Finance

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

Look, I'll be the first to admit that I'm not the youngest or hippest writer on the internet. 

So perhaps it's no surprise that I don't quite "get" bitcoin. I mean, I "get it" to some degree. The blockchain technology underlying it is an amazing innovation in cryptology, with a lot of potential disruptive implications for the financial industry, yada, yada, yada. There are bitcoin enthusiasts' "visions of liberation and revolution," and cheaper retail-payment solutions to boot. For a while, you could buy drugs online with bitcoin, so if that's your thing, I guess that's pretty cool. And, perhaps most important, you simply cannot ignore the fact that a bitcoin that cost five cents in 2010 is now fetching about $574 and went for more than $1,100 in 2013.

Still, when you start talking about the "fundamental value" of bitcoin, I feel like you might as well start talking about the fundamental value of an Articuno. But as Clint Eastwood once said (in more lucid days before he started talking to empty chairs): "A man's got to know his limitations." And one of my limitations is wrapping my head around what's a fair valuation for a bitcoin, or even how to go about determining one. 

I assume I'm not the only one with that limitation, considering the value of bitcoin has jumped around like this: 

Bit of Volatility
Bitcoin's boom-and-bust cycles have made the cryptocurrency about three times more volatile than even the British pound during its recent swings
Source: Bloomberg

This is not to say people should stay away from bitcoin. It could be a good speculative bet, or hedge, or just a lucrative trading instrument for those who want to go down the rabbit hole of "mining" and "halving" and bitcoin exchange arbitrage and whatnot. 

One thing I do know is that if I wanted to buy $100 worth of bitcoins, I know what price I'd like to pay: $100. Maybe a little bit more. But you know what price I would not like to pay? $180. Or $200. However, that is what investors who buy shares of the Bitcoin Investment Trust fund have been doing consistently. The fund's premium to net-asset value has averaged about 40 percent over its lifetime. It was as high as 100 percent in June, and 77 percent as of Wednesday. That means investing in the fund bought you $100 of bitcoin for $177.

The premium, or discount, to an open-ended fund's net asset value should be microscopic. It's only when something weird is going on that it looks like this:

Paying a Premium
The Bitcoin Investment Trust has traded at an average 40% premium to the value of its assets
Source: Bloomberg

So what's the weird thing going on in this instance? I had a few theories. First, remember all those people who bought narcotics with bitcoin on the dark web? Maybe they consumed those drugs and then proceeded to buy shares of the Bitcoin Investment Trust? I kid, I kid. 

There had to be a better explanation, and maybe it's explained by the weird news flow of bitcoin itself. Despite all of the trumpeted promise that the digital currency is safe and secure and free of fraud, scandalous robberies of bitcoin seem to keep happening over and over and over and over again. The latest caper was a $65 million heist from the Hong Kong-based exchange Bitfinex that led to a swoon in bitcoin value this week. 

With bitcoin accounts appearing to be about as secure as Democrats' e-mail, maybe the jargon-laden pitch from Grayscale Investments, the firm that manages the fund, has resonated:  

The Bitcoin Investment Trust’s assets are stored with Xapo, Inc., as Custodian, in deep cold storage vaults. Bitcoin stored in the Xapo Vaults reside on multisignature addresses, the private keys for which are protected by intense cryptographic, physical and process security. Xapo maintains third-party insurance to cover losses due to employee dishonesty or on-premises theft of bitcoin stored in the Vaults.

That's Custodian with a capital C, fella. 

The added security amid concern about counterparty risk in a nascent technology-based asset is definitely part of the premium, according to Michael Sonnenshein, Grayscale's director of sales and business development. And the fund is sold in private placements to accredited investors with restrictions that only allow them to be resold after they've been owned for 12 months, he pointed out, so nonaccredited investors have to wait for shares to show up on OTC Markets. (Grayscale got a bit of a slap on the wrist from the SEC a few weeks ago for how it handles liquidity in the fund. Here, Izabella Kaminska can explain that better than me.) 

Also, Sonnenshein said, some investors want to hold bitcoin in their regular brokerage or retirement portfolios, so this fund allows them to do that. 

I can't quite wrap my head around what sort of allocation someone should have for bitcoin in their retirement account, especially at these premiums. But hey, a man's got to know his limitations.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net