Bitwise 10 Crypto Index Fund
For the period ended Dec 31, 2023. Filed Mar 1, 2024.
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FY2023 · Filed Mar 1, 2024
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Item 1a. Risk Factors
Potential investors should be aware that an investment in the Trust involves a high degree of risk. There can be no assurance that the Trust’s investment objective will be achieved, or that Shareholders will receive a return of their capital. Shareholders may lose all of their investment in the Trust. In addition, there will be occasions when the Sponsor and its affiliates may encounter potential conflicts of interest in connection with the Trust. The following considerations should be carefully evaluated before making an investment in the Trust. However, the following does not purport to be a summary of all of the risks associated with an investment in the Trust. Rather, the following describes certain specific risks to which the Trust is (and, therefore, Shareholders are) subject. Potential investors should carefully consider these risks and consult with their professional advisors, as they deem necessary.
Summary of Risk Factors
Our business is subject to numerous risks and uncertainties, including those highlighted in this section “Item 1A. Risk Factors.” The principal risks that we face include the following:
competition from the emergence or growth of other Crypto Assets or the development of other methods of investing in Crypto Assets could have a negative impact on the price of Portfolio Crypto Assets and adversely affect the value of the Shares;
the extreme volatility of trading prices that many Crypto Assets have experienced in recent periods and may continue to experience;
the long-term viability of Crypto Assets is unknown;
the unregulated nature and lack of transparency surrounding the operations and governance of Blockchain technologies and Crypto Assets;
the value of the Trust’s Crypto Assets is dependent, directly or indirectly, on prices established by Crypto Asset exchanges and other Crypto Asset trading venues, which are new and, in most cases, largely unregulated;
the Blockchains on which ownership of Portfolio Crypto Assets are recorded and the Portfolio Crypto Assets themselves may be the target of malicious cyberattacks or may contain exploitable flaws in their underlying code, which may result in security breaches and the loss or theft of Portfolio Crypto Assets;
the Blockchains on which ownership of Portfolio Crypto Assets are recorded are dependent on the efforts of third parties acting in their capacity as the Blockchain transaction Miners and/or Validators, and if these third parties fail to successfully perform these functions, the operation of the Blockchains that record ownership of Portfolio Crypto Assets could be compromised;
transactions in Crypto Assets may be irreversible even if they are fraudulent or accidental transactions;
the market for Crypto Assets is characterized by shallow trade volumes, extreme hoarding, low liquidity and high bankruptcy risk;
the impact of geopolitical events on the supply and demand for Crypto Assets is uncertain and may negatively impact investments in the Trust;
the Value of Shares in the Trust relates directly to the value of Crypto Assets held by the Trust, and fluctuations in the price of Portfolio Crypto Assets could adversely affect an investment in the Trust;
the Bitwise 10 Crypto Index has a fairly limited history;
the methodology for determining the Index established by the Index Provider, which is an affiliate of the Sponsor, is relatively new; and
because of the holding period under Rule 144 and the lack of an ongoing redemption program for Shareholders who invest directly into the Trust (as opposed to Shareholders who acquire Shares in the public secondary trading market) there is no arbitrage mechanism to keep the price of the Shares closely linked to the value of the underlying Portfolio Crypto Assets and the Shares may trade at a substantial premium over, or substantial discount to, the value of the NAV Per Share.
Risks Related to Crypto Assets
Competition from the emergence or growth of other Crypto Assets or the development of other methods of investing in Crypto Assets could have a negative impact on the price of Portfolio Crypto Assets and adversely affect the value of the Shares.
Shareholders may invest in Crypto Assets through means other than the Shares, including through direct investments in Crypto Assets and through the purchase of other financial vehicles, including securities that hold, are backed by or are linked to one or more Crypto Assets (for example, exchange traded funds that hold Bitcoin), as well as through other Crypto Asset financial vehicles that are similar to and competitive with, the Trust. Market and financial conditions, as well as other conditions beyond the Sponsor’s control, may make it more attractive to invest in these other financial vehicles or to invest in Crypto Assets directly. This could limit the market for, and reduce the liquidity or value of, the Shares. In addition, to the extent other Crypto Asset financial vehicles that track the price of one or more Crypto Assets are formed, and these vehicles represent a significant proportion of the demand for any particular Crypto Asset, large purchases or redemptions of the securities of such Crypto Asset financial vehicles could negatively affect the relevant Crypto Asset reference rates, the relevant Crypto Asset holdings, the price of the Shares, the NAV and the NAV Per Share. Any of these situations could have a negative impact on the price of Portfolio Crypto Assets or adversely affect the value of the Shares.
The Blockchains on which ownership of Portfolio Crypto Assets are recorded and the Portfolio Crypto Assets themselves may be the target of malicious cyberattacks or may contain exploitable flaws in their underlying code, which may result in security breaches, the loss or theft of Portfolio Crypto Assets or the decline in value of Portfolio Crypto Assets.
The Portfolio Crypto Assets rely on Blockchains for records of ownership. As a result, the Portfolio Crypto Assets are subject to a number of reliability and security risks attendant to Blockchain and distributed ledger technology, including malicious attacks seeking to identify and exploit weaknesses in the software. Some of these known risks include:
“51% attacks,” which occur when an attacker controls a majority of computing power or staked Crypto Assets necessary to validate transactions on a Blockchain, giving the attacker a majority of the validation power on the network. Miners or Validators on Blockchains who successfully obtain this validation power—either individually or as part of a “Mining pool” or group of validators—may block other users’ transactions or make it appear as though they still have Crypto Assets that have been spent, which is known as a “double-spend attack,” or otherwise change the order of transactions. A 51% attack may also allow an attacker to use its monopoly over new blocks to “censor” other user transactions by actively preventing them from being written to the Blockchain. Any such attack on the Blockchains could result in the loss of Portfolio Crypto Assets or their valuation.
A "Sybil attack" occurs when a single entity or a concentrated number of entities attempt to gain a larger influence on the Blockchain by creating multiple identities (or Sybil identities) that appear to be unique. This puts the reputation of the Blockchain at risk. A Blockchain's failure to be Sybil-resistant can lead to 51% attacks.
A “Finney attack” occurs when an attacker mines a block but does not announce it to the network. In this case, a Miner can double-spend Crypto Assets by sending them to another user in a legitimate transaction and then create a valid new block with a double-spend of those same Crypto Assets; for the attack to be successful, this block must be released so that it is added to the Blockchain before the target user’s legitimate transaction. Once the block the attacker mines is accepted, the legitimate transaction will not be accepted and the honest user will not receive the Crypto Assets, thereby being out of a payment. Typically, developers and users who accept “quick transactions” (transactions that are accepted before the counterparty can confirm that the transaction has been written to the correct version of the Blockchain) when accepting payment on the network are vulnerable to this type of attack. These attacks can be avoided by requiring that several additional network operations be written to the Blockchain after any transaction before considering that transaction complete; however, developers may be incentivized not to do so to allow for quicker processing of network operations on their application.
Such attacks may materially and adversely affect Blockchains recording the ownership of Portfolio Crypto Assets, which may in turn materially and adversely affect the transfer or storage of Portfolio Crypto Assets. As a result of these and other risks of malicious attacks, there can be no assurances that the transfer or storage of Portfolio Crypto Assets will be uninterrupted or fully secure. Any such interruption or security failure may result in impermissible transfers of Portfolio Crypto Assets and/or loss of Portfolio Crypto Assets.
The networks underlying the Portfolio Crypto Assets rely on software and programming that is complex, and if this software contains undetected errors, the value of the Portfolio Crypto Assets and the Shares could be adversely affected.
The networks underlying the Portfolio Crypto Assets rely on software that is highly complex. Any errors, bugs or defects discovered in the software on which these networks rely could result in harm to the reputations of these networks, loss of developers or users on those networks, and, in turn, loss in value of Portfolio Crypto Assets and the Shares. In the past, for example, flaws in the source code for Crypto Assets have been exposed and exploited, including flaws that disabled some functionality for users, exposed users’ personal information and/or resulted in the theft of users’ Crypto Assets. In addition, the cryptography underlying a Crypto Asset held by the Trust could prove to be flawed or ineffective, or developments in mathematics and/or technology, including advances in digital computing, algebraic geometry and quantum computing, could result in such cryptography becoming ineffective. In any of these circumstances, a malicious actor may be able to take the Crypto Assets held by the Trust, which would adversely affect an investment in the Shares.
The Sponsor may experience loss or theft of its Portfolio Crypto Assets during the transfer of Portfolio Crypto Assets from the Custodian to the Sponsor or to Crypto Asset trading venues.
Under certain circumstances, the Sponsor may gain control of the Trust’s Portfolio Crypto Assets. These circumstances may include withdrawals of its Portfolio Crypto Assets by the Sponsor in order to send Portfolio Crypto Assets to certain trading counterparties or to approved Crypto Asset trading venues in order to make certain types of trades. The ability to gain temporary control of even a portion of the Portfolio Crypto Assets is restricted to a limited number of authorized personnel of the Sponsor. The withdrawal process requires that one authorized person initiate a request for the withdrawal of Portfolio Crypto Assets from the Custodian and that a second authorized person approve the withdrawal before the Custodian will process the request. A video call with the necessary authorized personnel of the Sponsor is then required for confirmation of the withdrawal before the Custodian will complete the withdrawal request. Once the Custodian processes the transaction, the Sponsor has the ability to send the withdrawn Portfolio Crypto Assets to the delivery address of trading counterparties or trading venues. During any such transfer, the Portfolio Crypto Assets may be vulnerable to security breaches, including hacking and other efforts to obtain the Portfolio Crypto Assets, as well as the risk that while Portfolio Crypto Assets are under the Sponsor’s control, an employee of the Sponsor could access and obtain the Portfolio Crypto Assets. Some of these attempts to obtain the Portfolio Crypto Assets may be successful, and the Sponsor may lose some or all of the transferred Portfolio Crypto Assets. In addition, Portfolio Crypto Assets transferred to exchanges or other trading venues or protocols are subject to increased risk of loss or theft due to reliance on the security procedures of the trading venue (when the Portfolio Crypto Assets are no longer in the custody of the Custodian) and because the same withdrawal procedures required by the Custodian, which are designed to reduce the risk of error or theft, may not be required by trading venues.
