In-Kind Bitcoin

With BTC finally flowing, Crypto ETFs become a new kind of legit

{This article originally posted at ETF.com! I’ll continue to repost things here with a lag for substack subscribers!}

Every so often I sit down with someone one on one for as long as it takes to get really darned nerdy about something.

This week, I asked Teddy Fusaro from Bitwise Asset Management to help me understand why their recent "first ever" in-kind creation of a bitcoin ETF (in this case, their BITB), is actually a big deal. I came away pretty convinced. Full video above, 5 key takeaways below, and keep scrolling if you want the whole transcript to feed your LLM.

1: Cash-only BTC ETF creation was actually helpful at launch.

[00:08:00]: "Something that I don't think was broadly anticipated is that this actually ended up working out better for most Authorized Participants, because most of the APs are big TradFi institutions... Do you think those companies were ready to turn around and deliver Bitcoin to us? Remember, this is a different era."

The back office of ETFs is just something most investors never have to think about. The SEC's initial cash-only in-and-out requirement seemed like a limitation, but it gave traditional Wall Street firms time to build their crypto capabilities without being forced to handle Bitcoin directly (and deal with the regulatory soup of the time). For ETF investors, this meant the major market makers like a Goldman Sachs and Jane Street could participate in keeping ETF prices efficient without needing to immediately develop Bitcoin custody solutions. This helped ensure that there was real liquidity back in January of 2024, which is one of the reasons we have .

2: In-kind = Efficient

[00:14:28]: "If the order is in kind, all we're doing is accepting the order. We don't need to go out and trade today. We just wait until the Bitcoin arrives. We don't have to pay for it. The efficiency comes in is because ... remember the example I used was that we paid BRRNY (Bitcoin Reference Price) plus two basis points? Someone's gotta pay for that two basis points, right?"

This is perhaps the most important development for cost-conscious ETF investors. Those two basis points (0.02%) in trading costs might seem small, but moving to in-kind creations and redemptions externalizes those costs -- they'll show up, maybe, in the spread, but they won't impact existing shareholders at all. Yes, we're already at the shaving basis points era of Crypto ETFs.

3: Bitcoin ETFs are inherently Anti-Money-Laundering.

[00:21:00]: "A regulated registered vehicle is just about the worst place that someone should try to launder money. What's the point of sending bad Bitcoin into an ETF when you're getting back registered securities that have to be traded and custodied in regulated institutions?"

"Bad Bitcoin" is something the crypto industry has spent a lot of time on. There are now multiple layers of KYC/AML checks - both at the authorized participant level and at the custodian level, leading to a situation where Bitcoin ETFs likely have stronger controls than most traditional ETFs or funds. When you buy an ETF, you get all the regulatory protections of the TradFi system (like, say SIPC protection if your broker goes under), and all of the additional blockchain analytics that make these products arguably "cleaner" from a compliance perspective than, say, a Gold ETF.

4: Conspiracy Theorists Will be Sad: You can Audit the Vaults.

[00:25:02]: "Even compared to GLD -- and we know the fear-mongering and conspiracy theories -- Bitcoin is amazing because it is so transparent. You can look at the blockchain to see where the balances are in each one of these Bitcoin ETFs. Even if they don't publish their addresses themselves, there are block Explorer tools that you can use to see what their balances are on chain."

For years, goldbugs have derrided GLD and it's competitors as "paper gold," positing that there might not actually be gold bars sitting in vaults backing up the ETFs, or that the gold had been "rehypothecated" (loaned around). Despite years of audits and occasional stunt-tours and me making content about it, the unbelievers will never believe. But BTC is just different. You can do the audit yourself on chain. Whatever your opinion about crypto or Bitcoin as investments, it's just factually true that Bitcoin ETFs offer an unprecedented level of transparency that could make concerns about "paper anything" obsolete. This real-time verifiability also makes it much harder for any potential fraud to go undetected.

5: Real Big Fish will be the Norm

[00:34:12]: "If I can find a way to give my Bitcoin to someone and they can give me shares of the ETF back then I may be able to get out of that spot position and into an ETF without recognizing a taxable event... Even if I have a hundred million dollars worth of Bitcoin, I'm not a big client to the biggest custodians. But the ETFs are all big clients to the biggest custodians. So I can then outsource that custody risk.

There's a lot of misconception about how creation/redemption affects taxes. I was on air with a massive ETF/Crypto guy a few months ago who was absolutely convinced all the BTC in the ETFs had been "in kinded to was away cap gains." Which is just not how any of this works. BITB (or IBIT or any other BTC ETF) should never make a capital gains distribution, because it just owns the one, non-producing asset. You can't "wash out" gains by going in and out of the same security.

