Attempts to build an asset offering financial exposure to bitcoin for the average investor has interested global entrepreneurs for years, yet an SEC-registered product that can be traded easily from a standard portfolio remains to be seen. Given the regulatory scrutiny such an instrument would be subject to, the most efficient way to access public markets with a bitcoin asset may be a known subversion of the standard issuance process: the reverse merger.
In July 2013, Winklevoss Capital brought significant attention to this topic when they filed the S-1 for an ETF to track the price of bitcoin. The fund is still under review by regulators, with the lawyer tapped to manage the process recently stating that it may be approved by the end of 2014. Given that approval for J.P. Morgan’s copper ETF took more than two years to gain regulatory approval, it’s of little surprise that a similar instrument for a still-undefined underlying asset would take at least that long.
SecondMarket’s Bitcoin Investment Trust has become a relatively popular solution, garnering NAV of more than $60 million. As a private investment vehicle it’s proven attractive for accredited investors, yet as a private vehicle with weekly liquidity it leaves a segment of the market that would prefer a publicly-traded instrument unserved.
In the past, one method has worked well for companies looking to quickly achieve publicly-traded status: the reverse merger. In a reverse merger, a private company generally buys control of a publicly-traded entity but keeps the acquired company’s name as a shell entity, offering the previously-private company access to public capital markets without having to undergo the regulatory or analytical scrutiny associated with an IPO. Thereafter, shares of the public company trade on the value of the newly-combined entity.
For the purposes of creating a publicly traded vehicle to track the price of bitcoin, the use of a reverse merger may actually be viable, given the right operators and target company. A private company holding a large amount of bitcoin could buy a publicly-traded micro cap entity then convert all assets of the company not needed for operations into bitcoin, enabling the market to trade on the book value of the company’s assets, which would reflect the market rate of XBT while remaining SEC-registered, effectively acting like an ETF.
Reverse mergers have had a tumultuous history, involved with great successes and tremendous frauds over the past decade. The transaction structure was widely taken advantage of by Chinese companies looking to gain easy access to US capital markets, leading to billions of dollars of losses and public embarrassment for a number of leading investment and audit firms when many of the Chinese companies turned out to be utterly fraudulent.
It became such a widespread issue that the SEC issued a five-page warning about the risks of investing in reverse merger companies. Regulators have even halted trading or even registration of many entities, generally for improper or incomplete filings.
Reverse mergers have also functioned as respectable financial transactions for some of the world’s most significant institutions. Clearview acquired a division of Sprint in this manner, and even NYSE Arca was formed in this manner and has become the leading US exchange for Exchange Traded Products with 22% of total US trading volume in the asset class in November.
Managing a Bitcoin Asset Product
Should someone manage to actually create a publicly-traded bitcoin asset, the value proposition is clear. In addition to standard management fees, the equity would likely trade at a notable premium to the underlying bitcoin as a reflection of the increased convenience and liquidity. Similarly, counterparty risk would likely be underplayed, given that the primary alternative would be personal storage which may not be attractive to the technically unsavvy investors the asset would attract. The issuing company would make an attractive spread simply buying / storing bitcoin and selling shares in secondary offerings.
The risks would also be significant, both for investors and the broader digital currency industry. Whatever entity is behind such an asset would also become a de facto face of digital currency for many investors, having gained the position through unorthodox financial engineering. While anyone looking to execute on such a concept would certainly have a complicated regulatory landscape to navigate, a reverse merger may still be the most efficient way to a publicly traded bitcoin vehicle.
Our thanks to Dan Matuszewski for his contributions to this research.