BITO: Rising Tensions in Europe Creates Opportunities for Bitcoin

At launch time, the cryptocurrency was valued at $65K compared to $38.7K today. However, after the dip to the $35K level suffered in the final week of January, things are looking better for BITO, which, it must be mentioned does not invest in bitcoin directly. Still, as seen in the orange chart below, the ETF’s share price is closely correlated to bitcoin‘s, depicted here in purple.

My aim with this thesis is to analyze BITO’s performance in the last month when it gained 15.63% compared to the S&P’s negative 2.39% (-2.39%). This period coincided with the Russian aggression against Ukraine and the imposition of economic sanctions by the United States and its allies.

Invasion and economic sanctions benefiting bitcoin

First, the concept of an economic sanction against countries that go against U.S interests whereby their foreign currency reserves are frozen is not something new. Some of these sanctions remind us of the ones imposed on Huawei two years back and which hit the Chinese telecom giant so hard that it lost billions of dollars of sales. Iran has also been previously impacted by sanctions which severely curbed the ability of its banks to trade in foreign currencies.

This time, America and its allies have gone a step further by punishing Russia which happens to be the world’s eleventh-largest economy by nominal Gross Domestic Product and a giant natural gas exporter. Some of the country’s banks have been barred from utilizing the Swift banking network, which severely limits their ability to receive or issue payments worldwide.

Other measures include drastically limiting Russia’s access to European capital markets and crucial technologies including semiconductors, electronic components, and software. Additionally, sanctions that were intended to hit individuals in Mr. Putin’s circle of power like freezing of their assets mostly in European territories have unfortunately reverberated on ordinary citizens as they queued to withdraw foreign currency from local banks.

Moreover, Russia which has about $630 billion of reserves in dollars is being prevented from accessing it. This is a huge amount and means that the idea of the dollar being viewed as a worldwide reserve currency plus a safe store of value is now jeopardized and only applies to countries that abide by U.S. values and interests. This level of currency weaponization is something unprecedented and paves the way for alternative means of transacting or stores of value, with one of them being cryptos.

Also, many are turning to cryptos because of practical benefits.

First, in light of their own currency losing value similarly to ice melting in the sun, crypto represents a safe store of value for Russians and Ukrainians alike. Second, if you are a Ukrainian refugee, it’s easy to transport as people only need to memorize the seed phrase. In comparison, gold and paper-based currencies like dollars or the European euro can be easily stolen by corrupt border guards. Storing bitcoins on an exchange constitutes some risk but is still better than transporting paper or metals.

Furthermore, cryptocurrency donations have poured in to support pro-Ukraine groups with NGOs, and volunteer groups have received 30 million dollars in form of cryptocurrencies since the Russian invasion. Bitcoin donations are also pouring in to support Ukraine’s military because it’s quick and easy, as it bypasses national financial and monetary regulations.

Thus, crypto-assets have emerged as an alternative funding method as they enable cross-border donations that circumvent financial institutions that might otherwise block payments. Also, at this stage, it is hard to see any action by U.S. regulators which may impede the flow of money into Ukraine.

BITO both as investment and trading tool

Increased flow levels led to higher bitcoin demand, but, BITO’s underlying fund does not invest directly in the digital coin as I mentioned above. Instead, as the first U.S. bitcoin-linked ETF, it provides exposure to bitcoin futures contracts. Now, a contract is normally a term used for the commodities market and allows investors to speculate on a product’s future price in order to gain from short-term price movements without holding it. In the case of BITO, it is bitcoin.

As per the fund managers, BITO “also offers investors an opportunity to gain exposure to bitcoin returns in a convenient, liquid and transparent way”.

However, historically speaking, the fund has failed in its objective to provide capital appreciation, at least for those who have held it from inception as illustrated by an initial investment of $10K being worth less than $7K today.

Still, due to the liquidity factor and the fact that it is volatile, BITO can enable traders to achieve considerable gains. An example is an investment done around October 27 when the share price was around $38 being valued at $43 just two weeks later.

For this matter, BITO’s average daily share volume at 8 million is nearly eight times more than the Valkyrie Bitcoin Strategy ETF (BTF) which was incepted just days after BITO and also holds future contracts. The ProShares ETF has $676 million of assets under management compared to only $33.58 million for its peer. Both ETFs charge fees of 0.95%.

Thus, investing in bitcoin futures contracts through BITO allows investors to better profit from short-term price movements regardless of the long-term direction and this is helped by the fact that crypto enjoys international recognition, making it suitable for everyone at anytime and anywhere in the world.

The risks and the long term rationale

However, keeping and paying with bitcoin comes with risks as the value of a currency is largely dependent on people’s trust. The trust level shot up with the events in Ukraine mainly due to erosion in confidence in traditional or fiat currencies caused by uncertainty. However, cryptocurrencies remain largely unregulated, extremely volatile, and not completely immune to hacker attacks due to the fact that they are digital in nature.

Still, relativizing risks, I consider that in view of heightened tensions in Ukraine, high-inflation concerns in Europe due to rising energy costs, and the euro losing ground against the dollar, there are more opportunities for bitcoin which is based on blockchain software residing on a decentralized network of computers around the globe.

Thus, virtually available bitcoin now looks relatively less vulnerable compared to physical currencies sitting in central banks whose dollar assets may not prove useful when most needed, depending on whether their leadership is aligned with the West.

The above factors should gradually contribute to making crypto assets more central to finance and payments.

Therefore, given the possibility of other countries being sucked into the conflict, there could be wider adoption of crypto somewhat similar to El Salvador where there was a decision to adopt bitcoin as legal tender last year. Even if governments do not go that far, some Eastern European leaders may order their central banks to diversify some of their dollar assets into bitcoins as a precautionary measure.

There is another factor that should increase demand for digital assets.

For this purpose, in addition to the crowd funding aspect, whereby the objective is to raise funds from common people for supporting Ukrainians, there are also projects based on Non-Fungible Tokens or NFTs.

Thus, OpenSea, the largest NFT marketplace is hosting a collection of unique artworks by Artists for Peace and collectors can bid for about 60 pieces in Ethereum (ETH-USD) with the proceeds going towards supporting the Ukrainian people. Now, Ethereum is different from bitcoin, but, as the second cryptocurrency by market valuation, its wider usage should give support to the crypto world in general.

Coming back to BITO, for those who have held to their investments, the ETF represents a safe way to remain invested in the cryptocurrency without risk of theft or misappropriation.

Finally, my bullish stance is firstly reinforced by crypto breaking its correlation with (or decoupling from) the tech sector as I had initially pointed out in my article on the Grayscale Ethereum Trust (OTCQX:ETHE) two weeks earlier. Hence, BITO (in blue) is now outperforming the Invesco QQQ Trust (QQQ).

Data by YCharts

Second, according to Zero Hedge, there are reasons to think that the surge in bitcoin’s value and by ricochet BITO’s share price was more the result of investors expecting a surge in demand from Russia than an actual increase. Thus, more crypto demand should sustain the ETF’s upside. Meanwhile, demand for gold as a safe haven asset is up showing that established hedging mechanisms still work.

Taking into consideration these factors I am bullish on BITO for the long term, but do not exclude a surge to $30 by mid-2022, a level last reached at the end of December. This should be also driven by more support from institutions like Citadel, the largest U.S. market maker which is now more favorable to bitcoin.

Finally, at $23.53, BITO is currently available at a slight discount to NAV of $0.03.