The Custodian may experience loss or theft of the Portfolio Crypto Assets.
The Custodian may experience malicious attacks seeking to identify and exploit weaknesses in its software and gain access to the Portfolio Crypto Assets. Some of these attempts to obtain the Portfolio Crypto Assets may be successful, and the Custodian may lose some or all of the transferred Portfolio Crypto Assets. As a result of the risk of malicious attacks, there can be no assurances that the storage of Portfolio Crypto Assets with the Custodian will be uninterrupted or fully secure. Any such security failure may result in impermissible transfers of Portfolio Crypto Assets and/or loss of Portfolio Crypto Assets.
The Blockchains on which ownership of Portfolio Crypto Assets are recorded are dependent on the efforts of third parties acting in their capacity as the Blockchain transaction Miners and/or Validators, and if these third parties fail to successfully perform these functions, the operation of the Blockchains that record ownership of Portfolio Crypto Assets could be compromised.
Blockchain Miners and/or Validators maintain the record of ownership of Portfolio Crypto Assets. If these entities suffer from cyberattacks or other security incidents (whether from hacking, which involves efforts to gain unauthorized access to information or systems, or to cause intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment, the inadvertent transmission of computer viruses or other malware, other forms of malicious attacks, malfeasance or negligent acts of its personnel, or via other means, including phishing attacks and other forms of social engineering), or for financial or other reasons cease to perform these functions, the functioning of the Blockchains on which the ownership of Portfolio Crypto Assets is recorded and the valuation based may be jeopardized. Any such interruption could result in impermissible transfers of Portfolio Crypto Assets and/or loss of Portfolio Crypto Assets and/or their value.
In addition, over the past several years, Crypto Asset Mining operations have evolved from individual users Mining with computer processors, graphics processing units and first-generation application specific integrated circuit (“ASIC”) machines to “professionalized” Mining operations using proprietary hardware or sophisticated machines. If the profit margins of Crypto Asset Mining operations are not sufficiently high, Crypto Asset Miners are more likely to immediately sell tokens earned by Mining, resulting in an increase in liquid supply of that Crypto Asset, which would generally tend to reduce that Crypto Asset’s market price.
Additionally, crypto Mining entities may encounter financial difficult and have to cease or curtail operations, which
could result in a reduction of the “hash power” dedicated to mining a particular Crypto Asset, which could reduce that asset’s security and potentially reduce the price of related Crypto Assets.
Finally, a significant amount of capital staked in proof of stake Blockchains may be from centralized entities including centralized exchanges, like Coinbase. In the event that such centralized entities find themselves in financial and/or legal difficulties, staked capital (in the form of Crypto Assets) could be at risk of being sold off and/or being tied up in litigation, which could materially harm the value of Crypto Assets or interfere with certain activities. For example, in November 2022, the centralized exchange FTX filed for bankruptcy and halted user withdrawals of Crypto Assets.
The technology underlying Crypto Asset and Blockchain technology is subject to a number of known and unknown technological challenges and risks that may prevent wide adoption and use of the Portfolio Crypto Assets, which may negatively affect the value of Portfolio Crypto Assets and the Shares.
The Blockchain technology used in connection with Portfolio Crypto Assets, which is sometimes referred to as “distributed ledger technology,” is a relatively new, untested and evolving technology. It represents a novel combination of several concepts, including a publicly available database or ledger that represents the total ownership of the currency at any one time, novel methods of authenticating transactions using cryptography across distributed network nodes that permit decentralization by eliminating the need for a central clearing-house while guaranteeing that transactions are irreversible and consistent, differing methods of incentivizing this authentication (for example, the issuance of new Crypto Assets for each new block as a reward for the Validator on PoS Blockchains or for the Miner or PoW Blockchains), and hard limits on the aggregate amount of currency that may be issued. As a result of the new and untested nature of Crypto Assets and Blockchain technology, the Portfolio Crypto Assets are vulnerable to risks and challenges, both foreseen and unforeseen. Examples of these risks and challenges include:
Scalability is a challenge for platforms working with large Blockchains, because the addition of records to a Blockchain requires the network to achieve consensus through a transaction validation mechanism, which often can involve redundant and extensive computation, processing of transactions is slower than that achieved by a central clearing-house, and delays and bottlenecks in the clearance of transactions may result as the Crypto Asset expands to a greater number of users.
To the extent incentive payments are used to incentivize the validation of a transaction or record to a block on the Blockchains that record ownership of the Portfolio Crypto Assets, these fees may spike during times of high transaction volume. We believe that these rewards do not warrant validator registering as a broker-dealer, as discussed in the section “Item 1. Business—Overview of Government Regulation”; however, there is no guarantee that regulatory agencies will agree with our position.
Generally, blocks cannot be removed from a Blockchain, but during the validation process for large Blockchains, competing Blockchains may arise with respect to the last few blocks on the Blockchain. As a result, a block is often not considered to be irreversible on the Blockchain until several additional blocks have been added to it and occasionally blocks with a handful of confirmations can be dropped and modified.
Although Blockchains are generally considered reliable, they are subject to certain attacks as described above under “—The Blockchains on which ownership of Portfolio Crypto Assets are recorded and the Portfolio Crypto Assets themselves may be the target of malicious cyberattacks or may contain exploitable flaws in their underlying code, which may result in security breaches, the loss or theft of Portfolio Crypto Assets or the decline in value of Portfolio Crypto Assets.”
The software related to the Blockchains on which ownership of Portfolio Crypto Assets is recorded may either increase or decrease the incentive payments paid to Miners or Validators required to complete transactions, which could materially and adversely affect the transfer or storage of Portfolio Crypto Assets. In addition, changes could also reduce the number of Miners or Validators on the Blockchains on which ownership of Portfolio Crypto Assets is recorded—which could possibly leave these Blockchains increasingly vulnerable to a 51% attack.
Because the Blockchains on which ownership of Portfolio Crypto Assets are recorded are public Blockchains, malicious users may freely view and access and interact with key components of these Blockchains.
Although there may be solutions that have been proposed and implemented to these and other challenges facing various Crypto Assets, the effectiveness of these solutions has not been proven. Further, other challenges may arise in the future that we cannot predict. For example, advances in cryptography and/or technical advances, such as the development of quantum computing, could present risks to the Blockchains on which ownership of the Portfolio Crypto Assets is recorded and the Portfolio Crypto Assets by undermining or vitiating the cryptographic consensus mechanism that underpins the Blockchain protocols. Similarly, legislatures and regulatory agencies could prohibit the use of current and/or future cryptographic protocols which could limit the utility and value of the Portfolio Crypto Assets and, in turn, the Shares, resulting in a significant loss of value or the termination of Portfolio Crypto Assets. Accordingly, the further development and future viability of Crypto Assets in general or specific Crypto Assets, such as the Portfolio Crypto Assets, is uncertain, and unknown challenges may prevent their wider adoption.
The technology underlying Crypto Assets and Blockchain technology is subject to a number of industry-wide challenges and risks relating to consumer acceptance of Blockchain technology. The slowing or stopping of the development or acceptance of Blockchain networks and Blockchain assets would have an adverse material effect on the value of the Portfolio Crypto Assets and the Shares.
The growth of the Blockchain industry in general, as well as the Blockchain networks on which the Portfolio Crypto Assets will rely, is subject to a high degree of uncertainty regarding consumer adoption and long-term development. The factors affecting the further development of Crypto Assets and the Crypto Asset industry, as well as Blockchain networks, include, without limitation:
worldwide growth in the adoption and use of Crypto Assets and other Blockchain technologies;
government and quasi-government regulation of Crypto Assets and their use, or restrictions on or regulation of access to and operation of Blockchain networks or similar systems;
the maintenance and development of the open-source software protocol of Blockchain networks;
the availability and popularity of other forms or methods of buying and selling goods and services, or trading assets including new means of using government-backed currencies or existing networks;
the extent to which current interest in Crypto Assets represents a speculative “bubble”;
general economic conditions in the United States and the world;
the regulatory environment relating to Crypto Assets and Blockchains; and
a decline in the popularity or acceptance of Crypto Assets or other Blockchain-based tokens.
Crypto Asset industries have been characterized by rapid changes and innovations and are constantly evolving. Although they have experienced significant growth in recent years, the slowing or stopping of the development, general acceptance and adoption and usage of Blockchain networks and Blockchain assets may negatively affect the value of Portfolio Crypto Assets and the Shares.