But, a large investor can work with an AP to "in kind" their securities to an ETF in return for ETF shares. This effectively keeps their basis intact for tax purposes (no magic), but they get their BTC exposure onto TradFi rails, and take advantage of the ETFs position as the 800 pound gorilla with the custody providers. While it's difficult to tease out in real time, I think Teddy's right that we'll see more and more large pools of BTC moving towards ETF holdings, at least partially.

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Full Transcript

[00:01:04] Dave: All right folks. Welcome back to Rabbit Cave. My name is Dave Nadig, President and Director of Research at ETF.com and today, very excited to be joined by Teddy Fusaro, who's head of Trading Capital Markets. Teddy, what's your actual title over at Bitwise?

[00:01:19] Teddy: I am the president of Bitwise Asset Management and in my capacity, I also wanna say to you, Dave, since I have the honor of being here with you on the first week after the announcement. Congratulations to you on your new role as president of ETF.com.

[00:01:36] Dave: We can be, co-presidents here as we figure this stuff out.

[00:01:40] Teddy: That's right.

[00:01:40] Dave: But I'm not wrong that you are heavily involved in the deep weeds of how this thing trades, how all of these crypto ETFs trade now that they're alive. Right. That's, that's your core.

[00:01:52] Teddy: That's totally right. And like a little bit of background before I. Got into crypto full-time at the beginning of [00:02:00] 2018, end of 2017. That's how I grew up. I grew up as a portfolio manager, head of trading, head of ETF Capital Markets head of Operations at a handful of early stage and alternative types of ETF issuers. So just at around the same time that you and Bitwise, CIO, Matt Hogan, were running around and standing up. The first big, ETF publication companies, media and research companies. I was on the other side doing all of this stuff with market makers, with APs, with structuring, and I feel like in my mind, at least, it wasn't all that long ago that the same types of things that we're gonna talk about today related to Bitcoin and crypto ETFs were the hot topic for equity ETFs and fixed income ETFs. How does this stuff work? Oh my gosh. Is there risk here? I remember, ETFs were gonna be weapons of, financial mass destruction my whole career. They

[00:02:59] Dave: [00:03:00] have been, And, so in my mind this is like really, a repeat of those conversations. The mechanics are not exactly the same, but they really rhyme a lot.

[00:03:11] Teddy: and so yeah, that's, that's what I grew up doing. That's what I, I still oversee the portfolio management trading capital markets and. And product structuring teams here at, Bitwise, and this is the stuff I love talking about, and nobody's better at talking about it. so that others can digest it than you, Dave, and happy to be here to chop it up.

[00:03:29] Dave: Awesome. Well, let's dig in. So let's go back a little bit. It was January last year. We got the first of these things trading at all, and back then I approached them as well. They're just like bond ETFs because back then or still to this day, a lot of bond ETFs, if you show up to, with a billion dollars to get into a GG, chances are you're actually gonna be giving them mostly cash. Mm-hmm. And particularly some firms like pimco. Notoriously don't want in-kind creation. So if you want new shares, you've given them cash, they do the trading. If you wanna get out, they do some selling, they give you the cash and you're out. That's how things have been working. Right. What's different about how it had been working versus that base case for bonds?

[00:04:12] Teddy: Yep. So maybe we take a little brief detour down memory lane and we go back to the time that the, the Bitcoin ETFs were initially approved, as you said, January, 2024. So as we're in the run up to that approval process, one thing that was the source of a bit of consternation in the industry is all of the issuers were going to the SEC and, and, and all of them wanted to do in kind transactions. And all of them, if you're really deep in the weeds, all of them, up until really the last couple of days or weeks had the ability to do. In kind creations and redemptions in their regulatory documents, in their prospectuses, in their filings. At the time, in the, in the final mile, the SEC had said to them, we're not, we're gonna allow these things to go to market, but we're not gonna allow you to do in kind creations and redemptions, and here's why. The, the why is that in. 2020. So you gotta go all the way back to 2020. The, the SEC had issued a release, maybe we can put this in the show notes. It's release number 3 4 9 0 7 8 and this release. I'm telling you, I've been through the, through the ringer on this. This release has to do with custody of digital assets by broker dealers, special purpose broker dealers. And what they had said in that release is that you could be a special purpose broker dealer and you could take custody of either digital assets that are securities or other digital assets, or you can be a regular broker dealer, not a special purpose broker dealer that has. Custody of regular securities, but you can't do both, right? Can't have both. Bitcoin and. What we call in crypto TradFi securities. Right, right. And that was the loop that they couldn't close in this process. They still had this guidance outstanding. and they, and they, they had to approve these ETFs basically because of the grayscale lawsuit. but they wouldn't do it with the in-kind creations and redemptions. And so the way that these things came to market in January of 2024 and the way that they have been operating up until this month has been cash only creations and redemptions. And so that's just setting the stage.

