On The Brink with Castle Island - Matt Hougan (Bitwise) on the approval of spot Bitcoin ETFs (EP.497)

Episode Date: January 11, 2024

Matt Hougan, the CIO of Bitwise Asset Management joins the show. In this episode we discuss:  Spot Bitcoin ETFs are approved! The process to get to this point. The competitive landscape for the 11 products that were approved by the SEC on Wednesday.  BITB, the Bitwise spot product which is the low cost option in the market. How it works and when it will trade.  Bitwise's plan to donate 10% of profits to The Human Rights Foundation, Brink and OpenSats The outlook for an evolving custody and trading market structure.  Ethereum ETFs in the near future? Learn more about Bitwise's BITB

Matt Walsh and Nick Carter are partners at Castle Island Ventures. All of these expressed by them or the guests on this podcast are solely their opinions and do not reflect the opinions of Castle Island Ventures. Guests and host may maintain positions in the assets discussed in this podcast. You should not treat any opinion expressed by anyone on this podcast as a specific inducement to make a particular investment or follow a particular strategy but only as an expression of their personal opinion. This podcast is for informational purposes only.

Hi, everyone. Welcome to an emergency version of On the Brink. The Bitcoin Spot ETFs have finally been approved and we have repeat guest Matt Hogan, the chief investment officer of Bitwise on to talk about it. Bitwise's spot product is trading tomorrow under BITB. It's the lowest cost of all these ETFs that were approved today. I was excited to talk to Matt about BitWise's process to get here. Their plans to donate 10% of profits to Brink the Human Routes Foundation, open sats, and also his views on just what flows are going to look like into these products in the coming weeks. I hope you enjoy this one. So without further ado,

here's my conversation with Matt Hogan at Bitwise. Lock down by bad mortgage investments, Lehman, which has 25,000 employees, will be liquidated. The federal government loans American International Group, AIG, $85 billion. This is a different kind of market, and the Fed is asleep. The federal government is stepping it to stabilize Fannie Mae and Freddie Mac, the two mortgage giants that have been threatened by the housing crisis. The Bank of England has pumped 75 billion pounds more to Britain's ailing economy with a new round of Constitution Easy.

You print a couple trillion dollars, and all of a sudden, people are start to worry. So out of this worry, we have something called the Bitcoin. Matt, well, welcome back to the podcast. This is probably like your fifth time on, and it's the first time I have the opportunity to say congratulations on the Bitwise Bitcoin Spot ETF. Oh man, thank you for having me on and thank you for the congratulations. Yeah, it's been a long five plus year journey for Bitwise. And the fact that we're finally over the line, it feels amazing. So we're recording this on Wednesday night. It just happened. I first think, up. Let's just talk about the process. What a crazy process. When did this start for Bitwise? Just talk about

what it took to get here. Yeah, you got to go way back to 2018, 2019 when we first filed for Bitcoin ETFs. The very first thing we did, if you want a throwback, was write that report on fake volume in the ETC in the crypto space, where we said 95% of the volume was fake. And that was an effort to make an argument in favor of an ETF, believe it or not. I do think it helped. clean up the crypto ecosystem a little bit. Data got better after that. Since then, it's been literally countless meetings. We submitted over 400 pages of academic research. Obviously, others in the space did great research as well. Arc, Fidelity particularly, and Grayscale was suing the SEC. It took a village on this one, but we finally got across the line.

And then just all the drama towards the end of this process. So Grayscale wins the lawsuit on the the Administrative Procedures Act. And then all this uncertainty, the SEC announcing that there was an ETF a day before and it was actually a hacked account. Talk about the last few days here. Oh, man, BlackRock coming in. I mean, you couldn't have scripted the last few days. No one would believe you.

I mean, you had the hacked account with them posting approval on Twitter. And then it took a while for them to take it down. And you find out they didn't have two-factor authentication on it, which is a really funny note to bring into this. And then even today, the day after that, they posted the 19B4 approval on their website and then took it down for like an hour. And no one knew, literally no one knew,

were they approved, were they not approved? We all read the document. Many people saved it onto their desktop. I read through the whole thing, but it wasn't then on the SEC. And exchanges didn't know. it's just so ridiculous. It's so nice to be over the hump. Finally, investors will be able to have a low-cost simple ETF. The shenanigans to get here have been incredible.

