Interpretation of encryption refers to the "gray" base: Bitwise10 cryptographic index fund

Original title: "Interpretation of encryption refers to the" gray "in the Base: Bitwise10 Encrypted Index Fund"

Author: Ann Hsu, chief index analyst, Chain Hill Capital Qianfeng Capital

Bitwise10 cryptographic index fund adopts the method of cross-market circulation and transfer, that is, the issuance market and circulation and transfer are respectively in the cryptocurrency market and the US stock market. The operation mode is not open to redemption and allows physical investment of Bitcoin, which is similar to the product design of grayscale. As the advantages of index funds are gradually recognized by investment institutions, more and more crypto asset management companies launch index funds, and index funds will become an important force in the cryptocurrency market in the future.

New cryptographic index fund BITW

On December 9, 2020 eastern Time, Bitwise10 Crypto Index Fund, managed by Bitwise, a provider of crypto index management products, was successfully listed on OTCQX, the otc market of THE US Stock Market. The trading code of the secondary market of the fund is BITW.

Founded on November 22, 2017, Bitwise10 Cryptocurrency Index Fund is a market capitalization weighted index fund that seeks to track cryptocurrency market movements. As of December 21, 2020, the fund had $199 million in assets under management and $27 million in secondary market transactions.

Bitwise10 Encrypted Index Fund AUM, Quotes, trading, source: Bitwise Official Twitter

According to the fact sheet disclosed on the official website, as of November 30, 2020, Bitwise10 cryptographic index fund held a total of 10 cryptocurrencies, including BTC, ETH, XRP, LTC, BCH, pNK, ADA, XLM, EOS, XTZ, etc., with position weights of 74.4%, 13.1%, 6.2%, 1.3%, 1.2%, 1.0%, 1.0%, 0.8%, 0.6%, 0.4%, respectively (On December 24, 2020, Bitwise has announced that its fund has liquidated its XRP position and XRP has been removed from the fund portfolio. As of December 21, 2020, BITW was quoted on the OTCQX market at $84.48, representing a 327% premium to the fund's net value.

Bitwise10 encrypted index fund net value and price trend, position distribution (note: the blue line on the left is the fund net value curve, the green line is the secondary market price curve), source: Bitwise

Bitwise10 Encryption index compilation rules

Bitwise10 Crypto Index fund adopts full replication Index fund strategy, tracking the underlying Index is Bitwise10 Large Cap Crypto Index (BITX), Bitwise cryptographic Large market value 10 Index in Chinese. The index is weighted by the market value of currencies in circulation and is adjusted for inflation for five years to reflect the trend of the 10 largest cryptocurrencies in the cryptocurrency market by market value. With a base date of January 1, 2017 and a base point of 964 points, the index covers more than 80% of the market capitalization of the cryptocurrency market.

Bitwise encrypts the compilation rules of large-cap 10 index in terms of sample space, sample selection method, index calculation and sample adjustment as follows:

(I) Sample space

Cryptocurrencies that meet the following criteria:

(1) Encrypted and anonymous digital assets.

A combination of unstable currency, illegal currency, unstable currency and legal tender, non-hard assets.

Freely tradable and freely held digital assets.

(4) At least in two or more platforms, there is no delisted problem, and the trading volume of a single qualified platform shall not exceed 90% of the total trading volume in usd in the last 30 days.

Digital assets that allow air-gap refrigeration, including digital assets that generate offline wallets and offline transaction signatures.

Digital assets with no known security vulnerabilities. Security vulnerabilities include, but are not limited to, serious bugs, overexposure to 51% of the attack environment, or other security vulnerability factors identified by Bitwise.

Over the past 30 days trading volumes exceeded 10% of the current inflation-adjusted market value of digital assets.

Digital assets may be held as third-party custodians by regulated trust companies in New York or South Dakota, or by other regulated custodians authorized by Bitwise.

(9) other digital assets which do not violate existing laws and regulations.

Attending the other.

(2) Sample selection method

Step 1:

Select a digital currency that meets the following criteria based on the sample space:

1) Digital currency that trades on at least two qualified platforms and is not subject to capital controls on deposits or withdrawals.

2) In each of the past three months, at least one of the top 100 eligible cryptographic assets was the largest cryptographic trading pair, based on the most recent 30-day dollar-denominated trading volume.

Step 2:

Summarize all crypto-fiat trading pairs on the qualified trading platform, and eliminate the trading pairs with withdrawal problems.

