SecondMarket's Bitcoin Offering Defines New Asset Class

By Jon Matonis
CoinDesk
Monday, October 7, 2013

http://www.coindesk.com/secondmarkets-bitcoin-offering-defines-new-asset-class/

It’s not every day that a new asset class is born. The last time was probably a few decades ago when managed futures funds became an accepted asset class among portfolio managers.

Now, alternative trading system company SecondMarket has launched The Bitcoin Investment Trust (BIT), an open-ended, private trust that is exclusively invested in bitcoin and derives its value solely from the price of bitcoin.

The private investment vehicle is based in the US and open to institutional and accredited individual investors. Alternative Currency Asset Management (ACAM), a wholly-owned subsidiary of SecondMarket, is BIT’s sponsor and SecondMarket has also made a $2 million seed investment in the BIT.

Certainly, a bitcoin trust can be thought of as a unique proxy for investing in bitcoin startups that would not carry the specific risk of management team execution or adopting the correct business model.

Not many other currencies in the world can serve as a proxy investment for an entire high tech, venture-funded sector. Until the bitcoin ecosystem matures and deepens, it will be possible to bet on its success simply by going long on the actual monetary unit.

Generally, the bitcoin funds, or trusts, can also be thought of as precursors to more retail-oriented exchange-traded funds (ETFs) which require substantially more due diligence and regulatory clearance.

When bitcoin ETFs start appearing on a regular basis, bitcoin will have completed its transition into both retail and wholesale asset class.

The bitcoin offering from SecondMarket has been in development for over a year now and it will set the standard for best practices of bitcoin as an asset class in the US.

Non-correlated to other investment classes and alongside more conventional portfolio components like equities, bonds, real estate, and commodities, a position in bitcoin allows a portfolio to participate in the potential upside from an economy based on digital currencies.

Following Exante’s Bitcoin Fund from Malta which debuted last year, SecondMarket also intends to facilitate two-way trading of the trust shares on its proprietary platform enabling both long and short positions. This is significant because commercial processors and large merchants of bitcoin would have a reliable method to hedge their bitcoin inventories without having to liquidate actual bitcoin on a daily basis.

For instance, if a bitcoin merchant processor, such as BitPay, wanted to “lock in” a certain aggregate exchange rate for their merchants or for their own books, they could initiate a short position in the Bitcoin Investment Trust without the need to sell bitcoin on the open market.

The company has established relationships with over 100 players in the bitcoin space, including large merchants, early adopters, and exchanges which should aid in the development of additional liquidity.

The critic's view

Last week, the forlorn and chronic bitcoin skeptic Felix Salmon, of the Reuters blogging world, took a shot at SecondMarket and their new trust. Salmon says that “no sensible investor should go anywhere near it” and he doesn’t “really understand why [Silbert's] doing this.”

Correctly stating that bitcoin is a combination of currency and commodity, Salmon goes on to claim “this trust strips out the interesting bit, which is the currency part, leaving just the stupidly speculative commodity aspect.”

As with most professional critics at the beginning of a new asset class, the cries of disbelief and suggestions of investor imprudence are to be expected because prior to becoming portfolio orthodoxy an element of risk weeds out the non-brave.

I wouldn’t expect Salmon to promote the adoption of largely undefined risk, but I would expect him to understand why a particular investment vehicle makes sense for certain investors.

Firstly, there is the aspect of institutional participation and the possibility of favorable tax treatment for investments made through retirement funds.

Many endowments and institutions that administer investment funds have strict guidelines for placing those investments such as placement must be with registered broker-dealer. Therefore, a straight investment into bitcoin “on your own” would not satisfy those institutional parameters.

Secondly, Salmon must also realize that larger aggregated wholesale purchases of bitcoin can be accomplished at more preferential pricing terms than smaller individuals would be able to achieve acting on their own. The consolidated purchasing power of a trust could easily make up for a good portion of those fees.

Thirdly, and most importantly, the custodial features of safe-keeping and private key management are paramount.

The Bitcoin Investment Trust administrative and safekeeping fee is analogous to the storage fee assessed on gold and precious metals warehousing. Also, a professionally-managed trust provides protection against a slew of risks that could prove overwhelming for the casual weekend bitcoin investor.

For instance, as enunciated by Exante, top-level risks include data loss risk, hardware failure risk, jurisdictional risk, external hacker risk, dishonest employee risk, and employee death or disability risk. Also, succession planning and inheritance are just as important with a bitcoin asset as with any other asset.

Perhaps some year in the future Salmon will look back at this bitcoin article and say “I was not a True Believer when I really should have known better.” Or, maybe he will be smugly proud of himself for establishing a massive short bitcoin position in 2013. I doubt the latter.

According to the private placement memorandum, ACAM has retained prominent service providers including Sidley Austin LLP (legal counsel), Ernst & Young (auditor), Continental Stock Transfer & Trust (transfer agent) and SecondMarket (marketplace, custodian and authorized participant).

Investors who purchase shares in the BIT will have the opportunity to gain liquidity through periodic auctions on SecondMarket beginning in 2014. The Net Asset Value (NAV) of the BIT will be calculated daily and made publicly available.

Disclosure: Author is Executive Director of Bitcoin Foundation and participates on the Advisory Board for Alternative Currency Asset Management (ACAM).