserved for investment companies favored by BlackRock, and this list may change at any time. Physical redemption of Bitcoin can only be redeemed in whole (through “authorized participants”) and cannot extract part of Bitcoin from the trust.

· Re-mortgage

– In the traditional asset field, the operating practice of ETFs is to lend the assets in the asset pool they are responsible for to market participants (such as shorts). BlackRock will naturally extend this practice to its Bitcoin trust because there is no prohibition on re-mortgaging in the proposal document.

– Obviously, the problem here is that investors in the BlackRock Bitcoin Trust will have ownership of Bitcoin that should be held by BlackRock but has actually been lent out. In this case, the trust investors only have a claim on Bitcoin that BlackRock no longer holds.

– This means that BlackRock’s Bitcoin Trust will become a massive source of paper Bitcoin. When FTX went bankrupt, they owed customers $1.4 billion in paper Bitcoin claims, but didn’t have any Bitcoin to distribute to those accounts.

– I don’t know about you, but I’d rather invest in Bitcoin trusts that don’t support rehypothecation, because the assets are still kept in a chain-custody.

· Forks

– BlackRock’s documents state clearly: “In the event of a fork, (BlackRock) will … determine which network is widely accepted as the Bitcoin network and should be considered the appropriate network and will treat the relevant assets as Bitcoin to meet the Trust’s objective.”

– To be fair, this language is a way to address the possibility of forks (i.e., when a splinter group changes the Bitcoin code and attempts to convince enough people to follow the modified code version to consider it the “real” Bitcoin).

– However, this language also allows BlackRock to impose its own view of what constitutes the “real” Bitcoin.

– Given Bitcoin’s history of enterprise-driven forks and BlackRock’s history of politically motivated finance, this is especially concerning. The Bitcoin Cash fork in 2017 was driven by large interest groups in the Bitcoin space – some speculate government interests. Similarly, BlackRock is also the founder of “ESG scores,” which is a kind of corporate social credit score, undoubtedly developed and promoted in collaboration with government interests.

– In sum, this creates a reasonable scenario: BlackRock’s ETF could become a hugely successful investment tool for institutions to gain Bitcoin exposure and expand to a large portion of the total Bitcoin supply. BlackRock could suddenly decide that it supports a new ESG branch of Bitcoin and will ignore the existing Bitcoin network, considering it not the “real” Bitcoin.

– While I don’t believe this attack is enough to convince savvy, hardline Bitcoin investors to align with BlackRock’s political objectives, it could mean that countless customers of the BlackRock Bitcoin Trust become unwitting hostages in BlackRock’s power game. Ultimately, BlackRock’s clients may suffer the same fate as Bitcoin Cash investors.