For example, in November 2022, FTX and several of its affiliates filed for bankruptcy. Even if there is no direct material impact on our business from such bankruptcies, we have been and may continue to be impacted indirectly. Following these events, users’ confidence in trading of cryptocurrency has decreased and the crypto asset market has experienced negative publicity and extreme price volatility. These events have negatively impacted a number of other entities in the crypto asset industry as well as the liquidity of certain crypto assets. Continued price volatility, as well as negative publicity and a lack of standardized regulation in the crypto asset market, has negatively affected and may continue to negatively affect several other entities in the crypto asset industry and overall crypto market confidence. Such decrease in confidence in crypto assets has had and may continue to have a negative impact on our business. If the liquidity of the crypto asset markets continues to be negatively impacted by these events, crypto asset prices may continue to experience significant volatility and confidence in crypto asset markets may be further undermined. These events are continuing to develop and it is not possible to predict at this time all of the risks that they may pose to us or on the crypto asset industry as a whole.
In addition, the creation of Crypto Assets as a medium of exchange is not the sole purpose of some networks on which Portfolio Crypto Assets are used. The Ethereum network, for example, is a digital decentralized ledger protocol that powers smart contracts. The differing focus of any such Crypto Asset could affect its growth and acceptance by users, which may negatively affect its expansion and an investment in the Shares.
The Blockchain network on which ownership and transfer of Portfolio Crypto Assets are recorded utilizes code that is subject to change at any time. These changes may negatively affect the value of the Portfolio Crypto Assets and the Shares.
In addition to the aforementioned risks regarding development and acceptance of Blockchain networks or the price of Blockchain assets that may negatively affect the Blockchain networks that record ownership of the Portfolio Crypto Assets, other changes such as upgrades to these Blockchains, Hard Forks, or a change in how transactions are confirmed on these Blockchains may have unintended, adverse effects. These changes may occur at any time and may cause problems with the Blockchain networks that record the ownership of the Portfolio Crypto Assets. Any such changes could, as a result, negatively affect the value of the Portfolio Crypto Assets and the Shares.
Changes in the governance of a Crypto Asset's Blockchain network may not receive sufficient support from users, Validators and/or Miners, which may negatively affect that Blockchain network’s ability to grow and respond to challenges.
The governance of decentralized networks, such as the Bitcoin network, is by voluntary consensus and open competition. As a result, there may be a lack of consensus or clarity on the governance of any particular decentralized Crypto Asset network, which may stymie such network’s utility and ability to grow and face challenges. The foregoing notwithstanding, the protocols for some decentralized Crypto Asset networks, such as the Bitcoin network, are informally managed by a group of core developers that propose amendments to the relevant network’s source code. Core developers’ roles evolve over time, largely based on self-determined participation. If a significant majority of users and Validators or Miners adopt amendments to a decentralized network based on the proposals of such core developers, such network will be subject to new protocols that may adversely affect the value of the relevant Crypto Asset. As a result of the foregoing, it may be difficult to find solutions or marshal sufficient effort to overcome any future problems, especially long-term problems, on Crypto Asset networks. This could, in turn, have a materially negative effect on the value of the Portfolio Crypto Assets and the Shares.
The long-term viability of Crypto Assets is unknown, and this could negatively impact the value of Crypto Assets.
Crypto Assets are a new and relatively untested product. There is considerable uncertainty about their long-term viability, which could be affected by a variety of factors, including many market-based factors such as economic growth, inflation, and others. In addition, the success of Crypto Assets will depend on the long-term utility and economic viability of Blockchain and other new technologies related to Crypto Assets. Due in part to these uncertainties, the price of Crypto Assets is volatile and Crypto Assets may be hard to sell. The Trust and the Sponsor do not control any of these factors, and therefore may not be able to control the ability of any Crypto Asset to maintain its value.
The growth of this industry in general, and the use of Crypto Assets in particular, are subject to a high degree of uncertainty. The factors affecting the further development of this industry, as well as the Trust, include:
continued worldwide growth in the adoption and use of Crypto Assets;
general economic conditions, as well as government and quasi-government regulation of Crypto Assets and their use, or restrictions on or regulation of access to and operation of Crypto Asset trading systems;
changes in consumer demographics and public preferences;
the availability and popularity of other forms or methods of buying and selling goods and services, including new means of using government-issued currencies; and
negative consumer sentiment and perception of Crypto Assets.
Blockchain networks face significant scaling challenges and efforts to increase the volume of transactions may not be successful.
Many Blockchains face significant scaling challenges due to the fact that public Blockchains generally face a tradeoff regarding security and scalability. One means through which public Blockchains achieve security is decentralization, meaning that no intermediary is responsible for securing and maintaining these systems. For example, a greater degree of decentralization generally means a given Blockchain is less susceptible to manipulation or capture. In practice, this typically means that every single node on a given Blockchain is responsible for securing the system by processing every transaction and maintaining a copy of the entire state of the network. As a result, a Blockchain may be limited in the number of transactions it can process by the capabilities of each single fully participating node, and in an effort to increase the volume of transactions that can be processed on a given Blockchain, many Blockchains are being upgraded with various features to increase the speed and throughput of Crypto Asset transactions.
As corresponding increases in throughput lag behind growth in the use of Blockchain networks, average fees and/or settlement times may increase considerably. For example, the number of transactions on the Bitcoin and Ethereum network has previously led to increased transaction fees. Increased fees and decreased settlement speeds could preclude certain uses for Crypto Assets (e.g., micropayments), and could reduce demand for, and the price of, Crypto Assets, which could adversely impact the value of the Shares.
Many developers are actively researching and testing scalability solutions for public Blockchains that do not necessarily result in lower levels of security or decentralization. However, there is no guarantee that any of the mechanisms in place or being explored for increasing the scale of settlement of the Bitcoin Network and Ethereum Network transactions will be effective, or how long these mechanisms will take to become effective, which could adversely impact the value of the Shares.
Security threats could result in a loss of the Trust’s Crypto Assets and adversely affect an investment in the Trust.
Security breaches, computer malware and computer hacking attacks have been a prevalent concern in the Crypto Asset exchange markets. Any security breach caused by hacking, which involves efforts to gain unauthorized access to information or systems, or to cause intentional malfunctions or loss or corruption of data, software, hardware or other computer equipment, and the inadvertent transmission of computer viruses, could harm the Trust’s operations or result in loss of the Trust’s Crypto Assets. Any breach of the Sponsor’s infrastructure could result in damage to its reputation which could adversely affect an investment in the Trust. Furthermore, as the Trust’s assets grow, it may become a more appealing target for security threats such as hackers and malware.
The security system and operational infrastructure may be breached due to the actions of outside parties, error or malfeasance of an employee of the Sponsor, or otherwise, and, as a result, an unauthorized party may obtain access to the Sponsor’s private keys, data or Portfolio Crypto Assets. Additionally, outside parties may attempt to fraudulently induce employees of the Sponsor to disclose sensitive information in order to gain access to the Sponsor’s infrastructure. As the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently, or may be designed to remain dormant until a predetermined event and often are not recognized until launched against a target, the Sponsor may be unable to anticipate these techniques or implement adequate preventative measures. If an actual or perceived breach of the Sponsor’s security system occurs, the market perception of the effectiveness of the Sponsor’s security system could be harmed, which could adversely affect an investment in the Trust.
In the event of a security breach, the Sponsor or the Trust may be forced to cease operations, or suffer a reduction in assets, the occurrence of each of which could adversely affect an investment in the Trust.
Crypto Assets are subject to volatile price fluctuations which can impact investments in the Trust.
Prices of Crypto Assets have fluctuated widely for a variety of reasons including uncertainties in government regulation and may continue to experience significant price fluctuations. Since the inception of the Trust, volatility has had a significant impact on the fair market value of the Portfolio Crypto Assets, to date resulting in a large positive change in the Trust’s net realized and unrealized gain on investment in Crypto Assets, but also periods of significant negative changes. For example, the average price of Bitcoin, the Trust’s primary Portfolio Crypto Asset, increased from an average of $8,119.40 a Bitcoin during the period from November 22, 2017 (the inception of the Trust) to December 31, 2018 to an average of $11,107.74 a Bitcoin during the period from January 1, 2020 to December 31, 2020 to an average of $47,422.06 a Bitcoin during the period from January 1, 2021 to December 31, 2021 to an average of $28,197.75 per Bitcoin during the period from January 1, 2022 to December 31, 2022 to an average of $28,836.24 per Bitcoin during the period from January 1, 2023 to December 31, 2023. There can be no assurance, however, that ongoing volatility will continue to positively impact the value of the Portfolio Crypto Assets. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Historical Portfolio Crypto Asset Prices.”
Several factors may affect the price of Crypto Assets, including:
Total Crypto Assets in existence;
Global Crypto Assets supply and demand;
Currency exchange rates;
Interest rates;
Crypto Asset market fragmentation and consolidation;
Fiat currency withdrawal and deposit policies of Crypto Asset exchanges and liquidity of such exchanges;
Interruptions in service from or failure of major Crypto Asset exchanges;
Cyber theft of Crypto Assets from online Crypto Asset wallet providers, or news of such theft from such providers, or theft from individual Crypto Asset wallets;
Investment and trading activities of hedge funds and other large Crypto Asset investors;
Regulatory measures, if any, that restrict or facilitate the ability to buy, sell or hold Crypto Assets or use Crypto Assets as a form of payment;
Availability and popularity of businesses that provide Crypto Asset-related services;
Maintenance and development of the open-source software protocol of the Crypto Asset network;
Increased competition from other forms of Crypto Assets or payments services;
Global or regional political, economic or financial events and uncertainty;
Manipulative trading activity on Crypto Asset exchanges, which are largely unregulated;
The adoption of such Crypto Assets as a medium of exchange, store-of-value or other consumptive asset and the maintenance and development of the open-source software protocol of the applicable Crypto Asset;
Forks in the applicable Crypto Asset network;
Consumer preferences and perceptions of such Crypto Asset specifically and Crypto Assets generally;
An active derivative market for such Crypto Asset or for Crypto Assets generally;
Fees associated with processing a transaction of such Crypto Asset and the speed at which such transactions are settled;
Decreased confidence in Crypto Asset exchanges due to the unregulated nature and lack of transparency surrounding the operations of Crypto Asset exchanges; and
The failure or bankruptcy of infrastructure providers to the Crypto Asset ecosystem, including miners, banks, trading firms, prime brokerages, lending firms and other service providers.