[00:06:47] Dave: Got it. And let's talk about. What that looks like, because I'm sure in some of the other products, and certainly in other crypto securities, not everything's gonna be in kind outta the gate. So talk a little bit about that process. A normal authorized participant, and for folks who aren't familiar, that's generally a big market maker. A Goldman, a bank in New York, a, somebody like that, A GTS, a big one.. They show up and they're the ones that actually deliver a bunch of cash to you all and what they're expecting back is bit B, right? That's what they're, yeah. Hoping to get back after the end of that transaction. So that comes in like a normal creation, right? Sometime in the afternoon you get the notification, somebody wants 50 K shares or something, and then you end up with a bunch of cash. Can you walk through the, the process of that, if I'm showing up at three o'clock with a creation order for cash, how quickly does that turn into a transaction and who's making that transaction?

[00:07:40] Teddy: Yeah, absolutely. And I, and I, before I get into it, I'll also just say that. Something that I don't think was broadly anticipated is that this actually ended up working out better for most of those APs that you referenced, because most of the APs are big TradFi institutions, like you said, and [00:08:00] didn't yet at the time have Bitcoin trading, Bitcoin custody, Bitcoin transaction. So this, this got, this was actually

[00:08:06] Dave: a bit of a get outta jail free card for a while.

[00:08:08] Teddy: Yeah. it kind, it got a little like, and, and I remember saying this to our counterparties and to the market and to the SEC at the time, like, do you think those companies that you mentioned are ready to turn around and deliver Bitcoin to, to us? Remember, this is a different era. I know everybody's working on it now, but in December, 2023, in January, 2024, not all of these banks were standing up crypto trading desks for sure. So this, this worked out better for them in the, in the short run. Now. To go more to the heart of your question about how it works. Yeah. So you have every single day that the stock market is open, the ETF is also open to take these creation units, large blocks of shares that one of these APs, a registered broker dealer who has one of these. Authorized participant AP agreements with the, with the ETF can come in and they can enter an order. It has to go through another TradFi institution, usually Bank of New York or State Street, the custodian bank to say, Hey, I wanna create 50,000 shares of the ETF today. They've put that order in now. Instead of the regular way process that we all know in ETF land where they're gonna give us the underlying assets to settle the trade, they're not gonna do that. They're gonna deliver us cash. And so when an AP comes into our ETF today and says, I want to create 50,000 shares of the ETF out my portfolio managers. Know that they need to spend that cash today to buy Bitcoin. And so what do they do? They go out to the, to the market. And here, when I'm referring to the market, I'm talking about what we refer to as OTC trading desks in our regulatory filings, in our, disclosure documents like our S one or our prospectus, we refer to these as Bitcoin trading counterparties. Got it. Think about firms like. Cumberland Falcon X B2C two non co flow traders, Jane Street. These are the largest Bitcoin trading desks in the marketplace. And so what our team does, our portfolio management team does is let's say the 50,000 share create is worth $10 million. They go out to this roster of liquidity providers trading counterparties, and they say, Hey, I need to trade. $10 million worth of Bitcoin today, and they're gonna, those counterparties are gonna provide a quote back to our desk that is relative to a pricing benchmark. Most of the ETFs use a pricing benchmark that is from CF Benchmarks, which is effectively a one hour. Time weighted average price between three and 4:00 PM

[00:10:59] Dave: So that's [00:11:00] B-R-R-N-Y, right? That's the, that's B-R-R-N-Y. Got

[00:11:02] Teddy: it. On Bloomberg. Yeah, exactly right. You can find it on the CCF Benchmark website. And that's basically just

[00:11:06] Dave: telling you going into the close, which the Bitcoin isn't closing obviously, but going into the close of the ETF trading three to four, and that tends to be when most of the AP orders have rolled in by then, that's when I got 10 million to buy. And you're going out to one of these counterparties and you're saying, what's the best, what's the best you can do for me here? And they're gonna say, beer and y, plus or minus something, depending on which way it's going.

[00:11:32] Teddy: Exactly right. So they're gonna, they're gonna quote you, okay? Plus two basis points if you're a buyer, minus three basis points. If you're a seller, we're a buyer today. one of them comes back with plus four. The other one comes back with plus three, and the third comes back with plus two. We're gonna hit the plus two, or we're gonna lift the plus two offer, and we're gonna be buying Bitcoin on that day for B-R-R-N-Y, which hasn't been published yet, right? It's the three to four pricing window, and we're gonna buy that Bitcoin for two basis points above whatever the benchmark price is. Got it. Then. So that's on trade date. Today is the day that the order came in and the day that we traded, and then tomorrow settlement's gonna occur.

