The macro environment and growing institutional adoption both support taking bitcoin seriously as an investor. Bitcoin is the ultimate tail risk hedge. In fact, it seems almost irresponsible to not have any exposure at all. Yet getting bitcoin exposure isn’t easy. Owning bitcoin directly provides the best security for extreme scenarios, but is inconvenient and has limitations. GBTC is an expensive and flawed solution, but it still makes sense to own it, as I’ll explain in this article.

The Macro Case for Bitcoin

The macro case for bitcoin is stronger than ever.

At the beginning of 2020, government and private debt were already near record levels. Then the pandemic arrived and governments responded with stimulus plans unprecedented in both their scale and creativity. In the last six months, the US government has printed two-thirds as much money as it did during the prior 11 years. Year to date, the Federal Reserve has expanded its balance sheet by more than it did during the six years of quantitative easing that followed the financial crisis.

These charts shows the scale of the central bank balance sheet expansion, and rising global debt levels:

Source: Tudor Group

Central banks around the world are all following a similar trajectory. This shows the combined central bank balance sheets of different central banks around the world:

Source: John Street Capital

Also important to note, fiscal and monetary policy are now hopelessly intertwined. Under the CARES act, the Treasury has capitalized a special purpose vehicle which the Federal Reserve can leverage 10 to 1.

After the 2008-2009 global financial crisis, government stimulus was primarily targeted at financial institutions, not households. However, in response to COVID-19, policymakers aggressively provided households with direct transfers that in aggregate more than compensate for temporary demand destruction caused by lockdowns. Therefore, in the coming years, we are likely to have inflation in the real economy, not just in financial markets. Most investors are unprepared for inflation and fiat currency debasement. Bitcoin is one tool to help.

Global macro investor Paul Tudor Jones stated that bitcoin reminds him of gold at the beginning of the 1970s commodity bull market. The portfolio investment case for bitcoin is similar to that of gold: it serves as a hedge against systematic risk. Bitcoin, like gold, is not someone else’s liability. It is independent of the high debt levels widely found around the world. However, Bitcoin does have advantages over gold.

Gold is scarce, but there is no hard limit on how much gold can be mined. Improving technology will always serve as a catalyst to increase gold supply. Deep sea and asteroid mining could both drastically increase supply in the near future. These ideas might seem far fetched today, but ⅔ of the gold above ground today was mined since 1950. In contrast, the maximum supply of bitcoin is fixed at 21 million. Additionally, there is a mechanism to automatically increase the difficulty of mining bitcoin as prices go higher. As the gold price gets higher, it is riskier to hold because of increased incentive to pursue major technological breakthroughs that will create a surge in supply. In contrast, as value investor Bill Miller has argued, through network effects, bitcoin in some ways actually becomes less risky to hold as its total market cap increases.

Additionally, bitcoin is more portable than gold. A totalitarian regime can confiscate gold, but won’t be able to confiscate bitcoin from everyone. This applies only to holding bitcoin directly, and not to holding it via funds, but it nonetheless demonstrates an advantage of the asset class.

I view bitcoin as a complement to gold, not a substitute. Yet it’s worth noting that while gold and bitcoin have similar utility in a portfolio, gold currently has a market cap that is more than 40x that of bitcoin. This justifies a lot more upside for bitcoin.

Institutional Adoption And Easier Access

Bitcoin started out as a fringe asset, yet it is starting to be more widely accepted in the asset management industry. In 2019, Cambridge Associates, which provides consulting services to pensions and endowments, published a report that was favorable to bitcoin and other digital assets. As John Street Capital noted, the reputational risk for taking bitcoin seriously goes away as well known investors such as Paul Tudor Jones and David Swensen make allocations to bitcoin. The fintech sector is constantly expanding the ways for both retail and institutional investors to access digital assets. Over time, this will result in more buying pressure for a limited number of bitcoins.

How to Get Exposure

In spite of recent advances, investing in bitcoin and other digital assets is still operationally difficult. There are tradeoffs between protecting against accidental loss, protecting against theft, adequate verification, and convenience. Given the current state of technology, the most direct way to own bitcoin is to set up your own hardware wallet or cold storage wallet, then use a seed phrase to access it. Under this method, there is no risk of a third-party failure causing you to lose your funds, but it’s inconvenient, and there is the risk you could accidentally lose access. You can also use a custodial wallets – that is an exchange or broker that holds bitcoins on your behalf. Coinbase is the prime example of a custodial wallet. The convenience of a custodial wallet comes with the risk the custodian will get hacked or lose your assets. The bitcoin wiki provides additional information on the different storage methods for owning bitcoin directly.