If Crypto Asset markets continue to be subject to sharp fluctuations, Shareholders may experience losses as the value of the Trust’s investments declines. Even if Shareholders are able to hold their Shares in the Trust for the long-term, their Shares may never generate a profit, since Crypto Asset markets have historically experienced extended periods of flat or declining prices, in addition to sharp fluctuations. In addition, Shareholders should be aware that there is no assurance that Crypto Assets will maintain their long-term value in terms of future purchasing power.
If a Shareholder contributes to the Trust in Crypto Assets, the number of Shares the Shareholder ultimately receives will depend on the value of the Crypto Assets at the time of admission to the Trust. Shareholders are admitted periodically. There may be considerable differences in the value of a Crypto Asset from the time the Crypto Asset is contributed by a Shareholder to the Trust (or its agent) and the time the Crypto Asset is valued for purposes of determining the number of Shares received. For the avoidance of doubt, if the value of a Crypto Asset declines after a Shareholder contributes the Crypto Asset and before the Crypto Asset is valued, the number of Shares the Shareholder receives may decline, potentially significantly. All Crypto Assets will be valued in accordance with the Trust’s valuation policies and procedures at the time of the valuation. The functional currency of the Trust is U.S. dollars.
Transactions in Crypto Assets may be irreversible even if they are fraudulent or accidental transactions.
Transactions in Crypto Assets may be irreversible, and, accordingly, losses due to fraudulent or accidental transactions may not be recoverable. If there is an error and a transaction occurs with the wrong account, to the extent that the Trust is unable to seek a corrective transaction with such third party or is incapable of identifying the third party which has received the Crypto Assets through error or theft, the Trust will be unable to revert or otherwise recover incorrectly transferred Crypto Assets. To the extent that the Trust is unable to seek redress for such error or theft, such loss could result in the total loss of a Shareholder’s investment in the Trust.
The Shareholder is solely responsible for providing the Trust or its agent with accurate information with respect to its digital wallet and sending the Shareholder’s contributions to the Trust’s correct digital wallet address. If a Shareholder’s contributions are sent to the wrong wallet address or are not delivered to the Trust, the Trust will have no liability to the Shareholder. If information provided by a Shareholder proves incorrect, and as a result, Crypto Assets are not delivered to the Trust, the Trust will have no liability to the Shareholder for the Trust’s good faith reliance on such misinformation.
The market for Crypto Assets is characterized by shallow trade volumes, extreme hoarding, low liquidity and high bankruptcy risk.
By some comparisons, the market for Crypto Assets, by trade volume, is very shallow. Many coins may also be hoarded by a few owners. Ownership concentration can be high, which creates greater market liquidity risk as large blocks of Crypto Assets are difficult to sell in a timely and market-efficient manner and well-connected customers can gain preferential treatment in order execution. The daily trade volume of Crypto Assets is a fraction of the total Crypto Assets mined. The lack of a robust and regulated derivatives market for most Crypto Assets means that market participants do not have a broad basket of tools at their disposal, making hedging difficult.
Crypto Assets can be subject to permanent loss due to unsecure local storage sites, malware and data loss.
Similar to fiat currencies, Crypto Assets are susceptible to theft, loss and destruction. Destruction of the physical media storing private keys can result in a total and permanent loss of the Crypto Asset from the market. While traditional financial products have strong consumer protections, there is no intermediary that can limit consumer loss in connection with Crypto Assets.
Certain Crypto Assets may rely on a public or third-party Blockchain and the success of such Blockchain may have a direct impact on the success and value of Crypto Assets held by the Trust.
Some Crypto Assets are built on existing third-party Blockchains and are partly dependent on the effectiveness and success of such Blockchains, as well as the success of other Blockchain and decentralized data storage systems that are being used by the issuer of the Crypto Assets. There is no guarantee that any of these systems or their sponsors will continue to exist or be successful. This could lead to disruptions in the operations of the Trust and could negatively affect the Shares.
Crypto Assets held by the Trust may be negatively affected by technological advances that undermine the cryptographic consensus mechanism underpinning Blockchain and distributed ledger protocols.
Advances in cryptography or technical advances such as the development of quantum computing could present risks to the viability of Crypto Assets and the Trust by undermining or vitiating the cryptographic consensus mechanism that underpins Blockchain and distributed ledger protocols. Similarly, legislatures and regulatory agencies could prohibit the use of current and/or future cryptographic protocols which could limit the use of Crypto Assets, resulting in a significant loss of value of the Shares.
The value of Crypto Assets may be subject to momentum pricing and therefore, an inaccurate valuation.
Momentum pricing typically is associated with growth stocks and other assets whose valuation, as determined by the investing public, accounts for anticipated future appreciation in value. The price of a Crypto Asset is determined primarily using data from various currency exchanges, over-the-counter markets, and derivative platforms. Momentum pricing of Crypto Assets has resulted, and may continue to result, in speculation regarding future appreciation in the value of Crypto Assets, thereby inflating and making the price of such Crypto Assets more volatile. Crypto Assets that lead the market are subject to even more speculation. Generally, the Trust tracks the Index and therefore largely invests in the top 10 Crypto Assets in the Crypto Asset market and therefore is susceptible to increased price fluctuations in part from momentum pricing.
The Sponsor is solely responsible for determining the value of Portfolio and Shares in accordance with the Trust Agreement, and any errors, discontinuance or changes in such valuation calculations may have an adverse effect on the value of the Shares.
The Sponsor will determine the value of the Trust’s assets and Share price in accordance with the terms of Article 6 of the Trust Agreement. The Sponsor has not engaged a third-party calculation agent. The Sponsor calculates the price and sends it to Theorem Trust Fund Services LLC which then uses that information to calculate the NAV. The NAV of the Trust is calculated by summing the assets and liabilities and the NAV Per Share is calculated by dividing the total NAV by the shares outstanding. To the extent that these calculations are not made correctly, the Sponsor may not be liable for any error and such misreporting of valuation data could adversely affect the value of the Shares.
The value of the Trust’s Crypto Assets is dependent, directly or indirectly, on prices established by Crypto Asset exchanges and other Crypto Asset trading venues, which are new and, in most cases, largely unregulated.
Crypto Asset exchanges and other trading venues on which Crypto Assets trade are relatively new and, in most cases, largely unregulated and may therefore be more exposed to fraud and failure than established, regulated exchanges for securities, derivatives and other currencies. Much of the daily trading volume of Crypto Assets is conducted on poorly capitalized, unregulated, unaudited and unaccountable exchanges located outside of the United States where there is little to no regulation governing trading. Such exchanges may engage in unethical practices that may have a significant impact on Crypto Asset pricing, such as front-running, wash trades and trading with insufficient funds. To the extent that the Crypto Asset exchanges or other Crypto Asset trading venues are involved in fraud or experience security failures or other operational issues, this could result in a reduction in the Crypto Asset market prices and adversely affect an investment in the Trust. The SEC, in March 2017, stated that Crypto Asset exchanges currently lack the ability to enter into surveillance-sharing agreements with significant, regulated markets for trading in Crypto Assets thereby lacking the ability to detect and deter price manipulation. Although there has been improvement on this front with the self-certification of certain Bitcoin futures contracts resulting in information sharing agreements between certain futures markets and several Crypto Asset exchanges, regulators still lack the ability to surveil many Crypto Asset exchanges. In addition, users transacting on Crypto Asset trading platforms do not receive many of the market protections that they would when transacting through broker-dealers on registered securities exchanges or alternative trading systems, such as best execution, prohibitions on front running, short sale restrictions, and custody and capital requirements.
During the past few years, a number of Crypto Asset exchanges have been closed due to fraud, business failure or security breaches. In many of these instances, the customers of the closed Crypto Asset exchanges were not compensated or made whole for the partial or complete losses of their account balances in such Crypto Asset exchanges.
Crypto Asset prices on public Crypto Asset exchanges have been volatile and subject to influence by many factors including the levels of liquidity on the exchanges specifically and on the Crypto Asset exchange market generally. Even the largest exchanges have been subject to operational interruption (e.g., thefts of Crypto Assets from operational or “hot” wallets, suspension of trading on exchanges due to distributed denial of service attacks by hackers and/or malware and bankruptcy proceedings or cessation of services by exchanges), limiting the liquidity of Crypto Assets on the affected Crypto Asset exchange and resulting in volatile prices and a reduction in confidence in the Crypto Asset exchange market generally. The price of Crypto Assets on public exchanges may also be impacted by policies on or interruptions in the deposit or withdrawal of fiat currency into or out of larger Crypto Asset exchanges.
