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Winklevoss Bitcoin ETF May Not be Redeemable in Bitcoins for Individual Investors

Published on July 10th, 2013 by bcohen

By now you must have heard that the the Winklevoss Twins are bringing Bitcoin to Wall Street.  If you need to get up to speed, read  Nathaniel Popper And Peter Lattman’s piece for Dealb%k over at the New York Times “Winklevoss Twins Plan First Fund for Bitcoins.”  And if you want to read the fine print, here is the S-1 filing with the Securities and Exchange Commission for the Winklevoss Bitcoin Trust ETF (Exchange Traded Fund).

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(Image Credit:Youtube)

BrotherJohnF, producer of the ever popular Youtube Channel “The Bitcoin Channel”  recently pondered in Bitcoin Report Volume 55 (queued to 2:30) if  individual investors who own the Bitcoin ETF would be able redeem the ETF for actual Bitcoins.

In fact BrotherJohnF stated that “…one of the key issues of the ETF—-can you redeem the underlying asset if you decide to cash in your underlying shares…this is a critical factor…”

Unless you are a large player known as Authorized Participant such as a bank or financial institution, individual investors are usually unable to redeem the shares of the ETF into the underlying asset.

 

Index Universe’s Education Center explains in  What is the ETF Creation/Redemption Mechanism? that

“The key to understanding how ETFs work is the “creation/redemption” mechanism. It’s how ETFs gain exposure to the market, and is the “secret sauce” that allows ETFs to be less expensive, more transparent and more tax-efficient than traditional mutual funds…”  

and further explains “The Role of Authorized Participants.”

So what does the Winklevoss S-1 filing say about Individual Investors (also known as Retail Investors) and Authorized Participants in this regards?

Here is an extract from the filing:

"…Baskets may be created or redeemed only by Authorized Participants. Each Authorized Participant must (1) be a registered broker-dealer or other securities market participant such as a bank or other financial institution which is not required to register as a broker-dealer to engage in securities transactions, (2) be a direct participant in DTC, (3) have entered into an agreement with the Trustee and the Sponsor (“Authorized Participant Agreement”) and (4) have established a Bitcoin custody account (“Authorized Participant Custody Account”) with the Trustee. The Authorized Participant Agreement provides the procedures for the creation and redemption of Baskets and for the delivery of Bitcoins required for such creations or redemptions. A list of the current Authorized Participants can be obtained from the Trustee or the Sponsor. See “Creation and Redemption of Shares” for more details…."

further it states

“…Shares are issued and redeemed continuously in aggregations of [50,000] Shares solely in exchange for Bitcoins, rather than cash. Individual investors cannot purchase or redeem Shares in direct transactions with the Trust. The Trust only deals with registered broker-dealers eligible to settle securities transactions through the book-entry facilities of The Depository Trust Company and which have entered into a contractual arrangement with the Trustee and the Sponsor governing, among other matters, the creation and redemption processes. Holders of Shares of the Trust may redeem their Shares at any time acting through an Authorized Participant and in the prescribed aggregations of [50,000] Shares; provided, however, that redemptions of Shares may be suspended during any period in which regular trading on the [EXCHANGE] is suspended or restricted, or in which an emergency exists as a result of which delivery, disposal or evaluation of Bitcoins is not reasonably practicable…

I’m going to repeat three parts of the extracts above:

  1.  Individual investors cannot purchase or redeem Shares in direct transactions with the Trust.
  2. Baskets may be created or redeemed only by Authorized Participants. 
  3. Shares are issued and redeemed continuously in aggregations of [50,000].

So let us assume that an Authorized Participant would like to redeem his ETF into Bitcoin.

To find out how much this would cost we need to make an assumption about the price of Bitcoin per United States Dollars..we’ll assume its $100 USD per 1 BTC.  And we also need to know how many Bitcoins make up 1 Share of the ETF.

via the S-1 filing

“The Trust expects to create and redeem Shares from time to time but only in Baskets (a Basket equals a block of [50,000] Shares). The number of outstanding Shares is expected to increase and decrease from time to time as a result of the creation and redemption of Baskets….. On the first day of trading, each Share in the initial Baskets was comprised of [0.20] Bitcoins, and each initial Basket was made up of [10,000] Bitcoins.”

so .2 BTC = 1 ETF share.  That would be $20 per share for the ETF (using my $100 assumption).  And

$20 X 50,000 = $1,000,000

Thats One Million Dollars to Make a Redemption.

The $20 per share number is confirmed by reviewing the “Calculation of Registration Fee” at the top of the S-1 filing (actually it states $20.09) and while it mentions using a weighted average  (“The price of Bitcoins is based on a weighted average of the average of the high and low transaction prices of Bitcoins on June 27, 2013 on three major Bitcoin Exchange sites: Mt. Gox K.K., Bitstamp and BTC-e.”)

I went to OANDA to obtain a historical price for bitcoin on June 27th and it states $103.96 BTC per 1 USD… which is close enough to $100 to make me feel comfortable tossing these numbers around. But of course this is dependent upon the price of Bitcoin when it is actually redeemed (i.e. the conversion rate might not be a 100 to 1).

Reviewing this registration fee calculation you will also see that the fund initially seeks to raise $20 Million.

So a $1 Million redemption would be 5% (1/20) of the fund.

Although it doesn’t appear that ETFs are convertible into the underlying asset at the individual investor level, there are ETFs that are trying to let investors do just that.  Van Eckis one of those companies.  Kitco Metals Reports in “Proposed Van Eck Gold, Silver ETFs Would Allow Redemptions Of Metal” that:

"Several analysts told Kitco News that it appears the main factor differentiating this planned product from the majority of the existing ETFs in North America is the ability of investors to get their hands on physical gold or silver whenever they choose to exit, although they could also cash out."

So where does that leave the Winklevoss Bitcoin Trust?   Well i’ve tried to wrap my head around it and I think that even though retail investors cannot redeem their shares through the Trust that the Trust could possibly work with an Authorized Participant(s) who would be the enabler for such a transaction (in aggregate).

One has to wonder (hmmm, I wonder!), could BitInstant become an Authorized Participant?  Winklevoss Capital was the lead underwriter for BitInstant’s recent $1.5 million financing round (See Colleen Taylor’s TechCrunch article, “With $1.5M Led By Winklevoss Capital, BitInstant Aims To Be The Go-To Site To Buy And Sell Bitcoins”).  Though i’m unsure if BitInstant currently has the infrastructure or capital to provide a mechanism for individual investors to redeem their ETF in Bitcoin or if there are compliance issues (beyond my technical expertise / knowledge base).

Let’s Talk Bitcoin! contacted Winklevoss Capital for comment on this article.  No comment was available by press time.

What do you think about individual investors redeeming their ETF for Bitcoin?  Let us know below!

Note that this is not a recommendation to buy or sell a security.  Always seek the advice of your financial advisor before making an investment decision.  Brian Cohen is not a financial advisor (he’s just a freelance writer with too much time on his hands).

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