Bitwise Believes Indexing is a Superior Crypto Strategy; Here’s Why

Bitwise Asset Management is one of the growing number of crypto fund firms continuing to bring to market investment products that offer investors exposure to a new asset class. 

As part of Blockworks’ series of Q&As with fund managers in the space, I recently spoke with Matt Hougan, the firm’s chief investment officer, about Bitwise’s focus on serving financial advisors, its newest crypto ETF, its approach to indexing and the long-awaited physical bitcoin ETF that US regulators have not yet greenlit.

Bitwise’s flagship fund, the Bitwise 10 Crypto Index Fund was the world’s first crypto index fund and is also the largest. The company launched a DeFi index fund in February and earlier this month introduced funds that invest directly in the native tokens of DeFi protocols Uniswap and Aave.  

Before becoming Bitwise’s CIO last October, Hougan spent nearly three years as the asset manager’s global head of research and was chairman of event company Inside ETFs during that time. Earlier in his career, he spent nearly a decade at ETF.com in the roles of global head of editorial, president and ultimately CEO.

Let’s get the Q&A started:

Strack: What type of investor is Bitwise targeting with its investment offerings?

Hougan: A lot of the crypto ecosystem grew up focusing on self-directed retail investors – you can think of Coinbase and Kraken and other brokerages. Parts of the crypto ecosystem focused on pensions and endowments and other large institutions, so you can think of [a16z] Crypto. 

Bitwise is focused exclusively on serving the financial advisor and RIA market, which we believe is the next big market to move into crypto. That’s reflected both in the funds we’ve developed and continue to develop, and in the structure of the company and how we support those funds with research, education and an advisor support team.

The financial advisor market is huge. By most estimates it’s as large as the institutional market, and it’s many times larger than the self-directed retail market. …It’s a hard market to serve in that it requires education and support and a national distribution team, but I do think the crypto industry has perhaps been overfocused on the institutional market and not on the advisor market, which built a huge swathe of the ETF ecosystem into the multi-trillion-dollar market that it is today. That’s one fact that I think is not commonly understood.

Strack: Aside from investment offerings, what else does Bitwise provide for advisors?

Hougan: We produce regular research that arms advisors to answer the questions that their clients have. And then we have a 15-person distribution team located around the country that’s meeting face-to-face with advisors. I think a lot of advisors are somewhat intimidated to go into crypto because they know that their clients know a lot about it. 

They need to have a good answer if their client calls them up and says, ‘what’s EIP-1559 and how will it influence the Ethereum market?’ If the client calls them and asks, ‘Is Cardano or Solana going to seriously threaten Ether’s position as a layer 1 solution?’ they need to have an answer. Most advisors don’t have that at their fingertips, the way they would if you called them and asked them about the outlook for the US economy. So we’re set up to serve them, and I think that’s resonating and making a lot of them more comfortable to come into the market.

Strack: Why has Bitwise focused its efforts on index products?

Hougan: Crypto index funds are a good solution for advisors because many of them are making an allocation to client accounts at a relatively small percentage of the portfolio — let’s say 1%, 2%, maybe 5% of the portfolio. But those advisors just want to make sure they’re participating in the potential upside of crypto in a professionally managed product. 

They don’t want to make any individual active bets. They don’t want [do due diligence on] different active managers. They just want to know they have exposure to the market.

I think [indexing] is an even better strategy in crypto than it is in equity or bonds. This is a disruptive new market and it’s difficult to forecast exactly how it will turn out, but the data historically has been very strong. So taking a broad-based bet is a great solution for many investors. The worst thing you can do, particularly as an advisor, is to bet right on the market but bet on the wrong horse, and lose. 

Before costs, indexing is an average strategy in equity, and it wins because it’s the lowest-cost way to allocate into the market. But in the crypto market, there’s something different at work; all of crypto is a network-effect business. In other words, the fact that bitcoin is the largest asset means it’s the most liquid asset, has the most robust regulatory framework, is likely to get the first ETF. The fact that Ethereum is the largest DeFi layer-1 protocol means it has the most developer activity and means it has the most liquidity. 

