Winklevoss twins to offer Bitcoin ETF • Hacker News Board

Re: Winklevoss twins to offer Bitcoin ETF

#81

Post by zhoutong » Tue, Jul 02, 2013, 4:55 AM UTC

jpdoctor wrote: post #72

It's clear that many folks don't understand how the price dynamics of ETFs with underlying securities operate. A share in an ETF is a fixed basket of securities. If the price of the ETF differs from the basket, the ETF share creation/redemption mechanism drives the price back to the fair-market value of the basket. If the price of the ETF share is too high: Market participants will short the ETF and buy the underlyin…

As you have said, the creation/redemption mechanism will enable fair price discovery. The inability of shorting the underlying doesn't matter here, because if the ETF can be redeemed freely, an investor can buy the underpriced ETF and redeem immediately and sell in the spot market.

The only difference of this from actually shorting is the time. During the time of this operation, there may be adverse movement in the underlying price making the arbitrage too risky. It's true that fully efficient arbitrage may not happen.

But saying that there's no mechanism to maintain equilibrium price of the ETF is entirely wrong. If the ETF price is $60/BTC and the spot is $85/BTC, there's a huge incentive for investors to buy ETF and redeem and then sell in the spot market, even if it takes days. People who already have both BTC and USD in their hands can also quickly increase their BTC holdings, for free!

Therefore, the ability to short underlying simply doesn't matter, as long as ETFs can be created and redeemed fairly freely.

Re: Winklevoss twins to offer Bitcoin ETF

#82

Post by zhoutong » Tue, Jul 02, 2013, 5:03 AM UTC

paulsutter wrote: post #21

Surprise - a good idea from the Winklevii. The convenience of buying and selling bitcoin from the comfort of an ordinary brokerage account, and making it possible to hedge bitcoin by selling and shorting. Anyone know how to estimate whether there's enough liquidity in existing bitcoin exchages to support it, and allow them to track the price accurately in the ETF?

The price of ETF and the price of underlying are simply correlated as a result of market forces. There's no "tracking" between the two. The only "tracking" happens to the Net Asset Value of the ETF, which the quantitative fund manager must aim to follow the underlying as much as possible. In this case, by holding 100% of asset in Bitcoin in this trust, the NAV tracking can be assumed to be perfect.

The liquidity doesn't matter if the ETF has a fixed pool (with regular creation and redemption). The volume of the ETF can exceed the volumes of all Bitcoin exchanges combined, because the investors are actually trading paper - certificates that represents some units of the trust, which holds Bitcoin.

If creation needs to happen, the investor needs to give the underlying to the trust in exchange for units. In this case, only BTC changes hands.

If redemption needs to happen, the investor will receive the underlying from the trust. In this case, only BTC changes hands.

So, at the trust's side, it's entirely possible to eliminate all fiat transactions after the ETF is issued. All future changes in units will happen with the underlying only, which is Bitcoin. This is similar to and consistent with most of the stock indices ETFs out there in the market.

An analogy: The liquidity of gold ETFs can obviously exceed the liquidity of physical gold. Actually it already does (for retail investors).

Re: Winklevoss twins to offer Bitcoin ETF

#83

Post by mrb » Tue, Jul 02, 2013, 5:19 AM UTC

sneak wrote: post #48

mrb wrote: post #41

Earlier quoted context omitted.

"the whole public BTC order book on MtGox can be had right now for under $2mm USD" No it cannot. Some people have placed sell orders at $1000, $10k, $100k, etc. To the point it would take trillion and trillion of dollars to buy up all BTC. But you can be sure that if you tried to do this, a lot of other sell orders would pop up, making it effectively impossible to buy up all bitcoins.

> But you can be sure that if you tried to do this, a lot of other sell orders would pop up, making it effectively impossible to buy up all bitcoins. Yes, at entirely reasonable prices, right? :D A substantially higher cost basis starts to cut into fund profits... Also, a minor correction to your comment: the depth of the MtGox order book is public, and it was accurate at the time of my comment. It's up to $2.2mm USD…

Whatever site you are using to see the order book does not show it in its entirety. It really is a lot deeper than $2.2M. I know for a fact because there has always been sell orders at ridiculous amounts such as 1 BTC at 1 trillion dollar.

For example bitcoincharts.com now truncates the order book (2 or 3 months ago it was showing everything, on the sell side at least).

Re: Winklevoss twins to offer Bitcoin ETF

#84

Post by drivebyacct2 » Tue, Jul 02, 2013, 5:20 AM UTC

sirsar wrote: post #75

drivebyacct2 wrote: post #74

This creates an interesting point of failure. What happens when the private key is stolen or hacked? Because the ETF holders are holding cash with the expectations of assurances and insurances that cash comes with. But uh, that's not how Bitcoins work.

If the Winklevii own "1% of all Bitcoins," I would hope that they know how to do split key sharing and store their Bitcoins on paper. I would hope.

I thought it said proprietary system with the key stored in a US bank? :(

Re: Winklevoss twins to offer Bitcoin ETF

#85

Post by jpdoctor » Tue, Jul 02, 2013, 5:36 AM UTC

zhoutong wrote: post #81

jpdoctor wrote: post #72

It's clear that many folks don't understand how the price dynamics of ETFs with underlying securities operate. A share in an ETF is a fixed basket of securities. If the price of the ETF differs from the basket, the ETF share creation/redemption mechanism drives the price back to the fair-market value of the basket. If the price of the ETF share is too high: Market participants will short the ETF and buy the underlyin…

As you have said, the creation/redemption mechanism will enable fair price discovery. The inability of shorting the underlying doesn't matter here, because if the ETF can be redeemed freely, an investor can buy the underpriced ETF and redeem immediately and sell in the spot market. The only difference of this from actually shorting is the time. During the time of this operation, there may be adverse movement in the u…

> if the ETF can be redeemed freely

Not just freely, but without any substantive delay.