[00:12:18] Dave: So tomorrow, well, so let, let me tease that apart. Mm-hmm. The settlement in the Bitcoin that you're buying pretty much happens a couple blocks later, right?

[00:12:27] Teddy: So, no. So the settlement occurs on T one for all legs of the transaction. Okay. The important thing that we drove forward, a Bitwise that was very important to us is none of the first piece of the settlement. Has to be that Bitcoin arriving on chain at our Bitcoin custodian, and we can talk a little bit more about that if you want. But from a risk perspective, for the sanctity of the product, we don't want to be sending cash out and we don't want to be sending shares out until that Bitcoin has settled on chain at our custodian. So tomorrow, the first thing that is gonna happen that kicks off the settlement process is we're gonna be waiting for that. $10 million worth of Bitcoin that we just purchased at VRR NY plus two. We're waiting for that to settle on chain at our custodian. Once that hits, we're willing to send the cash to the trading counterparty and send the shares out to the AP, and that's how the settlement process unfolds. And

[00:13:34] Dave: is it still work through the overnight matching process at NSCC like most Creation redemption does, or is there a side card process here?

[00:13:42] Teddy: Yep. The, the equity leg works that way. Okay, so the, the settlement of cash versus shares works really synchronously with the existing TradFi. Pipes. Got it.

[00:13:54] Dave: So let's, let's, we're gonna come back to some of the custody issues here for in a minute, but let's just stick on [00:14:00] this money coming in thing, as of a couple weeks ago, that's different, right? Right. So now you guys have done the, the first, and I'm gonna guess there have been some more, inkind creations. I dunno whether there have been any incurring redemptions yet. Talk to me about what's different about that, because now instead of showing up with cash and then doing a buy and waiting for those, share the Bitcoin to actually show up. Now you're actually just getting like, Hey, here are the coins. Just like a wallet transaction like anybody else would have. Right?

[00:14:28] Teddy: It is totally right. So really like the way that I think about it simply, and then we'll go into the weeds as I know you like to do, and I like to do that too, is it just compresses down the complexity. So all the stuff that I described to you about going to three counterparties, asking them for a quote, considering which one is the best quote, lifting the best offer, or hitting the best bid, waiting for settlement tomorrow. Needing to wait to send the cash. None of that needs to happen. And importantly, that two basis points of slippage, that two basis points of trading cost that we paid above V-R-R-N-Y, that doesn't need to happen either. Here's why,. If the order is in kind, all we're doing is accepting the order, we don't need to go out and trade today. We just wait until tomorrow and then tomorrow we just wait until the Bitcoin arrives. We don't have to pay for it. Once the Bitcoin arrives, we can turn around and send out the shares to the AP that created it. Got it. And so it's, you've gone from needing, you've gone from needing. Every element of the cash transaction to just stripping that out, taking it away. And all you're doing is waiting for Bitcoin to be delivered, or in the case of redemption, delivering out Bitcoin. And that's all you need to do. And where I say the efficiency comes in is because going back to our transaction of my portfolio managers spending the money to buy the coin. Remember the example I used was that we paid VRR NY plus two basis points. Someone's gotta pay for that two basis points, right? That's gotta work its way into the spread. It's gotta work its way into either, a slight premium or slight discount to fair value depending on how, how, how wide that, that, that bid ask spread is on actually buying or selling the coin and that piece of it. Goes away, and that's why we think that this really collapses the cost structure for this because of that efficiency in the in-kind process.

[00:16:33] Dave: Does it change the nature of the kinds of APs you're dealing with? Does it change that list? Like are there only a handful of them that can do the in-kind, but you still got some that are showing up with cash?

[00:16:44] Teddy: Dave, you always go right to the important questions. And there's a, there's a reason that I, that I had started with the, with the SEC release number that we're gonna put in the show notes because the, the, [00:17:00] like a complicating factor here is that while this past month, the SEC did approve the ability for in-kind creations and redemptions to occur, they have not yet closed the loop on the broker dealer custody release. Meaning they, they, they said, okay, ETFs, you guys can go ahead and accept in-kind creations and redemptions. They did not say, we are rescinding, SEC release number 3 4 9 0 7 8 and issuing new guidance for broker dealers. So that still needs to be. a loop that is closed. Now, by all indications, all the regulatory process and movement that we're seeing, we're anticipating that will get closed. But for now, all of these APs, which are also broker dealers, in order to be an AP, you need to be a broker dealer. They all need to figure out how to comply with this complexity on their side. It's not need to have, so you can only work with.