On large Crypto Asset exchanges, users may buy or sell Crypto Assets for fiat currency or transfer Crypto Assets to other wallets. Operational limits (including regulatory, exchange policy or technical or operational limits) on the size or settlement speed of fiat currency deposits by users into Crypto Asset exchanges may (1) reduce demand on such exchanges, resulting in a reduction in the Crypto Asset price on such exchange or (2) reduce supply on such exchanges, potentially resulting in a temporary increase in the Crypto Asset price on such exchange during the existence of such operational limits. To the extent that fees for the transfer of Crypto Assets either directly or indirectly occur between Crypto Asset exchanges, the impact on Crypto Asset prices of operation limits on fiat currency deposits and withdrawals may be reduced by “exchange shopping” among Crypto Asset exchange users. For example, a delay in U.S. Dollar withdrawals on one site may temporarily increase the price on such site by reducing supply (i.e., sellers transferring Crypto Assets to another exchange without operational limits in order to settle sales more rapidly), but the resulting increase in price will also reduce demand because bidders on Crypto Assets will follow increased supply on other Crypto Asset exchanges not experiencing operational limits. To the extent that users are able or willing to utilize or arbitrage prices between more than one Crypto Asset exchange, exchange shopping may mitigate the short-term impact on and volatility of Crypto Asset prices due to operational limits on the deposit or withdrawal of fiat currency into or out of larger Crypto Asset exchanges.
These risks also apply to other Crypto Asset trading venues, including over-the-counter markets and derivatives platforms, which may be used by public Crypto Asset exchanges and therefore by the Sponsor in calculating the net asset value of the Trust.
The Trust is designed to have limited exposure to individual trading venue interruptions by using multiple data sources and liquidity providers. Despite efforts to ensure accurate pricing, the Trust, and the price of Crypto Assets generally, remains subject to volatility experienced by the Crypto Asset exchanges and other Crypto Asset trading venues. Such volatility can adversely affect an investment in the Trust. The value of Crypto Assets is also dependent on the availability of exchanges on which to buy and sell such assets. If exchanges for Crypto Assets became increasingly sparse, then there would be a material adverse impact on the value of Crypto Assets and an investment in the Trust.
The failure, closure or manipulation of Crypto Asset exchanges could adversely affect an investment in the Trust.
Instability in the Crypto Asset exchange market and the closure or temporary shutdown of Crypto Asset exchanges due to fraud, business failure, hackers, malware, or government-mandated regulation may reduce confidence in the Crypto Asset exchange market and result in greater volatility in Crypto Asset prices. Since the Index uses Crypto Asset prices published on public Crypto Asset exchanges, the failure, closure, or manipulation of such exchanges could adversely affect an investment in the Trust which relies on the Index for its investment strategy.
A temporary or permanent “fork” could adversely affect the value of the Shares.
Many Crypto Asset networks operate using open-source protocols, meaning that any user can download the software, modify it and then propose that the users, Validators and Miners of the Crypto Asset adopt the modification. When a modification is introduced and a substantial majority of users, Validators and Miners consent to the modification, the change is implemented, and the network remains uninterrupted. However, if less than a substantial majority of users and Miners consent to the proposed modification, and the modification is not compatible with the software prior to its modification, the consequence would be a Hard Fork, with one group running the pre-modified software and the other running the modified software. The effect of such a fork would be the existence of two versions of the Crypto Asset running in parallel, yet lacking interchangeability.
Forks may also occur as a network community’s response to a significant security breach. A fork may also occur as a result of an unintentional or unanticipated software flaw in the various versions of otherwise compatible software that users run. Such a fork could lead to users, Validators and Miners abandoning the Crypto Asset with the flawed software. It is possible, however, that a substantial number of users, Validators and Miners could adopt an incompatible version of the Crypto Asset while resisting community-led efforts to merge the two chains. This could result in a permanent fork.
Furthermore, a Hard Fork can lead to new security concerns, as a result of, for example, inherent decrease in the level of security due to significant amounts of Mining power (PoW) or stated capital (PoS) remaining on one network or migrating instead to the new forked network. After a Hard Fork, it may become easier for an individual Miner or Mining pool’s hashing power to exceed 50% of the processing power of the Crypto Asset network that retained or attracted less Mining power, thereby making Crypto Assets that rely on PoW more susceptible to attack. A future fork in the network of a Portfolio Crypto Asset could adversely affect the value of the Shares or the ability of the Trust to operate. In addition, after a Hard Fork, it may become easier for Validators to perform a 51% attack on the PoS Blockchain that retained or attracted less staked capital, thereby also making Crypto Assets that rely on PoS susceptible to attacks.
Banks may be reluctant to provide banking services, or may cut off banking services, to businesses that provide Crypto Asset-related services or that accept Crypto Assets as payment.
A number of companies that provide Crypto Asset-related services have found it difficult to find banks that are willing to provide them with bank accounts and banking services. Similarly, a number of such companies have had their existing bank accounts closed by their banks. Banks may refuse to provide bank accounts and other banking services to Crypto Asset-related companies or companies that accept Crypto Assets for a number of reasons, such as perceived compliance risks or costs. If the Sponsor or the Trust is unable to secure bank accounts or banking services, it could have a material adverse effect on the Sponsor’s ability to manage the Trust and the ability of the Trust to continue operations.
The impact of geopolitical events on the supply and demand for Crypto Assets is uncertain and may negatively impact investments in the Trust.
As an alternative to fiat currencies that are backed by central governments, Crypto Assets, which are relatively new, are subject to supply and demand forces based upon the desirability of an alternative, decentralized means of buying and selling goods and services, and it is unclear how such supply and demand will be impacted by geopolitical events. Nevertheless, political or economic crises, events and trends may motivate large-scale acquisitions or sales of Crypto Assets either globally or locally. Large-scale sales of Crypto Assets would result in a reduction in the value of Crypto Assets and adversely affect an investment in the Trust.
The further development and acceptance of the cryptographic and algorithmic protocols governing the issuance of and transactions in Crypto Assets, which represents a new and rapidly changing industry, is subject to a variety of factors that are difficult to evaluate.
The use of Crypto Assets to, among other things, buy and sell goods and services, is part of a new and rapidly evolving industry that employs Crypto Assets based upon a computer-generated mathematical and/or cryptographic protocol. The growth of this industry in general, and the use of Crypto Assets in particular, are subject to a high degree of uncertainty. Many networks are still in the process of developing and making significant decisions, such as decisions that will affect policies that govern the supply and issuance of their respective Crypto Assets.
The factors affecting the further development of the industry, include, but are not limited to:
Continued worldwide growth in the adoption and use of Crypto Assets;
Governmental and quasi-governmental regulation of Crypto Assets and their use, or restrictions on or regulation of access to and operation of Crypto Asset exchanges or similar Crypto Asset trading venues;
The maintenance and development of the open-source software protocol of Crypto Asset exchanges;
General economic conditions and the regulatory environment relating to Crypto Assets; and
Negative consumer sentiment and perception of Crypto Assets generally.
The slowing or stopping of the development or acceptance of these protocols may adversely affect an investment in the Trust.
In addition, the open-source structure of many Crypto Asset Network protocols means that developers and other contributors are generally not directly compensated for their contributions in maintaining and developing such protocols. As a result, the developers and other contributors of a particular Crypto Asset may lack a financial incentive to maintain or develop the network, or may lack the resources to adequately address emerging issues. Alternatively, some developers may be funded by companies whose interests are at odds with other participants in a particular network. A failure to properly monitor and upgrade the protocol of a particular Crypto Asset could damage that network, which could adversely affect the value of Portfolio Crypto Assets and the Shares.
In addition to forks, a Crypto Asset may become subject to an Airdrop. In an Airdrop, the promotors of a new Crypto Asset announce to holders of another Crypto Asset that such holders will be entitled to claim a certain amount of the new Crypto Asset for free, based on the fact that they hold such other Crypto Asset. Shareholders may not receive the benefits of any forks, and the Trust may not choose, or be able, to participate in an Airdrop. There may be operational, securities law, regulatory, legal and practical issues with accepting such assets. Additionally, laws, regulation or other factors may prevent Shareholders from benefiting from such forks or Airdrops. For example, it may be illegal to sell or otherwise dispose of such assets, or there may not be a suitable market into which such assets can be sold (immediately after the fork or Airdrop, or ever).
In the event of a Hard Fork of the network of a Crypto Asset held by the Trust, the Sponsor will use its discretion to determine which network should be considered the appropriate network for the Trust’s purposes, and in doing so may adversely affect the value of the Shares.
In the event of a Hard Fork affecting a Portfolio Crypto Asset, the Sponsor will use its discretion to determine, in good faith, which peer-to-peer network, among a group of incompatible forks of such network, is generally accepted as the network for such Crypto Asset and should therefore be considered the appropriate network for the Trust’s purposes. The Sponsor will base its determination on a variety of the relevant factors, including, but not limited to, the Sponsor’s beliefs regarding expectations of the core developers of such Crypto Asset, users, services, businesses, Miners or Validators and other constituencies, as well as the actual continued acceptance of, Mining power on or Validator participation in, and community engagement with, the network of such Crypto Asset. There is no guarantee that the Sponsor will choose the Crypto Asset that is ultimately the most valuable fork, and the Sponsor’s decision may adversely affect the value of the Shares as a result.
Any name change and any associated rebranding initiative by the core developers of a Portfolio Crypto Asset may not be favorably received by the Crypto Asset community, which could negatively impact the value of such Crypto Asset and an investment in the Shares.
From time to time, Crypto Assets may undergo name changes and associated rebranding initiatives or changes in how such assets are used. We cannot predict the impact of any name change and any associated rebranding initiative on the relevant Crypto Asset. After a name change and an associated rebranding initiative, a Crypto Asset may not be able to achieve or maintain brand name recognition or status that is comparable to the recognition and status previously enjoyed by such Crypto Asset. The failure of any name change and any associated rebranding initiative by a Crypto Asset may result in such Crypto Asset not realizing some or all of the anticipated benefits contemplated by the name change and associated rebranding initiative, and could negatively impact the value of the relevant Crypto Asset and an investment in the Shares.