> If the ETF price is $60/BTC and the spot is $85/BTC, there's a huge incentive for investors to buy ETF and redeem and then sell in the spot market, even if it takes days.

Once you think this through, you will come to the conclusion that the mean-squared deviation of the (spot-ETF) is related to the speed at which the shares can be redeemed. Modern investors quickly lose faith in any derivative that does not track the underlying.

If you want an example: Shorting of bank stocks was banned by the SEC during the Lehman meltdown. The bank index ETFs went nuts, and the levered ones never really recovered. (See SKF. Those of us who predicted the meltdown made a lot less money because of it.)

Re: Winklevoss twins to offer Bitcoin ETF

#86

Post by RockyMcNuts » Tue, Jul 02, 2013, 5:54 AM UTC

jpdoctor wrote: post #72

It's clear that many folks don't understand how the price dynamics of ETFs with underlying securities operate. A share in an ETF is a fixed basket of securities. If the price of the ETF differs from the basket, the ETF share creation/redemption mechanism drives the price back to the fair-market value of the basket. If the price of the ETF share is too high: Market participants will short the ETF and buy the underlyin…

not sure I agree with your detective work.

If the price of the ETF is too low... you can buy the ETF, take it to the ETF sponsor, they will convert it into the underlying, you can then sell the underlying.

Ability to short = ability to borrow. If you can borrow Bitcoins from someone, you can sell them, and then you're short. While there may not be an active lending market, in principle no reason it couldn't be done.

A lot of times the ETF sponsor or a related entity will participate in arbitrage to keep prices in line... they might have ability to lend to each other. In fact, that may be an important way the Winklevii expect to make money. (in addition to the fact their Bitcoin hoard is more valuable if it's more liquid and more accepted by traditional investors)

Now, if the underlying is illiquid and doesn't have good price discovery, the ETF will probably be in the same situation. In the example above, if you're not darn sure you can sell the underlying pretty quickly at a higher price than the ETF, you're not going to attempt the arb. So if the market is illiquid, the arbs don't step in until the spread is more egregious.

Re: Winklevoss twins to offer Bitcoin ETF

#87

Post by foobay » Tue, Jul 02, 2013, 6:10 AM UTC

epoxyhockey wrote: post #36

Interesting to see the Bitcoin value dropping after this announcement. I wonder what is going on there..

it was dropping before the announcement. this stabilized it

Re: Winklevoss twins to offer Bitcoin ETF

#88

Post by sneak » Tue, Jul 02, 2013, 6:37 AM UTC

jpdoctor wrote: post #72

It's clear that many folks don't understand how the price dynamics of ETFs with underlying securities operate. A share in an ETF is a fixed basket of securities. If the price of the ETF differs from the basket, the ETF share creation/redemption mechanism drives the price back to the fair-market value of the basket. If the price of the ETF share is too high: Market participants will short the ETF and buy the underlyin…

If I'm reading this right, doesn't that mean a "basket" at a time, or 10k BTC increments?

Re: Winklevoss twins to offer Bitcoin ETF

#89

Post by SilasX » Tue, Jul 02, 2013, 8:40 AM UTC

7Figures2Commas wrote: post #46

erikig wrote: post #24

Earlier quoted context omitted.

One additional advantage that hasn't been mentioned is that ETF's offer an options market allowing owners of Bitcoins to buy puts to protect the value of their bitcoins (or) buy calls to take advantage of future movements in the price of Bitcoins. In my opinion allowing Bitcoin ETF options might be the next step in allowing widespread Bitcoin adoption because corporate entities can hedge against the fluctuations in t…

That's technically not true. Options would enable you to hedge your equity position in the trust . The trust is designed to "reflect the performance of a weighted average price of Bitcoins." The degree to which it does this accurately is yet to be determined; tracking error is a real problem with some ETFs. Bitcoin has proven to be subject to extreme volatility, the trust may not achieve its investment objective, the…

>The trust is designed to "reflect the performance of a weighted average price of Bitcoins." The degree to which it does this accurately is yet to be determined; tracking error is a real problem with some ETFs.

How so? If you guarantee (by holding the assets in trust) that [a larger number of shares] can always be redeemed for their corresponding ETF assets, then the possibility of arbitrage ensures that the ETF price tracks the net asset value per share.

For example, the ETF could buy 50,000 BTC and issue 500,000 shares, with the proviso that anyone can present 50,000 shares to the fund in exchange for for 5,000 BTC.

So I don't think tracking is the problem, but rather, just avoiding being "too clever" with how you ensure NAV = ETF share price.

Re: Winklevoss twins to offer Bitcoin ETF

#90

Post by justincormack » Tue, Jul 02, 2013, 8:58 AM UTC

jessaustin wrote: post #76

scarletham wrote: post #58

Earlier quoted context omitted.

The order book would show people who are sitting on either side of the market, so if they have a bot that's adjusting their quote it would still show it - unless I'm misunderstanding your question?

I think we're talking about parties who don't actually have an order in. Rather they have automated a process to enter orders in response to certain conditions. Depending on what those conditions are, you won't be able to rely on a continuous price trajectory. Admittedly, I don't see how this is different for BTC than it would be for any other asset.

Those are not providing liquidity in a useful sense right now. Usually the measure is people prepared to trade at current bid or offer ie a very narrow measure. If you want to buy at 1% down that's not useful now.