[00:18:01] Dave: You can only deal with the crypto native people at the moment for those kinds of inkind creates because they had to have made that choice about which BD they want to be when they grow up.

[00:18:10] Teddy: So there's a, there's a few different models that can work here. One that we have seen work the best is over time. A lot of the ETF and crypto market makers in general tend to be the same types of firms, because if you're good at. Making tight bids and offers in the futures market or the ETF market or the equity market, that technology ports over really well to being good at keeping tight markets in the Bitcoin market. Right, right. And they love the Bitcoin market. It's 24 7. It's global liquid. It's volatile. It's volatile, right. Like it's, it, it, it, it checks all the boxes. It's cracker

[00:18:51] Dave: candy. I get it. Yeah,

[00:18:52] Teddy: it is great. So, what has happened over time is that a lot of these global trading firms have [00:19:00] set up. Different entities than their US domestic registered regulated broker dealer that can handle their crypto trading Now. Some of the firms that you mentioned haven't gotten to that step yet, but others that you mentioned have and have had this infrastructure operating for a few years. So really it's a scenario where the ones that are now ahead of the game and have been, in the market from a regulatory perspective to trade Bitcoin spot or crypto spot, they can facilitate these types of transactions. There's another path. Where if you are a registered broker dealer that doesn't have a crypto trading entity, you can, you can effectively appoint an agent to do the delivery. Right. The you into it, right? Yeah. Yeah. So there's a few different models, but what I would say is that like this is still. System wide. This is still new and the market is still adjusting to it. We see a lot of demand for it. We can talk about some of the reasons for that, but the market is definitely still adjusting.

[00:20:05] Dave: Got it. Okay. Let me dig in a little bit deeper on some of this. One of the issues that I had read was a concern about doing in kind create people just showing up with a whole bunch of their coin, was that, some coins are good and some coins are bad. They're, they're addresses that are, excised and not on white lists. And there are, there are attempts in the A-M-L-K-Y-C process. To keep people from using things like a creation redemption process to magically blend their, their bad actor crypto. how is that resolved now? Because that was an issue, but apparently it's not anymore. Did the broker dealer community just figure their side of that out, or did you have to do anything?

[00:20:45] Teddy: Yeah, I would, stepping back from that, I, I would, I would first say, it was a concern that was often raised, but. In the first instance.

[00:20:57] Dave: A regulated registered vehicle is just [00:21:00] about the worst place that someone should try to launder money.

[00:21:03] Teddy: Agree. It's just not a good idea. it's not gonna work well for someone who's trying to, trying to do it that way. and it, it is a,

[00:21:12] Dave: it is been a common concern in Bitcoin and crypto over the years, but I think it's been overblown One of the things that's so amazing about the Bitcoin blockchain is just how transparent it is,

[00:21:23] Teddy: right? But how you deal with that as a practical matter, is that whoever you're, whoever a an ETF entity or a regulated entity, is going to accept a delivery of Bitcoin from needs to have KYC and a ML procedures done over that relationship you exchange. Test information with the wallets and you do K off chain, we refer off chain, on chain, off chain, K-Y-C-A-M-L, on the entity itself that's gonna do the delivery. And so like that's the basic practice for how that everything is, is going to be safe and sane. But the other thing I'll say is that we, we work with and all the, the Bitcoin ETFs do work with, with regulated institutional Bitcoin custodians. And they have very high standards for this too, as you can imagine. And they do things like run. Tests and ongoing scans on all of their incoming transactions. So even away from what the ETF is doing, the custodian is looking at all the incoming deposits to see what's happening here. Where has that coin been? Has it been in any quote unquote tainted wallets or tainted, locations that are known to be affiliated with any. nefarious activity. So it, it really, to me, once you start digging into how one would even consider doing something like layering or, or, or using one of these funds as a money laundering tool, it seems like a really bad idea. 'cause then remember also like. What you're getting back is US registered securities. Right. So like if, like what's the point? You're, what's the point of sending bad Bitcoin into an ETF when you're getting back registered securities? It, it's, it, it that have to be traded and custom and regulated institutions. That makes

[00:23:11] Dave: sense. So it sounds like there's at least the two different gates. There's the gates that are set up in the relationship that the ETF has with the broker dealer community and that whole process where there's one layer of check and then in the back you've got Coinbase custody or somebody else. Putting their own layer of checks on everything that comes in the door. So that makes total sense. Yeah. Let's talk a little bit more about that custody relationship. One of the myths I wanted to try to bust here, which I see every time I bother to wade into a terrible Twitter thread about people thinking the world's ending. Is that this is all paper Bitcoin and yes. How do anything is, it's the same thing we got with GLD. There's no gold in the vault. Yeah, it seems like exactly the same argument we've had forever. and for exactly the same reasons that I think GLD got heat on this, which is there's a difference between where all the money really is and the little sliver that you need to keep alive to trade and like have some cash to pay for things here and there. Can you talk a little bit about how that works? Maybe differentially versus something like GLD? There's still the same concept of the stable, secure pool that's really hard to touch, and the little bit that's actually getting traded every day, right?

