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Bitcoin has exploded into mainstream consciousness in the last few years. Despite this, for many institutions and other financial players, it can be challenging to own the asset directly, mainly for regulatory and compliance reasons.

This will change in time and is part of the reason that there is so much furore around spot ETF applications, which have been repeatedly denied by the SEC thus far. While purchasing Bitcoin directly and engaging in secure self-custody is not possible for some, there are other ways through which exposure to Bitcoin can be had.

Interestingly, this year has seen many of these mediums outperform Bitcoin. However, that doesnt mean that investing in them is not a mistake if buying the asset itself is also possible.

Some of the most popular Bitcoin-related investments are presented on the below chart. With Bitcoin returning 81% thus far this year, it has been outperformed by all four alternatives.

Or, to present the YTD returns alongside each other:

It should also be noted we have omitted the ProShares Bitcoin Strategy ETF (BITO), which the SEC approved in October 2021. BITO gains exposure to Bitcoin through Bitcoin futures, with the regulator indicating that it believes futures-based products provide stronger investor protections.

However, futures ETFs suffer from having to roll over futures contracts, meaning there is more tracking error. In addition to fees, this as led to BITO underperforming Bitcoin by close to 3% through the first half of this year. If the contango curve steepens in future, that divergence could also grow larger.

In short, there is absolutely no reason to own BITO if one can own Bitcoin, unless the slightly lower returns (which can add up in the long run!) are worth the convenience with regard to avoiding self-custody, or being able to trade it through ones broker account.

Nonetheless, there are far worse options than BITO. Despite the outperformance thus far this year, the Grayscale Bitcoin Trust (GBTC) is one of these. This is a trust rather than an ETF, meaning investors cannot redeem the underlying Bitcoin, causing the trust to trade at a discount or premium to its NAV.

When this fund launched, it originally traded at a premium, but this changed as competing options came online and demand for GBTC fell. The discount dipped as low as 50% in the aftermath of the FTX collapse in November, as questions also arose surrounding its parent company Digital Currency Group, which is also the parent company of crypto platform Genesis, which filed for bankruptcy after getting caught up in the Bankman-Fried storm.

The discount has since narrowed to 25%, as hope rises that the trust is more likely to be converted to an ETF, following the slew of applications lodged with the SEC over the past month. Conversion to an ETF should wipe the majority of the discount out.

Despite the renewed hope of conversion, the fund has been a disaster for all investors. A 25% discount is an enormous chasm especially considering the underlying asset, Bitcoin, is still 55% below its peak from November 2021, adding insult to injury. The fund is even facing a lawsuit from some investors who claim it misrepresented the likelihood it would be converted to an ETF.

Interestingly, if we analyse the correlation of the top Bitcoin-related investments with Bitcoin thus far this year, MicroStrategy comes in at an incredibly high 0.86.

The company now owns over 152,333 Bitcoin, equating to 1 in every 128 Bitcoins currently in circulation, or 0.78%. In essence, this is therefore now a Bitcoin holding company, its mammoth stash helping to explain its strong correlation.

In truth, its also hard to make an argument for MicroStrategy over Bitcoin. Not only are there other factors here (it remains a tech company!) but Michael Saylors borderline religious rants are not exactly what you want to see as a shareholder. Even for Bitcoin fans, not many agreed with his advice to mortgage your house to buy Bitcoin (it was trading at $50,000 at the time, so hopefully not many listened). Its not entirely clear what the long-term vision is, bar simply holding Bitcoin.

The best performing asset this year has been the Valkyrie Bitcoin Miners ETF (WGMI), which has gained 267% compared to Bitcoins 81%. This is in line with what we would expect, as mining stocks have displayed far more volatility than Bitcoin. In short, if Bitcoin rises, mining stocks rise more, and if Bitcoin falls, mining stocks fall more.

Last year, miners got absolutely hammered. Their fall was exacerbated by their refusal to monetise their Bitcoin, which they earn for validating each block of transactions. In the next chart, we can see that their reserves in Bitcoin terms were relatively steady throughout the bull market, however rocketed upwards in USD terms as the price of Bitcoin exploded. It shows that they did not capitalise on the increased prices by selling off their reserves, and instead held onto their Bitcoin.

While one may applaud the conviction, this heightened their exposure to the price and hence kicked up the risk of these companies. More bad news is the ever-rising hash rate while great for the security of Bitcoin and the long-term health of the network, it means miners require greater amounts of energy to receive the same revenue (the difficulty adjustment automatically adjusts to ensure blocks are still mined at pre-determined intervals of approximately ten minutes). With last year also bringing an acute energy crisis, the price of electricity jumped, meaning miners were hit twice as hard with falling revenue on the Bitcoin side and rising costs on the energy side.

Hence, the risk with Bitcoin mining stocks is elevated, and they represent a different investment opportunity than Bitcoin, even if they will always be tied to the latters fate.

This brings us to Coinbase, the final of the investments. Being a crypto exchange in the US, Coinbase has been embroiled in the regulatory crackdown this year. Despite this, it has printed impressive gains for investors, up 186% thus far this year. But with a correlation of only 0.59 over the same timeframe, it clearly is not a good substitute for Bitcoin. Not only that, but even after its rise this year, Coinbase is still nearly three-quarters below its IPO price. With a lawsuit filed by the SEC last month, choppy waters lie ahead.

It is also tempting to wonder what a spot ETF would do for Coinbase. While undeniably positive for the industry as a whole, and hence for Coinbase, would the existence of a spot ETF drive some users away from exchanges? If the regulatory climate around Coinbase is still hazy when that ETF finally gets approved, perhaps it is worth considering. Either way, Coinbase is obviously highly correlated to the price of Bitcoin, but it is a company in itself and hence is a separate investment.

All in all, there is nothing yet that really replicates Bitcoin. While Coinbase and MicroStrategy are companies in their own right and many invest in these for reasons other than simply Bitcoin, as they do with mining stocks, the presence of the Grayscale Trust and the BITO futures ETF highlight why there is demand for a spot ETF.

The BITO futures ETF comes closest to replicating Bitcoins returns, but its underperformance is still notable. It is inevitable that the day of an approved spot ETF will come, and then such underperformance should (mostly) dissipate. But for now, if one wants to gain exposure to Bitcoin and has the ability to access it directly, nothing beats the real thing.

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Bitcoin-related investments outperforming Bitcoin, but remain inferior ... - Invezz