Step 3:

Convert non-DOLLAR denominated transactions into dollars.

The fourth step:

Summarize the total volume of transactions per pair (crypto-to-fiat) in dollar terms over the past hour.

Step 5:

Assign a weight to each pair based on its share of trading volume in the past hour as a percentage of total trading volume for all pairs.

Step 6:

The combined price is obtained by multiplying the price of each pair of trades by its corresponding weight.

The seventh step:

The free circulation of each trade pair is summed with the inflation-adjusted circulation and multiplied by the combined price of the trade pair to obtain the inflation-adjusted market value of the trade pair.

The eighth step:

The top 10 cryptocurrencies are selected to form the index sample, ranked from highest to lowest in inflation-adjusted market value in circulation.

(3) Calculation method

(4) Sample adjustment

Bitwise periodically (every 1 month) adjusts the composition and weight of the index sample, including the sample currency adjustment, free circulation adjustment and five-year inflation adjustment. This article will not be expanded.

Bitwise10 Encrypted index fund investment process

Divided by the investment market, investors can invest in Bitwise10 encrypted index fund through the primary market and secondary market.

In the secondary market, investors can directly trade fund shares in the U.S. otc market by opening an account with a broker in the OTCQX market, which is the only exit channel for Bitwise10 encrypted index fund investors, since redemption of fund shares through the primary market is not currently supported. OTCQX is part of the US OTC Markets, which is owned by OTC Markets Group (OTC Markets Group), a private company that provides services to the US OTC securities market.

OTC Markets Group's market composition, mapped by: Chain Hill Capital

Investors can also subscribe to Biwise10 Encrypted index fund shares by participating in non-public development banks in the primary market.

Bitwise offers access to investors in entities such as individuals, institutions, and retirement accounts who are eligible to participate in a non-public offering of a primary market only if they meet the requirements of section 506 of Section D of the Securities Act of 1933.

In participating in a primary market non-public offering, investors can contribute capital in two ways -- cash or BTC. In the form of cash contribution, investors are required to submit purchase documents on Bitwise's official website and then upload relevant materials. Bitwise will employ one company (Theorblockquote Fund Services LLC) as Administrator to assist Bitwise in receiving subscription documents and subsequent Fund accounting and administrative tasks. After submitting the application documents, the other party needs to review the materials, which will take several working days. After the approval, the investor shall pay the subscription amount. The fund manager will convert legal tender cash into a basket of cryptocurrencies in the spot market in proportion to the weight of the index components, and then place them in cold storage Custody in Coinbase Custody. At the same time, Bitwsie hired a service company (American Stock Transfer & Amp; Trust Company, as the transfer agent of the fund, is responsible for the allocation and transfer of shares, etc. The Company will distribute the newly issued fund shares to the investors' accounts.

Bitwise10 Encrypted index fund Non-public offering (cash subscription) process schematic diagram, charting: Chain Hill Capital

In addition to cash subscriptions, Bitwise also offers a way to make in-kind contributions to Bitcoin. The investor sends the bitcoin to the blockchain address specified by Bitwise via an online transfer to complete the investment. After receiving the in-kind bitcoin investment, the fund manager will sell the physical bitcoin in the spot market according to the proportion of the weight composition of the index components, and finally convert the bitcoin into a basket of cryptocurrencies. After taking a basket of cryptocurrency, the fund manager takes the assets into Coinbase Custody for cold storage. The share transfer agent distributes the newly issued fund shares to the investor's account.

Bitwise10 Cryptographic index Fund non-public offering (Bitcoin physical subscription) process schematic diagram, charting: Chain Hill Capital

High premiums create arbitrage opportunities

Bitwise10 encryption adopted across the market circulation index funds transfer method, namely the issue market and circulation transfer encryption respectively in the money market and the stock market, is not open to redeem, allowing the currency to overlay payment-in-kind mode of operation, the operation mode with our previously published "the depth: deconstruction gray COINS trust" the gray model in the article have the same effect. In this mode of operation, when the fund share lockup period is over, the selling pressure in the cryptocurrency market will be transferred to the US stock market. Due to the huge deviation of the price from the net value, the borrowing arbitrage phenomenon often occurs. Due to the loan arbitrage, there is pressure to return the money after the maturity of the share. If the share is invested in kind with Bitcoin, the money obtained after selling the share in the US stock market can be brought back to the cryptocurrency market, forming the upward momentum to buy cryptocurrency, thus forming a perfect closed loop. After our research found that Bitwise10 cryptographic index fund also used the same strategy as gray scale, arbitrage opportunities emerged.