[00:24:19] Teddy: Yeah. Yeah. Well, for us, I'll say for, for Bitwise, the difference in custody is that we, we Bitwise keeps every. Bitcoin every, every, all of the Bitcoin in the cold storage solution at the custodian, it doesn't, doesn't touch an exchange. It doesn't go through a hot wallet. It's all straight into cold, straight out of cold. And so that's one thing. But the other thing is really even compared to GLD, and we know that's fearmongering and, and conspiracy theories. We've, we've been through those, but even compared to that. Bitcoin is amazing because it is so transparent. You can,

[00:25:02] Dave: you can look at the blockchain to see where the balances are in each one of these Bitcoin ETFs.

[00:25:09] Teddy: Even if they don't publish their addresses themselves, there are block Explorer tools that you can use to see what their balances are on chain. One of the reasons that. Bitwise I think was very successful in the early going is because what we did was we actually published on our website all of our Bitcoin addresses so that people could go and check those themselves. It since became very difficult to follow them all 'cause we had so many different addresses. That we actually even recently upgraded to a new service that does a proof of reserves and we publish that on our website. Now, not all of the issuers do that. I think that they all should. We, we, we encourage all of them to do that, and I think that they should. but yeah, that the transparency of the blockchain, of the Bitcoin blockchain really makes this even more, of something that, that investors can get comfort in. When they're looking at an ETF. And then the, the other thing I would say is, and, and I'll, I'll come back to this as we talk about why. Some of the largest and, and, and most prominent Bitcoin investors over time are starting to switch into ETF holdings, which is an amazing development that I didn't anticipate that's happening now. One of the reasons for that is because. You get such strong comfort with the custody process that the ETFs have. Now, look, these are bearer instruments. Bitcoin is a bearer instrument. You can never completely rid yourself of the custody risk, but in an ET tf F, just like gold,

[00:26:50] Dave: somebody can break into the JP Morgan Vault Yeah, and walk out with a 400 ounce gold buck.

[00:26:55] Teddy: It's a risk. You need to disclose that risk. You need to comfortably talk about that risk. It, it [00:27:00] exists. But at least with the, with the ETFs, you can be sure that your, your, your ETF sponsor is an important client of a state-of-the-art custodian that is providing custody over those assets in, in the best way possible.

[00:27:18] Dave: What's your take on some of the criticisms around custody that well, you should have five different custodians to, diversify your custodial risk. People do that in gold like that. Some of the gold ETFs make a big deal about the fact that they have gold and 16 different vaults. Like is that a real issue? Is there really even a service industry that where you could say, we're gonna be in 10 different Custo cus custodians?

[00:27:41] Teddy: This is one that I think is a, is a thoughtful. Criticism or a thoughtful risk? I don't, I don't know what the right answer is. Certainly, we, we, we have chosen and we work with Coinbase custody. Coinbase Custody Trust Company, LLC. It's a fiduciary under New York State banking law. They hold themselves out as a qualified custodian. They are regulated by the New York Department of Financial Services. They have SOC one, type two, and SOC two, type two audits. Those are all things that give us a really high level of comfort with their service. They're also a legally separate entity from the exchange. Right? Which I think is really important. It's not, it's not the same as having your money at an exchange. It's a legally separate custodial entity. They have an impeccable track record, but when people say. Wow. the big players, Bitwise High shares, they have all of their assets with the same custodian. Is that a, is that creating a centralized risk? It, it's that, that I, that I am thoughtful about. I do think that the way that this resolves over the very long term is that there are multiple custodians for each ETF, but I would also say that like. What's the other side of that, Dave? It's like you, it. You're, you're diversifying your risk perhaps, but you're also creating more surface area for risk. Oh yeah. Sure. If you, if, if you, if you, it's not acceptable to lose one fifth of the Bitcoin, just like it's not acceptable to lose all of the bids. It's not acceptable

[00:29:19] Dave: to lose any of, I get that. I get that. But it does seem like, SAB 1 21, right? The accounting rule that got revoked. That's, that allows people like BNY to get into this game now, where before Coinbase had a bit of a monopoly because they weren't doing the other stuff and they weren't allowed to. do you expect that over the next couple years we're just gonna have a, like literally everybody who custodys anything is also going to custody crypto.