The Trust’s investments in Portfolio Crypto Assets may be illiquid.
It may be difficult or impossible for the Trust to sell Portfolio Crypto Assets. Crypto Assets are also often difficult to value and market prices for Crypto Assets have experienced significant volatility in comparison to more liquid investments in other asset classes, such as equities. This could adversely affect the price at which the Trust is able to sell Portfolio Crypto Assets, if it is able to do so at all.
The Trust purchases Crypto Assets from various counterparties and if one of these counterparties were to become insolvent or otherwise default on its obligations to the Trust, it could result in financial loss and business disruption.
The Trust purchases Crypto Assets from approved counterparties that include exchanges, electronic trading systems that seek liquidity from multiple trading venues, and market making firms known as “over the counter” or “OTC” trading desks. The Trust faces the risk that one or more of its institutional counterparties may fail to fulfill their contractual obligations to the Trust. For example, it is possible that a counterparty would not settle a transaction in accordance with its terms and conditions because of a dispute over the terms of the contract (whether or not bona fide) or because of a credit or liquidity problem, thus causing the Trust to suffer a loss. Such “counterparty risk” is accentuated for Crypto Assets where the Trust has concentrated its transactions with a single or small group of counterparties. The Trust is not restricted from dealing with any particular counterparty or from concentrating any or all of its transactions with one counterparty. Moreover, the Trust has no internal credit function that evaluates the creditworthiness of its counterparties.
A counterparty may default on its obligations to the Trust for a number of reasons, such as changes in financial condition, a reduction in liquidity, operational failures, regulatory actions against the counterparty or insolvency. Counterparty defaults or limitations on their ability to do business with the Trust could result in financial losses or hamper the Trust’s ability to do business or manage the risks to its business. In addition, if the Trust is unable to replace a defaulting counterparty that performs services critical to the Trust’s business, it could adversely affect the Trust’s ability to conduct its operations. The ability of the Trust to transact business with any one or number of counterparties, the lack of any meaningful and independent evaluation of such counterparty’s financial capabilities and the absence of a regulated market to facilitate settlement may increase the potential for losses by the Trust.
Currently, there is limited use of Crypto Assets in the retail and commercial marketplace in comparison to relatively extensive use by speculators, thus contributing to price volatility that could adversely affect an investment in the Trust.
As relatively new technologies and products, Blockchain networks and their native Crypto Assets have only recently become selectively accepted as a means of payment for goods and services by certain commercial outlets, and the use of Crypto Assets by consumers to pay such retail and commercial outlets remains limited. Banks and other established financial institutions may refuse to process funds for Crypto Asset transactions; process wire transfers to or from Crypto Asset exchanges, Crypto Asset-related companies or service providers; or maintain accounts for persons or entities transacting in Crypto Assets. Conversely, a significant portion of Crypto Asset demand is generated by speculators and investors seeking to profit from the short- or long-term holding of Crypto Assets. Price volatility undermines Crypto Assets' role as a medium of exchange as retailers are much less likely to accept it as a form of payment. Market capitalization for Crypto Assets as a medium of exchange and payment method may always be low. A lack of expansion by Crypto Assets into retail and commercial markets, or a contraction of such use, may result in increased volatility which could adversely impact an investment in the Trust.
Risks Related to Bitcoin and Ethereum
In addition to the risks noted above regarding Crypto Assets in general, the following risk factors are specific to Bitcoin and Ethereum, the two primary Portfolio Crypto Assets held by the Trust.
Significant Bitcoin Network contributors could propose amendments to the Bitcoin Network’s protocols and software that, if accepted and authorized by the Bitcoin Network, could adversely affect an investment in the Trust.
A small group of individuals contribute to the Bitcoin Core project on Github. These individuals can propose refinements or improvements to the Bitcoin Network’s source code through one or more software upgrades that alter the protocols and software that govern the Bitcoin Network and the properties of Bitcoin, including the irreversibility of transactions and limitations on the Mining of new Bitcoin. Proposals for upgrades and discussions relating thereto take place on online forums.
To the extent that a significant majority of the users and Miners on the Bitcoin Network install such software upgrade(s), the Bitcoin Network would be subject to new protocols and software that may adversely affect an investment in the Trust. In the event a developer or group of developers proposes a modification to the Bitcoin Network that is not accepted by a majority of Miners and users, but that is nonetheless accepted by a substantial plurality of Miners and users, two or more competing and incompatible Blockchain implementations could result. This is known as a Hard Fork. In such a case, the Hard Fork in the Blockchain could materially and adversely affect the perceived value of Bitcoin as reflected on one or both incompatible Blockchains, and thus the value of the Trust’s Bitcoin.
Significant Ethereum Network contributors could propose amendments to the Ethereum Network’s protocols and software that, if accepted and authorized by the Ethereum Network, could adversely affect an investment in the Trust.
A small group of individuals contribute to the Ethereum code base on Github. These individuals can propose refinements or improvements to the Ethereum Network’s source code through one or more software upgrades that alter the protocols and software that govern the Ethereum Network and the properties of Ether.
For example, on June 17, 2016, a hacker began rapidly diverting Ether from the DAO, an unincorporated organization executed on the Ethereum Network, causing approximately 3.6 million ether—1/3 of the total ether raised by the DAO’s offering—to move from the DAO’s Ethereum Blockchain address to an Ethereum Blockchain address controlled by the hacker. Although the diverted Ether was then held in an address controlled by the hacker, the hacker was prevented by the DAO’s code from moving the ether from its address for 27 days.
To secure the diverted ether and return it to DAO Crypto Asset holders, the DAO’s founders and others endorsed a “hard fork” to the Ethereum Blockchain. The hard fork called for a change in the Ethereum protocol on a going forward basis that would restore the DAO Crypto Asset holders’ investments as if the hack had not occurred. On July 20, 2016, after a majority of the Ethereum Network adopted the necessary software updates, the new, forked Ethereum Blockchain became active.
A minority group, however, elected not to adopt the new Ethereum Blockchain created by the hard fork because to do so would run counter to the concept that a blockchain is immutable. Instead, they continued to use the former version of the blockchain, which is now known as “Ethereum Classic.”
During the DAO event, the price of ether was volatile and many users viewed the software update as contrary to the principles of a distributed system. While a majority of network and market participants supported the hard fork, it is possible that the hard fork could have affected the long-term viability of the Network and the price of ether. It is likely that additional changes to the Ethereum Network will be proposed, and such proposals could adversely affect the price of ether and investments in the Trust.
Significant changes to the Ethereum network’s core functionality and security mechanisms create significant execution and security risks. It is possible that during or after these upgrades, bad actors could attack and, if successful, manipulate the Blockchain in a manner that adversely affects an investment in the Trust. For example, Ethereum moved from a PoW to a PoS consensus mechanism as part of the Ethereum community’s strategy to scale the network and reduce its energy footprint.
A Blockchain’s consensus mechanism is a core aspect of its functionality and these types of significant changes introduce material execution risk where the potentially resulting emergence of any network vulnerabilities could have a material impact on the value of ether, which could adversely impact an investment in the Trust.
In 2023, the Ethereum Network transitioned from its PoW to PoS consensus mechanism. PoS networks use a consensus mechanism that requires users to stake their ETH to become Validators. As assets are staked in the network, a hack or theft could occur resulting in stolen staked Crypto Assets. Additionally, network centralization is a risk in PoS networks, which if achieved, could potentially permit bad actors to manipulate the Blockchain in a manner that adversely affects an investment in the Trust or the ability of the Trust to operate. Additionally, a coordinated attack on node infrastructure, if successful, could take a large amount of staked ETH offline, increasing the bad actors share of outstanding ETH. Any of these attack vectors could be exploited, and additional attack vectors could be discovered and exploited in the future, resulting in a reduction in the price of ether that could adversely impact an investment in the Trust.
There is no guarantee that any of the mechanisms in place or being explored for future implementation will be effective in achieving their eventual goal, or how long these mechanisms will take to become effective, which could adversely impact the value of ether that could adversely impact an investment in the Trust.
The open-source structure of the Bitcoin network and Ethereum network protocols means that the developers of the protocol are generally not directly compensated for their contributions in maintaining and developing the protocol. A failure to properly monitor and upgrade the protocols could damage the Bitcoin network and the Ethereum network and, in turn, an investment in the Trust.
The Bitcoin network and the Ethereum network operate based on open-source protocols maintained by developers, largely on the Bitcoin Core project on GitHub and on the Ethereum codebase on GitHub, respectively. As open source projects, Bitcoin and Ethereum are not represented by official organizations or authorities. As the Bitcoin network and Ethereum network are not sold and their uses do not generate revenues for developers, developers are generally not compensated for maintaining and updating the Bitcoin network and the Ethereum network. The lack of guaranteed financial incentive for contributors to maintain or develop the Bitcoin network and the Ethereum network, and the lack of guaranteed resources to effectively address emerging issues with the Bitcoin network and the Ethereum network, may reduce incentives to address the issues adequately or in a timely manner. This may adversely affect an investment in the Trust.
If a malicious actor obtains control in excess of fifty (50) percent of the processing power (or aggregate hashrate) active on the Bitcoin Network, it is possible that such actor could manipulate the Blockchain in a manner that adversely affects an investment in the Trust.
If a malicious actor obtains a majority of the processing power (referred to herein as “Aggregate Hashrate”) dedicated to Mining on the Bitcoin Network, it will be able to exert unilateral control over the addition of blocks to these Blockchains. As long as the malicious actor enjoys this majority it may be able to “double-spend” its own Crypto Asset (i.e., spend the same Crypto Asset in two or more conflicting transactions) as well as prevent the confirmation of other Crypto Asset transactions. If such a scenario were to materialize, it could adversely affect an investment in the Trust or the ability of the Trust to operate.