Bitwise also provides two ways of cash investment and in-kind investment of Bitcoin. Since the quotation in the secondary market presents a positive premium and redemption is not open, the direction of arbitrage is: subscription in the primary market and sale in the secondary market. There are three common arbitrage modes: cash borrowing arbitrage, physical borrowing arbitrage and share borrowing arbitrage. This paper focuses on the three kinds of arbitrage patterns, other extended arbitrage patterns will not be developed for the time being.

Cash borrowing arbitrage model:

In the cash lending arbitrage mode, the investor borrows legal currency cash and participates in the primary market subscription of Bitwise10 encrypted index fund. After the fund manager completes the subscription and confirms that it is appropriate, the investor obtains the fund share. Hedge funds can hedge against the downside of an index component currency in an encrypted market where the assets of the hedge fund mature insufficient to repay the money borrowed in fiat currency. After the 12-month lock-up period, investors sold BITW fund shares on the U.S. OTCQX secondary market for cash, while unwinding short futures positions they had hedged. The cash obtained by the investor after selling the shares is deducted from the borrowed principal and the corresponding interest, and the remaining part is the profit of cash borrowing arbitrage.

Bitwise10 encrypted index fund cash lending arbitrage process schematic diagram, charting: Chain Hill Capital

Physical loan arbitrage model:

Under the physical lending model, the investor borrows the physical bitcoin and participates in the primary market subscription of Bitwise10 cryptographic index fund. After the fund manager completes the subscription and confirms that it is appropriate, the investor obtains the fund shares and sells the BITW fund shares in the SECONDARY market of THE US Stock OTCQX after a 12-month lock-up period to obtain cash. Investors sell their shares of cash in the US stock market, bring it back to the cryptocurrency market, buy the spot Bitcoin, return the bitcoin spot and the corresponding interest to the loan, and the rest is the profit of the physical loan arbitrage.

Bitwise10 Cryptographic index fund Bitcoin physical lending arbitrage process schematic diagram, charting: Chain Hill Capital

Share borrowing arbitrage model:

In the share-borrowing arbitrage model, investors borrow available BITW fund shares and sell them in the U.S. Stock OTCQX market for cash. Investors will be given cash or they will have two options: one is to participate directly in the primary market subscription with cash; the other is to buy the physical bitcoin and then participate in the primary market subscription.

When the investor chooses to participate in the primary market subscription with cash, the cash obtained after selling shares will be used as capital contribution to subscribe the corresponding amount of shares. After the fund manager completes the subscription and confirms that it is appropriate, the investor will obtain BITW Fund shares. After a 12-month lock-up period, the investor may return the share to the investment institution together with the corresponding interest. The surplus cash is the arbitrage profit under the arbitrage mode of "share borrowing -- cash subscription".

Bitwise10 Encrypted index fund "Share borrowing -- Cash Subscription" arbitrage process schematic diagram, charting: Chain Hill Capital

When the investor chooses bitcoin as the subscription capital in the primary market, the cash obtained after selling shares will buy the equivalent bitcoin physical capital in the spot market, and use this as the capital to subscribe the corresponding amount of shares. After the fund manager completes the subscription and confirms that it is appropriate, the investor will obtain BITW fund shares. After a 12-month lock-up period, the investor may return the share to the investment institution together with the corresponding interest. The surplus cash is the arbitrage profit under the arbitrage mode of "share borrowing - purchase in kind".

Bitwise10 encrypted index fund "Share borrowing -- Physical Subscription" arbitrage process principle, charting: Chain Hill Capital

Because Bitwise10 encrypted index fund has just been launched, the current lending arbitrage activity is still far behind the grayscale products, so it is impossible to judge the size of participants in the three types of lending arbitrage. However, these three arbitrage models are likely to be adopted by the market in the future, as their design is very similar to that of grayscale products.

Similarities and differences with grayscale products

Bitwise10 encrypted index Fund is very similar to Grayscale Digital Large Cap Fund, and there are many similarities in terms of product design and market operation mode. This paper will take Grayscale Large-cap Fund as an example for comparison.