…So basing your allocation based on size can help you orient toward protocols and crypto assets that have built-in advantages over their smaller competitors that are hard to assail.

Strack: How does the firm construct its indexes?

Hougan: I think a lot of people hear index and they think you just take the largest assets, rank them and allocate and it should take you all of about 15 minutes. 

…There are two levels to index construction. One level [is] you want to make sure you own the largest assets in a market-cap weighted fashion, because what you want to offer investors is a promise that if crypto is bigger in the future than it is today you’ll have exposure to the assets that are leading that. The only way to do that is in an uncapped market-cap weighted index.

We screen out assets that can’t be custodied with institutional custodians. We screen out assets that we deem to be an undue risk of potentially being in violation of federal securities laws. We screen out assets that appear illiquid, and importantly we do this on an ongoing basis.

A lot of what advisors trust us to do is stay up to speed on what’s going on in the market and react to news so that they don’t have to, so the indexes are heavily monitored and have these screening rules in place to do that.

Strack: Why did the firm choose to launch the Bitwise Crypto Industry Innovators ETF (BITQ) and what differentiates it from competing products?

Hougan: It’s not the long-awaited bitcoin ETF — we’re still working on that — but it’s the first ETF to offer pure-play exposure to the crypto market. We did that, again, to serve the advisor market, because for many advisors, as great as funds like the Bitwise 10 are, they don’t fit into their workflow in the same way that an ETF would.

There’s actually a rule called the Investment Companies Names Act, and that rule states that you can’t have a word in the name of your fund or ETF unless at least 80% of the portfolio has pure-play exposure to that word or name or theme.

It was the first ETF with crypto in its name, and that’s not because other ETFs I think didn’t want to have crypto in their name. It’s the first ETF where the index is designed such that 80% of the portfolio is always invested in pure-play crypto companies, and not companies that do blockchain on the side.

You can have any ticker you want, so you can’t judge an ETF by its ticker, but you can judge it by its name. And I think if you look at some of the competing ETFs, you may see they have some very funky names. They may have crypto-related tickers, but look at the name carefully. It’s a cool decoder ring for evaluating competing ETFs.

Strack: How important is a bitcoin ETF? Where is Bitwise in terms of its process to offer one?

Hougan: People who are in the crypto industry don’t realize how important plumbing and practicality is to financial advisors. If you’re using a private fund as a financial advisor and you want to allocate to crypto and you have 100 clients and you want to rebalance, you may have to send 100 separate wires. Advisors are busy people, and it’s much easier for them with an ETF just to be able to push a button and rebalance or allocate.

We’ve met with the [SEC] I think a dozen times in the last 16 months discussing the crypto market and the bitcoin market and presenting research, and the questions they’re asking are smart and they’re appropriate.

We had a filing, it was disapproved, we withdrew it and we’ve still been working on it. We aren’t going to file until we feel confident that such a filing is likely to be approved…and we don’t think we’re there yet.

Strack: When do you expect the SEC might approve a bitcoin ETF?

Hougan: People in the crypto market are hugely frustrated with the slow pace of the SEC approving a bitcoin ETF, but if you look back over other novel categories of ETFs, you know that it was tough to get those approved as well. Nontransparent active ETFs were at the SEC for a decade. Even bond ETFs … were in the SEC for multiple years. Gold ETFs were a major effort. Leveraged ETFs I think took six or seven years. 

So anytime you’re opening up a new category, the SEC asks good questions, they’re very diligent, they’re focused on investor protection, and eventually in most cases, if the market is appropriate for it you can get there. …I do think we’re closer than we’ve ever been before, but I’m not going to give you a date.

To read Blockworks’ last fund manager Q&A, click here. Also be sure to check out Blockworks co-founder Jason Yanowitz’s recent interview with Hougan, during which the Bitwise CIO delves deeper into DeFi.