In 2014, a specific Mining pool approached and appeared to briefly exceed the threshold of fifty (50) percent of the Aggregate Hashrate on the Bitcoin Network. Reports about this incident indicate that such a threshold was surpassed for only a short period, and there are no reports of any malicious activity by the Mining pool. Furthermore, pool participants appear to have redirected their hashrate in the Mining pool to other pools on a voluntary basis, which is customary when a Mining pool exceeds forty (40) percent of the Aggregate Hashrate on the Bitcoin Network. Nevertheless, the approach to and possible crossing of the fifty (50) percent threshold indicate a greater risk that a single Mining pool could exert authority over the validation of Bitcoin transactions.
To the extent that the Bitcoin ecosystem, contributors and the administrators of Mining pools, do not act to ensure greater decentralization of Bitcoin Mining Aggregate Hashrate, the feasibility of a malicious actor obtaining in excess of fifty (50) percent of the Aggregate Hashrate on the Bitcoin (e.g., through control of a large Mining pool or through hacking such a Mining pool) will increase, which may adversely impact an investment in the Trust.
Additionally, there are some academics and market participants who believe the applicable threshold required to exert authority over the Bitcoin Network could be less than fifty (50) percent, which would increase the chances of a malicious actor exerting authority over the Bitcoin Network.
If a malicious actor obtains control in excess of fifty (50) percent of the staked ether on the Ethereum Network, it is possible that such actor could manipulate the Blockchain in a manner that adversely affects an investment in the Trust.
If a malicious actor obtains a majority of the staked ether on the Ethereum Network, it will be able to exert unilateral control over the addition of blocks to the Blockchain. As long as the malicious actor enjoys this majority it may be able to “double-spend” its own ether (i.e., spend the same ether in two or more conflicting transactions) as well as prevent the confirmation of other transactions. If such a scenario were to materialize, it could adversely affect an investment in the Trust or the ability of the Trust to operate.
Control over 51% staked ether becomes more feasible as the price of the Crypto Asset declines. Moreover, to the extent that the Ethereum ecosystem, validators, and developers do not act to ensure greater decentralization of staking, the feasibility of a malicious actor obtaining in excess of fifty (50) percent of the staked ether on the Ethereum Network will increase, which may adversely impact an investment in the Trust.
If the award of bitcoin for solving blocks and the transaction fees for recording transactions are not sufficiently high to incentivize Miners, Miners may cease expending hashrate to solve blocks and confirmations of transactions on the Blockchain could be slowed temporarily. A reduction in the hashrate expended by Miners on the network could also increase the likelihood of a malicious actor obtaining control in excess of fifty (50) percent of the Aggregate Hashrate active on the network, potentially permitting such actor to manipulate the Blockchain in a manner that adversely affects an investment in the Trust or the ability of the Trust to operate.
As the amount of new bitcoin rewarded for solving blocks declines, and if the transaction fees are not sufficiently high, Miners may not have an adequate incentive to continue Mining and may cease their Mining operations. The current fixed reward for solving a new block is six and one quarter (6.25) Bitcoin per block; the reward decreased from twelve and a half (12.5) Bitcoin in May 2020. It is estimated that it will halve every four years until the year 2140. This recent reduction in rewards, as well as future halvings, may result in a reduction in the Aggregate Hashrate of the Bitcoin network as the incentive for Miners may decrease. This would adversely affect the confirmation process for transactions(i.e., temporarily decreasing the speed at which blocks are added to the Blockchain until the next scheduled adjustment in difficulty for block solutions) and make the networks more vulnerable to a malicious actor obtaining control in excess of fifty (50) percent of the Aggregate Hashrate on the Bitcoin Network.
Periodically, the Bitcoin Network has adjusted the difficulty of solving blocks so that transaction processing speeds remain in the vicinity of the expected ten (10) minute confirmation time targeted by the Bitcoin Network protocol.Still, any reduction in confidence in the confirmation process or Aggregate Hashrate of the Bitcoin Network may negatively impact the value of bitcoin, which will adversely impact an investment in the Trust.
If the rewards of ether associated with proposing and validating blocks of transactions are not sufficiently high to incentivize validators, validators may cease to stake ether. A reduction in the number of ether staked and/or participating validators on the Ethereum Network could increase the likelihood of a malicious actor obtaining control in excess of fifty (50) percent of the staked ether on the Ethereum network, potentially permitting such actor to manipulate the Blockchain in a manner that adversely affects an investment in the Trust, or the ability of the Trust to operate.
If the rewards of ether associated with proposing and validating blocks of transactions are not sufficiently high to incentivize validators, validators may cease to stake ether. Prior to Ethereum’s transition from a proof of work to a proof of stake Blockchain (in an upgrade known as The Merge, which was implemented on September 15, 2022), the fixed reward for solving a new block was three (3) ether per block. Prior to that (specifically before October 2017) the reward was five (5) ether.
After The Merge was implemented in September 2022, the issuance rate dropped over 75% from its previous three (3) ether per block reward. The issuance rate is no longer fixed and now varies on how much of the total ether supply is staked. An increase in staked ether may disincentivize more stakers to participate due to lower rewards. However, a reduction in staked ether will increase staking rewards which may, in turn, incentivize more staking participation. Staking rewards are also impacted by how much network participants are willing to pay in priority fees (or tips) to prioritize the processing of their transactions. Priority fees may increase during periods of high network activity.
A reduction in the number of validators and/or the amount of staked ether on the Ethereum Network could increase the likelihood of a malicious actor obtaining control in excess of fifty (50) percent of the staked ether on the Ethereum network, potentially permitting such actor to manipulate the Blockchain in a manner that adversely affects an investment in the Trust or the ability of the Trust to operate. Additionally, a decline in the number of validators on the Ethereum Network and/or in the number of ether staked could result in a reduction in confidence in security and long term viability of the Ethereum network, which may negatively impact the value of ether, and, in turn, could adversely impact an investment in the Trust.
As the number of bitcoin awarded for solving a block in the Blockchain decreases, the incentive for Miners to continue to contribute hashrate to the Bitcoin Network will likely transition from the block reward to transaction fees. Either the requirement from Miners of higher transaction fees in exchange for recording transactions in the Blockchain or a potential change to the Bitcoin Network protocol to increase Miner compensation could impede its adoptions for transactions, such as with retail merchants and commercial businesses, resulting in a potential reduction in the price of Bitcoin that could adversely impact an investment in the Trust .
In order to incentivize Miners to continue to contribute hashrate to the Bitcoin Network, the Bitcoin Network may either formally or informally increase transaction fees earned upon solving for a block. This transition could be accomplished by Miners independently electing to record in the blocks they solve only those transactions that include payment of a transaction fee. However it might come about, if transaction fees required for Bitcoin transactions become too high, the marketplace may be reluctant to accept Bitcoin as a means of payment and existing users may be motivated to switch from Bitcoin to another Crypto Asset or back to fiat currency. Decreased use and demand for Bitcoin or viability for processing transactions may adversely affect their value and result in a reduction in the price of the Shares.
To the extent that the profit margins of Bitcoin Mining operations are low, operators of Bitcoin Mining operations are more likely to immediately sell Bitcoin earned by Mining, resulting in a reduction in the price of Bitcoin that could adversely impact an investment in the Trust.
Over the past two several years, Bitcoin Network Mining operations have evolved from individual users Mining with computer processors, to graphics processing units and first-generation application-specific integrated circuit processors (“ASICs”). Currently, new hashrate brought onto the Bitcoin Network is predominantly added by incorporated and unincorporated “professionalized” Mining operations. Professionalized Mining operations may use proprietary, sophisticated hardware like customized ASICs. Mining requires an investment of significant capital and expertise to acquire this hardware, the leasing of operating space (often in data centers or warehousing facilities), incurring of electricity costs and the employment of technicians to operate the Mining farms. As a result, professionalized Mining operations are of a greater scale than prior Bitcoin Network Miners and have more defined, regular expenses and liabilities. These regular expenses and liabilities may require professionalized Mining operations to more immediately sell Bitcoin earned from Mining operations on one of the various Bitcoin exchanges (each a “Bitcoin Exchange” and collectively, the “Bitcoin Exchange Market”), whereas it is believed that individual Miners in past years were more likely to hold newly mined Bitcoin for more extended periods. The immediate selling of newly mined Bitcoin may increase the supply of Bitcoin on the Bitcoin Exchange Market in a material way, potentially creating downward pressure on the price of Bitcoin.
The extent to which the value of Bitcoin mined by a professionalized Mining operation exceeds the operating costs determines the profit margin of such operation. A professionalized Mining operation may be more likely to sell a higher percentage of its newly mined Bitcoin rapidly if it is operating at a low profit margin—and it may partially or completely cease operations if its profit margin is negative. In a low profit margin environment, a higher percentage could be sold into the Bitcoin Exchange Market more rapidly, thereby potentially reducing Bitcoin prices. Lower
Bitcoin prices could result in further tightening of profit margins, particularly for professionalized Mining operations with higher costs and more limited capital reserves, creating a knock-on effect that may further reduce the price of Bitcoin until Mining operations with higher operating costs become unprofitable and remove Mining power from the Bitcoin Network. The knock-on effect of reduced profit margins resulting in greater sales of newly mined Bitcoin could result in a reduction in the price of Bitcoin that could adversely impact an investment in the Trust.