[00:29:45] Teddy: All of the big custodians will provide crypto custody services. There's no question about that in my mind, but there is a question about how much market share do they take and do they buy or do they build? Right? Because like I said, the, [00:30:00] the track record of Coinbase, of, of Anchorage, of, of Fidelity, these are really the, the, the three of the largest crypto custodians that we have. It's impeccable. They've spent the better part of a decade developing these solutions built, hardening them, building them such that they're the best in the world. It's, it's a pretty difficult thing to play come from behind with that tech stack and that moat that has been created by developing that business and that technology over the years. Right. What we're talking about when we talk about crypto custody is we're talking about. Generating a private key, storing that private key, and then using that private key to sign transactions, right, and getting the, the years of reps. Building a process that can withstand these service and organizational control audits that I talked about. These are things, getting these audits done from a big four auditor takes years to get done. You can't, you can't just get one in a couple of months. You, you're talking about needing to have auditors embed physically into the process to ensure that. The internal controls and systems over financial reporting or related to security are operating effectively. And so, like the, the SAB 1 21 thing was,. Bad for the industry generally because it didn't allow the big players to come in when they should have been allowed to. But it was also like a great moat for the early crypto custody companies. 'cause they got to get this multi-year advantage in building these systems and building these processes. Right.

[00:31:43] Dave: All right, a couple more myths I wanna bust here before I let you go.. I, I got into a little bit of a discussion with Tom Lee on CNBC about a month ago, where he was convinced that what was going on in the Bitcoin ETFs was a whole lot of tax washing. That's a whole lot of hooey, right? There is no tax advantage for this in kind creation, [00:32:00] redemption in the Bitcoin ETFs is there? my understanding was this was basically just like owning Bitcoin like a pass.

[00:32:08] Teddy: It is a pass through, but may, maybe this is a good point in the conversation to talk a little bit why, about why the in kinds coming online are opening up a lot of new investor possibilities and a lot of big bitcoin spot investors are thinking about moving into the ETF. So under, in under the tax law, generally just like for in-kind transactions in an equity ETF. If, if, if I exchange, like for, like, I don't have a taxable event right when that transaction occurs, right? So if I give you, the, the stocks in the s and p 500 and you give me an ETF back that represents those 500 stocks. I don't have a taxable gain on my, on my transfer out of those underlying stocks. The, the same thing applies in theory to bitcoin. So if I have Bitcoin that I purchased in 2015, that has now grown a lot, and I'm storing it on a, on a, on a ledger device, a ledger over here, a fresh ledger, if I'm storing it on a ledger device.. I maybe have seen the, the, the value of that Bitcoin grow tenfold or 15 fold. it's, it's outside of the financial system, right. But if, if I can find a way to give my Bitcoin to someone and they can give me shares of the ETF back then I may be able to get out of that, that spot position and into an ETF without recognizing a taxable event. Now, it's a little more complicated than that because of course, if I'm just sitting here at home with my Bitcoin on my ledger device. I'm not an AP. I can't do that directly. Right. We talked about KYC and am ML concerns, but if you can, if you can find a way to do it, there's a lot of reasons that in that early and large and other large Bitcoin investors are considering doing this, it's outsourcing the custody risk to a, to a registered transparent. Listed security that has an auditor that's doing this on chain analysis to make sure that their assets are there with their, with their custodian that's getting their financial statements audited every year. That has a big relationship with the custodian. Even if I have a hundred million dollars worth of Bitcoin, I'm not a big client to the biggest custodians. Right. But the ETFs are all big clients to the biggest custodians. So I can then. Outsource that Cofi risk. I can do it tax efficiently. I also, I, I, if I want to give some donations to my favorite charities, it's pretty difficult for me to give BTC to give Bitcoin, right? Some of them might take it, but, but everybody accepts all charities. Typically except securities.

[00:35:12] Dave: So I, I get that there's a convenience layer, like once you're, once you're on the TradFi rails by owning bit B versus owning BTC directly. Now I can, I can send it, I can, I can present it as collateral. Some places I can collateral sell it in small blocks here and there, like I can margin against it. I understand like there's real value in having. That investment now sitting on the trad fire rails. But there's not like a magic tax dodge here, right? It's not like you just get out of your 98% gains that you've been holding onto.