Well, it's just a great day for customers as well. Obviously, there's a lot of competition in this market. I think the fees, particularly on your guys' product, is just really friendly towards investors. So why don't we talk about the Bitwise product and then we'll take it from there. Tell us a little bit about the Bitwise spot product. Yeah, we're really excited BitB. You know, like all these ETFs, it does something really simple, acquires Bitcoin and holds it in an institutional, regulated third-party custodian, in our case, Coinbase custody. And then it charges an extremely low fee. We're excited to have the lowest fee ETF in America. It charges 20 basis points.

You're an ETF guy, so you know that that's low, even within ETFs, let alone crypto. It's half the price of the largest gold ETF, to give you an example. And if you think about where crypto was last week versus where it is today, it's true that the cost to access this space has literally fallen by 90% in a fund vehicle. The largest vehicle in the space charged 2% last week. And now we're talking about 20 basis points. And the less you pay, the more you keep. That's why it's a good thing for investors. And particularly for an asset that many of us plan to hold for 5, 10, 20 plus years, those fees,

actually really add up. The difference between 2% and 20 basis points is material. So we're really excited to bring BitB to market and to be the low cost leader. I'm sure there was all sorts of game theory around where to price this thing. And I guess having 11 sponsors going after this at the same time made it even more complicated. But is this where you thought it would price? And I'm curious just your thoughts more broadly on where others priced theirs. Yeah, we knew it was going to be priced low. We knew because it was a competitive crucible with, as you mentioned, 11 people coming to market. The ETF space is a winner-take-most market where one ETF or two or three tend to accumulate the most liquidity. So you need to be competitive. We knew that it would be

priced low. There were lots of whispers. It ended up coming in underneath that. But we, we're committed to this space for the long term. And we wanted to be the last. And we wanted to be the lowest cost. So we came under that. But yeah, there were plenty of game theory diagrams. We thought about the personalities of every ETF issue or and where they would come in. And then there were multiple updates, which was incredible. It wasn't just the initial filing, but then there were more filings. And so every night, just after you thought you had finally figured out where to price it, you had to reopen that can of worms again. It's been incredible. Yeah, exhausting, but really a lot of fun. And we love where we ended up.

It's like a game theory class. I love it. The other thing that I think is very interesting about your guys' product is just the donation side of this. And so talk a little bit about who you'll be donating some of these proceeds to and why you guys did that. Yeah, absolutely. So we announced that we would donate 10% of the proceeds from the ETF to Bitcoin open source developers. And we didn't want to do it to any just singular developer. So we're spreading it around amongst Brink, the Human Rights Foundation, and OpenSats. There's this little bit of tension in the crypto world about ETFs, where the crypto world is very excited about ETFs. But of course, it's not native Bitcoin, right? It's not self-sovereignty. It's not holding your own keys. It is an intermediated product.

We think ETFs can be a force for good in the Bitcoin ecosystem. We think they can bring more investors into the space. We think they can grow the market and enhance the liquidity of Bitcoin. We actually think they're a necessary part on Bitcoin's journey to being a globally acceptable and viable alternative rail. But the community that's building on this needs to give back. And so 10% of the proceeds for at least the next 10 years or 10% of the profits to these open source developers is part of our commitment to crypto. I would say, you know, different people have different perspectives. I think it's important that asset managers in this space care about crypto. Bitwise really cares about crypto. It's all that we do.

It's all that we've ever done. It's all that we intend to do. And so this donation is sort of putting our money where our mouth is in terms of supporting the ecosystem. I think it's a great, great way to proceed. You know, when you have 11 other market participants out there, you know, maybe we'll have others. It's really going to be in large part driven by who do you want to have your assets with from a ethos perspective. And so, you know, I think that's a huge part of this. You don't see some of the folks that are anti-crypto in this race yet, but I'm sure they'll have products at some point in the category. And, you know, it might be hard to raise capital if you've been bad melting Bitcoin or, you know, hopping on the private blockchain bandwagon

for the past four years. That's exactly right. That's exactly right. And, you know, open source developers, they deserve our support. They do incredible work and we wouldn't be here without them. So we're really excited for it. So let's talk about how this is actually going to work. So we're recording this on a Wednesday night. What happens tomorrow? Yeah. Tomorrow, you know, the funds will largely be seated tonight. So assets are in the funds as of this evening. And then at 9.30 tomorrow, they'll start the process of opening. People shouldn't panic if they don't start trading directly at 930. It often takes time for the order books to arrive and be structured on the market. But sometime in the early morning hours, these will start trading and you'll start to

see who is attracting volume and who is not attracting volume. The initial days could be a little strange because different issuers have lined up different commitments from investors to come in. But I think you'll see many of these products trade well. We feel very comfortable. We'll trade well. Yeah, you know, we'll enter the ETF era of crypto, which is a river that's fun to cross. It'll be fascinating. So you guys disclose that you have a buyer here, it seems like, for $200 million. What does that entail? Yeah, I'm pretty limited on what I can say from that, but we do have an indication of interest of $200 million into the product. And I think there'll be many more large institutions that want to come into the space.

