My QBTC Advice Last Week Was Completely Wrong

by JDH on February 27, 2021

Oops.

Last week I said it’s Time to Sell our Bitcoin Fund (But Not For the Reason You Think).  I said that QBTC was trading at a discount to NAV, so to prevent further erosion, it would be prudent to invest your funds in an ETF that trades closer to NAV.

No.

That’s completely backwards.

Let’s think about it, by first considering the two types of investment vehicles that exist in Canada today to invest in Bitcoin:

closed-end fund is closed, so it only accepts new funds occasionally.  If I want to own the fund, and if it is currently not accepting funds from new investors, my only option is to buy the fund on the open market.  If there are many buyers, the price of the fund will increase.  That’s simple supply and demand.  The underlying assets don’t change in value, but the price of the units in the fund can go up or down depending on supply and demand.

Stated more simply: Let’s assume the fund sells 50,000 units to investors for $1 each, and uses those funds to buy 1 Bitcoin for $50,000.  The fund has a Net Asset Value of $50,000, and is presumably trading at $1 per unit, which is exactly its NAV.

Let’s further assume that a lot of people want to own this fund, so they buy on the open market, and drive the price up to $1.10, while the price of the underlying Bitcoin remains at $50,000.  The fund is now trading at a premium to NAV of 10%.

In contrast, an Exchange Traded Fund, and ETF, rebalances every day.  They may start with the same initial investment: $50,000 invested in units at $1 each to buy one $50,000 Bitcoin, so the fund trades at $1.  But lots of investors want to own it, so they phone up their broker and say “I want to buy it”, so they bid the price up, but the fund then issues new units, which brings the price down, and they use those funds to buy more Bitcoin, so the fund may now own $60,000 worth of Bitcoin, but they would now have 60,000 units, so the NAV is still $1 per unit.  It is not trading at a premium.

Here’s the issue:

Up until mid-February, your only investment options were two closed-end funds started in 2020 by 3iQ, the Bitcoin Fund (QBTC) and the Ether Fund (QETH), so if you wanted to buy them on the Toronto Stock Exchange you had to pay a premium.  But then in mid-February two new Exchange Traded Funds began trading, the Purpose Bitcoin ETF, trading as BTCC.B.TO in Canadian dollars, or BTCC.U.TO trading in USD, and the Evolve Bitcoin ETF, trading as EBIT.TO in Canadian dollars, or EBIT-U.TO in USD.

So last week I said, “this is not good.  I own QBTC which was trading at a 10% premium, and now everyone will sell it and put the money in an ETF that does not trade at a premium”.  Makes sense.  If I can sell something for $1.10 and buy something for $1 that has the same underlying asset, I just pocketed 10%.  It’s an obvious arbitrage opportunity.

Many others arrived at the same conclusion and sold QBTC to buy BTCC and EBIT.  What happened?

As of the close of trading on Friday, February 27, QBTC had a Net Asset Value of $66.3394 and was trading at $62.44.  (You can see the closing numbers on the 3iQ website).  That’s a discount to NAV of almost 6%.

So investors that were sitting on a premium of 10% to NAV two weeks ago now are holding a security that trades at less than what it is worth.  That’s why, last week, I said to sell it.

Which now begs the obvious question:  If I want to invest in crypto, what should I do?

If you are sophisticated and don’t want to pay a premium, you should register on an exchange, create your own wallet, buy the crypto, and hold it yourself.

But, if you are less sophisticated, or if you want to hold crypto in your RRSP or TFSA, should you buy a closed-end fund, or an ETF?

The answer: buy the closed-end fund.

Why?

Because you are getting it at a discount to Net Asset Value. If something is worth $1.05, would you like to buy it on sale for only $1?  Of course.  That’s obvious.

Here’s the key to this strategy: over time, the closed-end funds will approach NAV.  Unlike me, some investors are smart, and they will realize that the closed-end funds are on sale, and they will buy them, and that buying will drive up the price, and eventually the discount will erode.

More specifically, here’s what will happen:

First, redemptions.  According to the QBTC prospectus, page 43, unitholders can redeem their units for cash once a year.  The next redemption date is June 16, 2021.  So if I want to redeem my units, on June 16, 2021, I surrender my shares, and I will get cash equal to the Net Asset Value, because the fund will sell the underlying Bitcoin and give me the cash.

It is reasonable to assume that, if the fund continues to trade at a discount to NAV on June 16, 2021, every unitholder will redeem their units, and the fund will cease to exist.

So, my second prediction is that prior to June 16, 2021, the fund will announce that they are converting all units in the closed-end fund into units in a new ETF.

Boom.

Instantly, the discount to NAV is gone.

So, I’ll trade in my units in the closed-end fund trading at $1 for units in an ETF trading at $1.10, or whatever the applicable NAV is at that time.

This is an obvious arbitrage opportunity.  If you want to own Bitcoin (or Ether) long-term, this is a way to do it.  As long as QBTC and QETH are trading at a discount to NAV, buy them.  If their price goes above NAV, sell them and put the money in an ETF.

But how do you know if they are trading at a discount to NAV?  At the end of each trading day you can get the numbers from the 3iQ website, or you can do the calculations yourself during the day.

Or, go to Bitbo, and scroll down to the closed-end fund section, and during market hours they calculate the premium or discount to NAV in real-time.  Note that these calculations are relevant during market hours, because while cryptos trade 24/7, the stock exchange doesn’t, so if Bitcoin has a significant move overnight or on the weekend the premiums will be meaningless.  During the day, check the premiums or discounts, and make your decision accordingly.

One final note: if you buy the closed-end fund with a plan to wait until June to redeem and pocket the premium, and Bitcoin crashes by 80% between now and then, you’ll get the 10% premium but lose 80% of the underlying value, so this strategy only works if you think Bitcoin will increase in value (or if you are a very sophisticated trader and are short the ETF while you are long the closed-end fund, but then you have the costs of shorting, so that’s a less profitable option).

There you go, a nice arbitrage opportunity.

Do with it what you will.

Thanks for reading.  See you next week.