[00:35:44] Teddy: No, because you can't, you can't erase the unrealized gain, right? That's right. You can, you can, you have to carry it over. You're gonna have to pay taxes on it eventually. Right. Okay. But you, you can get it into the system. Another, another big reason is estate planning, right? Like. Okay. My, my, my, my wife doesn't, may not know how to access my, my Ledger device, but if it's in my Fidelity account or my JP Morgan or my Goldman account

[00:36:10] Dave: Right. Just goes through the trust accounting then that be Yeah, yeah. Exactly. Get the step the whole nine yards. Yeah, yeah, yeah. Mm-hmm. I totally get that. I totally get that. Okay. So I just wanted to make sure, 'cause that's, that is another thing that I hear people saying is that everybody's loading into the Bitcoin ETFs 'cause they get a magic tax Dodge, which just, I've never been able to figure out why people think that. No. And the other, the other big tax efficiency we get with ETFs is irrelevant because you aren't making capital gains distributions out of a single asset fund. Right? That's right.

[00:36:39] Teddy: Yeah. And there is, there is no tax dollars. We get that question too. It's like. Again, not, not the place for it and it's not gonna happen. And whether or not people are paying all the taxes that they owe on their own personal crypto holding, different question. But just like the money laundering thing, not the place to do it in a regulated wrapper that has to settle through a broker dealer.

[00:36:59] Dave: All [00:37:00] right, let's, let's close up with one thing. So this has been a big deal from the perspective, like from my perspective, it feels like an actual bridge, right? We're going directly from the crypto rails directly to the TradFi rails and skipping a whole cash step in between. So it feels very much like we're finally getting the promise of ETFs as the bridge product between the two ecosystems. But that's just BTC right now. How do we think about how this is gonna impact something like the BITWISE 10 or other potential future index products or actively managed products where you've got multiple coins trading against each other and then you may actually have capital gains that need to be washed out or distributed. How do you think about the impact of this on portfolio management for the funds that you guys run that are really portfolios, not single assets?

[00:37:47] Teddy: Yeah, so I, I, I have, maybe obvious answer and then I have another little bit, little bit Zainer answer for you, Dave. One, it's gonna take a little bit of time, but I think it's gonna happen for all [00:38:00] the assets. All the portfolio strategies. So Ethereum, Solana, XRP, down the chain, I think is they're all gonna be operating in this world eventually where we have in kind in, in kind out index products. I think it's gonna happen there too. And I think the same tax efficiencies that you get. In the traditional world with the, with custom redemptions and creations and the ability to move things in and out through the in-kind process without recognizing taxable events at the portfolio level, I think those are gonna happen too. But the crazier thing that I wanna say is in a, in a sense, right? What we've done with Bitcoin ETFs is we've taken the on chain asset. Then we've moved it off chain so that all the normal people who wanna manage their wealth and their financial lives through their brokerage account can access it. What I think is gonna happen in the next five years is the ETFs are going back on chain.

[00:39:00] Dave: So the, ETF itself, just like I think all stocks, bonds, securities, and assets are gonna get tokenized. I think that the ETFs themselves are gonna get re tokenized and put back on chain. And then as we're doing everything else on chain in the future, ETFs are gonna be still first packaged in the security traditional security wrapper traded as they are.

[00:39:26] Teddy: But there's nothing to stop anyone. Once we figure out how tokenization works at scale to re tokenize the un tokenized version of Bitcoin. Yeah. Okay. And put it back on the blockchain.

[00:39:37] Dave: All right. You're right. That is crazy. I'm, I'm, I'm a seller on that, only because I don't want it to be true, not because I don't think we should tokenize assets, but because I want us to actually tokenize the assets, not wrap everything in another layer, because that just adds complexity and risk. But that is a story for a whole nother day.

[00:39:56] Teddy: We're coming back to talk about this soon, Dave, and then [00:40:00] 2030 when this has all happened. I'm gonna be the one here who's saying I told you so.

[00:40:03] Dave: No, I think it's, look, I think you are right. It is going to happen. I'm just sad about it because what I actually want is Congress to write real laws that change the infrastructure. So that DTC is tokenized, not that we're wrapping a bunch of crap in another layer, so, but I can dream about that. Teddy, this has been a lot of fun. I will get you back on to talk about real world assets and tokenization. I promise. Thank you for joining us. Anything, where can people find information about what you guys are doing? What's the best way to find you?

[00:40:33] Teddy: It was investments.com and I'm on Twitter. At Teddy Fuse.

[00:40:38] Dave: All right. Thanks so much, Teddy. Cheers. Great to be with you. Thank you for tuning into this episode. If you found this discussion interesting and valuable, please subscribe on your favorite audio platform or on YouTube. You can also follow all the podcasts in the ExcessReturnsnetwork@excessreturnspod.com. If you have any feedback or questions, you can contact us at excessreturnspod@gmail.com. No information on this podcast should be construed as investment advice securities discussed in the podcast may be holdings of the firms of the hosts or their clients.