again, bitwise, as the low-cost leader, a very attractive product for these folks, arguably lower cost that you can get in almost any other setting. And so that's an example of that, an entity that we knew who wanted to allocate into this space. One of the things that I'm really interested in tomorrow is what happens with the grayscale product. And so the Bitcoin Investment Trust is the largest Bitcoin product out there at the moment. they came in at 1.5% on their fee. Were you surprised by that? 1.5 is a high fee compared to the other providers.

Our fee is 86% lower than that at 20 basis points. I think the challenge they had and the advantage they have is they have a large embedded asset base and a great product that's done great work for the world. I think it will be interested to see how many people rotate out of that into lower cost products, particularly for tax-advantaged investors, investors in their retirements or IRAs, who won't gain the capital gains by rotating out, I think it's a good thing to think about when you can lower your fees, arguably by more than a percent, you know, 1.3 percent is pretty interesting.

Yeah, I think that, you know, you almost have to think that they modeled it, that they would lose most of the assets in that rollover IRA category into lower cost options. So it'll sort of be interesting to think about the flows in the context of grayscale because the discount needs to come back to par. And so there's a certain amount of AUM that just gets thrown at eating the discount almost. You could think of that way. And then you start to build. So I guess a roundabout way of saying what type of flows do you think we'll see into the suite of all these products over the next few weeks here? Yeah, over the next few weeks.

I mean, look, I think the one day record is a billion and a half in ETF land. And I think these could challenge for that if the market is doing well in the morning and there's a lot of excitement. I've seen estimates of $10, $20, $30 billion in the first year. That would be records for ETFs, but this is a uniquely appealing asset class that's hard to access for many. And so I think that's possible. We talk to financial advisors and financial professionals all the time.

They want access in an ETF. They tell us that. We ask them, do you want? private funds. Do you want OTCQX traded trust? Do you want futures based products? And they say, no, no, no. We want an ETF. And so finally they'll have one. So I think there will be substantial flows. Now, some of it will be people moving from higher cost exposures to lower cost exposures. And you could try to back those out. But some of it will be net new money. I know net new money that wants to come into these products. So it'll be real flows. That'll be fascinating. So I mean, a lot of the hard work has been

done in the years leading up to this. And so talk a little bit about what it takes to get listed on some of these brokerage platforms and RIA platforms and how you see that unfolding, you know, the fruits of the labor, so to speak. Yeah, it's a continual process. I mean, Bitwise has been in the market, building relationships with advisors for, you know, seven years. And they are relationships when you meet a financial advisor.

They don't allocate to your product day one. They want to get to know you. They want to do the research. They want to kick the tires. So even RAAs who are independent, it's a process and a journey that they've been on. And we've been having those conversations with thousands of advisors for the last few years. There's a whole other level with the major wirehouses, the Morgan Stanley's and Merrill Lynch's and UBSs and Wells Fargo.

They have their own due diligence standards. So even though an ETF has listed, many of those brokers can't access it or at least can't solicit clients to invest in it until it's gone through their due diligence process. That's one of the reasons why this ETF story is really not a one-day or a one-week story. You really have to think about it over the course of the year. I made an analogy earlier today to the having, right? The having is not a one-day story. It's not like one day you wake up and price go up because we're producing half as much Bitcoin. It's an important event and it impacts price, in the surrounding months.

And this is something similar to that. There's been some anticipation, I think, built into the price. And then there'll be a long tail as it gets approved on these platforms and people can actually allocate. It's a much longer story than crypto Twitter wants to make it out to be. And you mentioned the having. I mean, I guess that's also part of the investment case will evolve over this year more so than a lot of other years, right?

This will be the first having that occurs when this is truly an institutional-grade asset class. It's an amazing combination. I mean, I hate to be simple, but Bitcoin's a commodity whose price is determined by supply and demand. New supply will fall in half. And we have a demand shock from an ETF. That's a pretty good setup. That doesn't guarantee it goes up.