Although Grayscale Digital Large Cap Fund, the full English name of Grayscale Large-cap Fund, does not indicate that it is an index Fund, its product design is highly similar to Bitwsie's product, so it can be regarded as an index Fund. The Grayscale Large-cap fund tracks an Index called TradeBlock Grayscale Digital Large Cap Index, developed by Grayscale and calculated and maintained by TradeBlock. The underlying indexes of grayscale large-cap fund and Bitwise10 index fund are both market-capitalization weighting strategies, but the number of components of Bitwise Large-cap 10 index is 10, and the number of components of grayscale large-cap fund's underlying index is 5. There are also differences in the coverage of target market value of the two indexes and the frequency of index sample adjustment.

Bitwise10 cryptographic index fund and grayscale index index, charting: Chain Hill Capital

Two funds in the purchase, redemption level of the design is also somewhat similarities and differences. The primary market subscription of both funds is non-public offering (private placement), and both funds are required to meet the requirements for qualified investors under Article 506 of Regulation D of the Securities Act of 1933. Subscription channel is also the official website online subscription. Neither fund is currently open to redemptions.

However, there are differences between the two funds in terms of subscription time and subscription threshold. The Bitwise10 encrypted index fund is open every Wednesday and on the first business day after the bank of California closes on Wednesday. Gray market fund in principle daily open subscription, but gray can close subscription at any time. Bitwise has an initial subscription threshold of $25,000 and an additional requirement of $10,000 if investors have previously subscribed. The threshold for grayscale large-cap funds is $50,000.

Bitwise10 encrypted index fund and grayscale index fund in subscription and redemption comparison, charting: Chain Hill Capital

Bitwise10 cryptex index fund was established earlier than grayscale index fund, but both are now available for transfer in the OTCQX market. The newly issued Bitwise10 index fund also has a 12 month relock-up period, and both companies have chosen Coinbase DCM as their Custody.

The current annual management fee for grayscale large-cap funds is 3%/ year. On December 21, 2020, Grayscale announced that it will reduce the management fee for Grayscale large-cap funds to 2.5%/ year from January 1, 2021, when the management fee will be the same as Bitwise10 encrypted index funds.

Bitwise10 encrypted index fund and grayscale large-cap fund terms, service providers comparison, mapping: Chain Hill Capital

The advantages of index funds

In recent years, the trend towards indexation in the cryptocurrency market has become more pronounced, with a growing number of asset managers offering passive index fund products based on market indices. Index fund has been practiced in the traditional financial field for decades, with strong theoretical basis and excellent practical results, which provides a good reference for the practice of index investment in the cryptocurrency market. Index funds have the following advantages:

Market efficiency Angle

Based on blockquoteH (efficient market Hypothesis) theory, the closer the market is to a strong efficient market, the more efficient the market will be in pricing and the more difficult it will be for active fund managers to capture excess Alpha. The cryptocurrency market is a competitive, highly transparent and liquid market that will become increasingly efficient in pricing in the long run. Since index investing captures the overall benefits of the market, passive index funds will outperform actively managed funds in the long run.

High transparency

Index investing is highly transparent and can offset the opaque risk of asset exposure in active portfolios.

Strong liquidity

The index represented by the weighting of market value can meet the liquidity requirements of large funds due to the large market value range and good liquidity covered by the index sample and the characteristics of diversified allocation of index investment.

(4) with the survival of the fittest function

Index compilation has the function of regular sample adjustment, which is adjusted regularly according to the market performance and fundamental situation of underlying assets, and the sample adjustment rules are implemented in accordance with the preparation plan, so as to weaken the uncertainty risk brought by artificial subjective positions adjustment.

Qianfeng has proactively deployed its passive management products in the Encrypted digital asset market and currently operates two encrypted index funds. Different from other index funds, the encrypted index fund of Qianfeng Capital is more similar to the enhanced index fund. On the basis of tracking and replicating the index, some active management factors are added, and differentiated adjustment is made, especially in the aspect of risk control and return optimization, so as to realize the effect of income enhancement. There are two main advantages:

(1) Efficient position control scheme. The index fund of Qianfeng Capital has added the "Qianfeng Multi-factor investment strategy" developed by itself in the process of position building to control the position. This strategy is original among the peers, which can effectively reduce the holding cost/restrain the upward cost and improve the yield rate.

(2) Risk control strategy of quantitative hedging. The index fund of Qianfeng Capital introduces the quantitative hedging model, which uses a small amount of money to slow down the large deviation of the net value curve.

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