Another option is to invest in a fund or company that holds bitcoins. Many hedge funds have started investing in bitcoin. The SEC has not yet approved a bitcoin ETF, but exchange-traded products with bitcoin and other digital assets have raised over $1 billion in Sweden and $100 million in Switzerland. I wrote previously how a closed-end fund structure would be a good way to offer bitcoin exposure, although this solution isn’t available yet.

The most convenient option for US based investors that want to invest in bitcoin in their brokerage account is the Grayscale Bitcoin Trust (GBTC).

The Flaws in GBTC

Yet GBTC has several major flaws.

First of all is the ongoing and upfront costs. GBTC charges a 2% annual management fee. This seems absurd for simply buying and holding a digital asset, even if it is operationally difficult to deal with. Over time, as technology improves, and there is more competition in the space, I expect investors will push GBTC to reduce this.

GBTC also tends to trade at a premium, as shown in this chart:

Source Grayscale Bitcoin Trust

GBTC currently trades at a 7% premium to NAV. Thus, you are paying approximately 7% more than the current bitcoin cost. As a value oriented investor, it pains me to pay a premium like this. Yet the macro case for bitcoin is so extreme that this won’t matter a lot in the long run, especially if there is hyperinflation or other systemic problem. Additionally, the premium tends to widen when there is a surge in the bitcoin price, providing opportunities to trade around a position with less difficulty than the underlying asset.

Additionally, GBTC also has a set of operational risks that bitcoin purists might say defeat the entire purpose of owning a decentralised asset. The primary concerns are counterparty and custody risk. GBTC uses Coinbase Custody Trust Company LLC to serve as custodian, which means they must safeguard the bitcoin, and hold the private keys that provide access to its digital wallet and vaults. If the custodian gets hacked or becomes insolvent, GBTC would lose. Additionally, there is always the risk that GBTC itself will misstate its financials. All the service providers and GBTC itself are subject to audits, but that is still no guarantee of safety. With GBTC, you get the same inflation protection as owning bitcoin directly, but you don’t get the complete avoidance of counterparty risk.

On the other hand, GBTC is easy to hold in an IRA. Although new solutions are in development for more direct bitcoin access in IRAs, the fees are relatively high. None of them provide the pure exposure you get with a cold storage wallet. It’s possible to set up a “Checkbook IRA” that holds interest in an LLC, which in turn owns bitcoin, although this also introduces new complications. As far as I know, there is no way to own bitcoin in an IRA without taking on some form of counterparty and operational risk. This factor alone makes owning some GBTC a prudent decision.

Conclusion

The macro environment necessitates finding something to protect against fiat debasement. Even a modest increase in “mainstream” acceptance of bitcoin will drive the price radically higher. Therefore, holding 1-2% of assets in bitcoin across all portfolios provides an excellent risk-reward tradeoff. If bitcoin fails, it will not have a major lifestyle impact, but in an extreme upside scenario, an allocation to bitcoin can easily more than compensate for other financial losses during a catastrophic event.

It’s wise to hold a small amount of bitcoin in cold storage, just in case there is a near complete collapse of the financial system. Additionally, it makes sense to hold some bitcoin via Coinbase or one of their competitors for ease of access. Yet hyperinflation and paradigm shift can also happen without complete systemic collapse. If this happens, bitcoin would likely surge in nominal and real terms, while a lot of other assets drastically decline in value, or at least fail to keep up with inflation.

I also keep 1-2% of my Roth IRA and SEP IRA accounts in bitcoin, so that if it surges, it will support my retirement, even if all other assets decline, or fail to keep up with inflation. I also keep a small amount of GBTC in my regular taxable accounts for a similar reason. If bitcoin surges while other parts of the stock market collapses, I can trim GBTC holdings to buy discounted stocks, provided the opportunity set compensates for the tax hit.

All methods of holding bitcoin have flaws. That’s why I diversify the way I hold it. Just like bitcoin is a complement to gold rather than a substitute, GBTC is a complement to other ways of owning bitcoin.

Disclosure: I am/we are long GBTC, BTC-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.