But those are pretty good preconditions. So I do think the halving is nice. I also think it's nice from a narrative perspective. Right? We've been looking forward to the Bitcoin ETF for so long. If we had nothing to look forward to or if it were abstract, like, rate cuts or approvals on these platforms, I think that would be a little fuzzy for people. But there's this new big carrot hanging out in April on the second half of the Bitcoin equation.

And that's pretty exciting. So the timing couldn't be better for investors. Yeah, I can't wait to see it. I want to get your thoughts also on just market structure for these things. And so these are cash create. That's pretty in the weeds for most people. but I would say not optimal versus like an in-kind model. It would be a lot easier for some of the people doing the plumbing on the back end of this if you were able to do in-kind. So I'd love to see that change. I'd also love to see more custodians enter this market, particularly the bigger banks

who kind of want to play but can't do to the SEC's kind of obscure accounting rules. How do you see the market structure for these products evolving over the next couple of years? Yeah, it's just going to get better is the short answer to it. So I think new custodians will enter the market when they see how large this opportunity is. And I think the Bitcoin ETS will prove that out. I think liquidity will improve, particularly when we get options on these ETFs, which could take a while. But I think you get a nice liquidity ecosystem moving in that space. And I'm hopeful we'll get to in-kind creations.

It is a more elegant mechanism. It's a relatively small difference from cash, but it is more efficient. It is more elegant. and it's the way ETFs were designed to work. I think we'll get there. You know, if you zoom out, this is a huge step forward. We've seen this in other asset classes in the ETF industry. We saw what a gold ETF did to the gold market,

which was a disjointed over-the-counter market with one futures sort of exchange dominating. And now it's a really robust market. I think you're going to see the same time of maturation. So more custodians, lower costs, greater liquidity, and over time, these ETFs will be sort of optimized from their creation redemption process. But they're already going to be pretty great. It's already going to be one of the cheapest, easiest ways to access Bitcoin with a peace of mind

that comes from an ETF with a regulated custodian and tax and audit and those things. That's a really interesting point on liquidity with the options on these products. I hadn't really considered that. So how long do you think it'll take for us to get to those type of products? That'll take a while. That'll take a while. That could take months or even more than a year because of the listing rules. But we'll get there.

And that will really help enhance the liquidity of the ecosystem. Now, when you think about this from a bitwise perspective and all the other products, it would strike me that you guys are quite advantaged versus some of the other sponsors that might only have one product. And so you have longer tail things. Those will be very appealing. I would imagine to a certain subset of buyers here, financial advisors that might want SMAs, et cetera. How do you think about just the Bitwise business model in this race?

Yeah, I feel really great about it. I mean, if you know anyone who started investing in crypto and you've watched their journey, they come in the Bitcoin door and then they spread out from there as they start to realize everything that's going on in the space. Obviously, we're the largest crypto index fund manager in America. We have a number of diversified products that give exposure to defy or to coins like Ethan Solana. and we expect some of the people who come in through the Bitcoin door will then move on, graduate, or expand into these other products. It does make for a better holistic business than if it's where you're one-off crypto offering. And also, because it's our whole business, it's supported by research, it's supported by a distribution team that's solely focused on it.

And that creates a nice ecosystem as well. It'll be fascinating. So the ETH decision is coming up, what, in a few months now? The ETH decision on the first filings is in Q2. ETH is more complex from an ETH perspective than Bitcoin. I do think we can get there, but I'm not overly optimistic in the short term. But I think we'll get there. Look, once you crack the ETF door open, I believe it will expand. And particularly when you see what these ETS will do for Bitcoin.

terms of lowering costs and raising protections for investors. It's hard not to want it in other areas of the market. I think that'll happen. I think that's spot on. Yeah, after reading the dissent here, I'm maybe not as optimistic on ETH. But it still seems like there are some folks that might not like this industry over at the SEC. That may be true. It'll take a while, but I don't think it'll take 10 years.

Let's say that. Took 10 years for Spot Bitcoin. I'll take the under on ETH on that. one. Well, this is great, Matt. You have a busy day tomorrow, so why don't you close up by just telling folks where to go to learn more about the Bitwise spot Bitcoin ETF? Yeah, come over to bitBetf.com to learn about that ETF or find us at Bitwiseinvestments.com. A lot of great information there. We'd love to have you. Lowest cost Bitcoin ETF in America. Amazing. Thanks so much for joining and congratulations to you in the team. Thanks, Matt. Appreciate it.