FBTC: the arguments against self-custody (BATS: FBTC)

It has now been three months since the Bitcoin spot was approved (BTC-USD) ETF on the American market. I don’t think it’s an exaggeration to say that these funds have been a huge success from an AUM growth perspective. Even after adjusting for the exodus of assets from Grayscale Bitcoin Trust ETF (GBTC), more than 214,000 BTC of positive net flow were injected into these products in three and a half months. This BTC has a face value of over $13.1 billion at the time of article submission.

Despite all this success, the funds have recently experienced a small net outflow of BTC from a handful of spot ETFs as the market digests the halving and various other developments that could impact demand for Bitcoin.

While speculators seem to be taking After a tremendous start to the year from a price appreciation perspective, I think it’s a good time to re-examine some of the network metrics important to Bitcoin and, as a byproduct of those metrics, the bullish case for Fidelity Wise. Original Bitcoin Fund (BATS:FBTC).

Main catalysts of The Rearview

Of course, the approval of spot ETFs has been an important catalyst in absorbing demand for investment capital. The other side of the supply/demand relationship was also hit this year by the Bitcoin block reward halving on April 20. This has been well covered at this point, but to quickly summarize: Bitcoin was designed to hold only 21 million coins. To validate transactions, miners were typically paid by issuing new coins from this fixed supply of 21 million – this is called the “block reward grant”. Every four years, the Bitcoin rewards block grant is cut in half.

Historically, the price of Bitcoin rises to new all-time highs 12-18 months after a halving due to decreasing supply, while demand for BTC has generally increased due to a price mania that ensues. It could certainly be argued that much of the post-halving drop in Bitcoin prices has already occurred in part thanks to the approval of spot ETFs. Personally, I am not in the camp where the peaks of the cycle were reached. However, I am of the opinion that the top of the cycle will likely disappoint those looking for BTC prices of $400,000-500,000 next year.

The arguments against self-custody

As a digital asset, BTC is designed to require no custodians or intermediaries. Coming from the cypherpunk ethos, self-custody is actually the whole point of Bitcoin. But over the years, the intended utility of BTC has shifted from a peer-to-peer currency to a “digital gold” that should be “HODLed” rather than spent. We can certainly debate whether or not this change in direction has been beneficial for long-term adoption, but that’s the reality of the situation and the trade-offs that come with guarding versus self-custodial that influence the Bitcoin decisions we make as individual investors and speculators. .

Consider that using custodians has long been considered a risky way to own Bitcoin. “Not your keys, not your coins” is the mantra of recent cycles to show that explosions in centralized companies like Celsius (CEL-USD), FTX (TTF-USD), and Traveler (VGX-USD) are not indicative of the failure of Bitcoin but rather of a failure of human decision-making. I want to be clear about this; I remain of the opinion that BTC should be self-deposited if the individual holder can afford it. But we must recognize that if Bitcoin’s base layer does not adapt to wider use, average transaction fees will indeed increase as fees become the primary incentive mechanism for Bitcoin miners as the block reward continues to decrease. This will have a long-term impact on the viability of self-custody if truly decentralized large-scale networks do not (or cannot) reach critical mass.

We are already seeing what can happen with transaction fees during times of high network demand:

On April 20, the average transaction fee for moving BTC on the network exceeded $128, an increase of almost 600% from the day before. This huge spike was due to the launch of the Runes protocol on Bitcoin. The hype surrounding this project has since died down. Yet for the entire week following Runes’ launch, the average transaction fee was over $22. We haven’t seen a single-day average transaction fee below $10 before April 27. And for a little more context, the average fee between April 1 and April 19 was around $10.60.

All of this is important because transferring BTC in and out of self-custody requires paying these fees. A $10 transaction fee is ideal for larger value transactions. But for the majority of people to justify holding BTC in custody, these fees are high.

With an average fee of $10, almost 19 million of the 54 million non-zero Bitcoin wallet addresses are crippled. With an average fee of $100, almost 60% of on-chain wallet addresses cannot move funds. This is a serious risk and shows why the ETF option might actually make more sense for smaller value HODLing.

Let’s take the example of a speculator who wants to buy $5,000 worth of BTC. Doing it through an exchange will require an upfront fee and then additional fees for custody. If we use $10 as a base case for average transaction fees and 25 basis points as a base case for the ETF’s annual expenses, it takes five years to make self-custody more profitable than just buying of the ETF:

Click to enlarge

Source: analyst estimates

Then, if the personal custody holder wants to sell, they will have to pay these fees again. The cherry on top of all of this is that the FBTC allocation can easily be held in a tax-advantaged account like a Roth IRA and pay no capital gains taxes on asset appreciation.

Reiterate my FBTC purchase call

While I also like a few other funds, I maintain that FBTC is my personal preference for Bitcoin ETF exposure. The fee waiver for FBTC is still in effect, although this waiver will expire at the end of July. Following this waiver, the fund’s expense ratio will be 0.25%. This is not the cheapest expense ratio of spot BTC ETFs. However, it certainly remains competitive and I suspect that Fidelity’s fees may ultimately become the cheapest over time, as it has a critical advantage over almost every other spot ETF manager: it doesn’t rely on Coinbase to hold the asset. That’s what I said back in January:

While I have almost no concerns about Coinbase from a blockchain skills perspective, using Coinbase for custody adds an additional element of potential risk simply by virtue of being a third party. Again, I don’t see this as a significant risk, but I think it gives Fidelity a long-term advantage since the custody is done in-house through a subsidiary. Even though fees have become something of a race to the bottom for these ETFs, at some point this additional layer for these other ETFs may ultimately require a higher cost for the investor.

My thinking is this: As more retail investors and/or speculators purchase BTC through ETFs rather than directly through companies like Coinbase, Coinbase will need to replace lost revenue from its retail exchange business . I suspect the company will seek to increase custody fees for asset managers who rely on Coinbase for purchasing and storing BTC held in ETFs. Since Fidelity is essentially self-stored, the risk of rising fees over the long term is likely lower than other ETF providers.

Closing summary

There are also important tradeoffs to consider when purchasing BTC through ETFs like FBTC. The investor is at the mercy of market times and cannot necessarily sell when he wants if an exit is desired on the weekend or on a weekday evening. Additionally, FBTC holders do not ultimately control the BTC represented by their shares. But there is no perfect solution to Bitcoin exposure in 2024, in my opinion. As I have illustrated, self-custody clearly carries risks, especially for small holders of value, and it is not difficult to see how on-chain HODL can be much more expensive. Given my belief that miners will charge transaction fees to encourage long-term network security and the possible tax benefits of purchasing FBTC in a Roth account, I believe FBTC is a solid option for long-term exposure term to Bitcoin.