The acceptance of Bitcoin Network software patches or upgrades by a significant, but not complete, percentage of the users and Miners in the Bitcoin Network could lead to a Hard Fork in the Blockchain, resulting in the operation of two separate and incompatible networks. The temporary or permanent existence of forked Blockchains could adversely impact an investment in the Trust.
Bitcoin is an open source project and, although there is an influential group of contributors in the Bitcoin community, there is no designated developer or group of developers who formally control the Bitcoin Network. Any individual can download the Bitcoin Network software and make any desired modifications, which are proposed to users and Miners on the Bitcoin Network through modifications typically posted to the Bitcoin development forum on GitHub. A substantial majority of Miners and Bitcoin users must affect those software modifications; otherwise, such Miners and Bitcoin users would become substantially less relevant to the overall Bitcoin Network. A developer or group of developers could potentially propose a modification to the Bitcoin Network that is not accepted by a vast majority of Miners and users, but that is nonetheless accepted by a substantial plurality of Miners and users. In such a case, and if the modification is not compatible with the dominant implementation of Bitcoin Network software, a Hard Fork in the Blockchain could develop, and two separate Bitcoin Networks could result, one running the pre-modification software program and the other running the modified version (i.e., a second “Bitcoin Network”). A Bitcoin network fork of this kind could materially and adversely affect the perceived value of Bitcoin as reflected on one or both incompatible Blockchains.
In the event of an upcoming modification to the Bitcoin Network that could potentially result in a Hard Fork with two separate and incompatible Bitcoin Networks, the Sponsor maintains full discretion to elect which Bitcoin Network to support. However, it is anticipated that the Sponsor will elect to support the Bitcoin Network that has the greatest cumulative computational difficulty for the forty-eight (48) hour period following a given Hard Fork, in order to engage in Bitcoin transactions and the valuation of Bitcoin. Resignations may be halted during this period. The greatest cumulative computational difficulty is defined as the total threshold number of hash attempts required to mine all existing blocks in the respective Blockchain, accounting for potential differences in relative hash difficulty. [1]
If, at or after the time of such election, users’ and Miners’ support of the selected Bitcoin Network diminishes, this could adversely affect the value of the Trust’s Bitcoin and the value of an investment in the Trust.
The acceptance of Ethereum Network software patches or upgrades by a significant, but not overwhelming, percentage of the users and validators in the Ethereum Network could result in a “hard fork” in the Blockchain, resulting in the operation of two separate and incompatible networks until such time as the forked Blockchains are merged, if ever. The temporary or permanent existence of forked Blockchains could adversely impact an investment in the Trust.[2]
Ethereum is an open-source project and, although there is an influential group of contributors in the Ethereum community, there is no designated developer or group of developers who formally control the Ethereum Network. Any individual can download the Ethereum Network software and make any desired modifications, which are proposed to users and validators on the Ethereum Network through modifications typically posted to the Ethereum development forum on GitHub. A substantial majority of validators and ether users must affect those software modifications; otherwise, such validators and Ethereum users would become substantially less relevant to the overall Ethereum Network. A developer or group of developers could potentially propose a modification to the Ethereum Network that is not accepted by a vast majority of validators and users, but that is nonetheless accepted by a substantial plurality of validators and users. In such a case, and if the modification is not compatible with the dominant implementation of Ethereum Network software, a deviation or “hard fork” in the Blockchain could develop, and two separate Ethereum Networks could result, one running the pre-modification software program and the other running the modified version (i.e., a second “Ethereum Network”). An Ethereum Network fork of this kind could materially and adversely affect the perceived value of ether as reflected on one or both incompatible
Blockchains. For more information on past Ethereum forks, see the discussion regarding the DAO under the risk factor titled “Significant Ethereum Network contributors could propose amendments to the Ethereum Network’s protocols and software that, if accepted and authorized by the Ethereum Network, could adversely affect an investment in the Trust.”
In the event of an upcoming modification to the Ethereum Network that could potentially result in a hard fork with two separate and incompatible Ethereum Networks, the Sponsor maintains full discretion to elect which Ethereum Network to support. However, it is anticipated that the Sponsor will elect to support the Ethereum Network that has the greatest cumulative computational difficulty for the forty-eight (48) hour period following a given hard fork, in order to engage in ether transactions and the valuation of ether. Resignations may be halted during this period.
If, at or after the time of such election, users’ and validators’ support of the selected Ethereum Network diminishes, this could adversely affect the value of the Trust’s ether and the value of an investment in the Trust.
The Value of Shares in the Trust relates directly to the value of bitcoin and ether held by the Trust, and fluctuations in the price of bitcoin and ether could adversely affect an investment in the Trust.
The value of the Shares in the Trust is directly related to the value of the amount of bitcoin and ether held by the Trust. The prices of bitcoin and ether have fluctuated widely since the Crypto Assets were introduced in 2008 and 2015, respectively. Several exchange-related factors may affect the prices of bitcoin and ether, including:
Demand from people willing to acquire bitcoin and ether in the market, which is influenced by the growth of trading activity in the network, the amount of fees collected on network trading activity, the value derived from users being able to exert governance over the network, the expectation among participants that the value of the network will change, among other factors;
Supply from people willing to dispose of bitcoin and ether in the market, which is influenced by similar factors as the demand for acquiring Crypto Assets in the market in addition to the supply of new bitcoin and ether that are brought to the market according to the relevant protocol’s supply schedule;
Service availability on Crypto Asset Exchanges, such as but not limited to, fiat currency withdrawal and deposit policies, interruption in service for technical failure or strong market imbalances, and cyber theft or news of such theft;
Manipulative trading activity on Crypto Asset Exchanges, which are largely unregulated;
Investment and trading activities of large investors, including private and registered funds, that may directly or indirectly invest in bitcoin, ether or other Crypto Assets that utilize either Crypto Asset’s Blockchain;
Regulatory developments, if any, that restrict the use of the Bitcoin or the Ethereum network or the purchase of bitcoin or ether in the market;
The maintenance and development of the open-source software code of the Bitcoin or the Ethereum network; and
Increased competition from other platforms that allow users to program and execute smart contracts, including potential forks of the Bitcoin or Ethereum networks.
If ether and bitcoin markets continue to be subject to sharp fluctuations, investors may experience losses as the value of the Trust’s investments decline. Even if investors are able to hold their Shares in the Trust for the long-term, their Shares may never generate a profit, since Crypto Asset markets have historically experienced extended periods of flat or declining prices, in addition to sharp fluctuations. In addition, investors should be aware that there is no assurance that ether and bitcoin will maintain their long-term value in terms of future purchasing power.
Currently, there is limited use of ether in non-financial applications in the retail and commercial marketplace in comparison to relatively extensive use by speculators, thus contributing to price volatility that could adversely affect an investment in the Trust.
As a relatively new product and technology, most of the transactions of ether that settle on the Ethereum Network are related to speculative use cases. More recently, as DeFi and NFT applications gain traction, a bigger share of transactions is now related to the execution of smart contracts. Nonetheless, many such smart contracts are used for speculative purposes, such as trading across Crypto Assets or obtaining leverage against pledged collateral. If the Ethereum network fails to find use cases non-related to speculation, ether’s price volatility could remain high for a significant period of time and have an adverse impact on the Trust.
The price of bitcoin and/or ether could decline due to circumstances outside of the control of the Trust resulting in declined demand for bitcoin and/or ether, and such decline in the price of bitcoin and/or ether could negatively impact the value of the Trust’s shares.
Circumstances outside of the control of the Trust could result in a decline in demand for bitcoin and/or ether and a resulting decrease in the price of bitcoin and/or ether. These circumstances may include: the use of Bitcoin and/or Ethereum for illegal purposes, which could result in both affirmative action taken against Bitcoin and/or Ethereum, such as governmental bans on Bitcoin and/or Ethereum, as well as a shift in public perception which could cause Bitcoin and/or Ethereum to be viewed negatively and demand for Bitcoin and/or Ethereum to decline; a decline in Bitcoin Mining activity and/or the amount of capital staked on Ethereum due to regulatory action against Miners and/or Validators, including restrictions on Mining related to the environmental impact of Bitcoin Mining or the inability or unwillingness of centralized Validators to comply with sanctions or regulations; and the potential for new or different regulatory action against Bitcoin and/or Ethereum, which could have the effect of severely dampening demand for bitcoin and/or ether. Crypto asset mining operations can consume significant amounts of electricity, which may have a negative environmental impact and give rise to public opinion against allowing, or government regulations restricting, the use of electricity for mining operations. Additionally, miners may be forced to cease operations during an electricity shortage or power outage. Any of these circumstances or other circumstances that affect the demand for bitcoin and/or ether could cause the price of bitcoin and/or ether to decline which could then negatively affect the value of the Trust’s shares.
Risks Related to Decentralized Finance Portfolio Crypto Assets
Certain Portfolio Crypto Assets utilize DeFi protocols, which are typically developed on top of other public blockchain networks and are therefore subject to the risks of the underlying public blockchain network, as described above.
The Trust holds certain Portfolio Crypto Assets that utilize DeFi protocols, and therefore activities and issues that affect the associated Decentralized Finance protocols would also have an effect on the Trust’s Portfolio. In general, Decentralized Finance protocols do not operate on a native blockchain, but rather are built and operated on other public blockchain networks. As a result, a Decentralized Finance protocol does not control the blockchain network on which it operates. Any adverse impacts or changes on the underlying blockchain network could have a negative effect on the operation of the Decentralized Finance protocol and, as a result, could impact the price of the Decentralized Finance protocol’s Crypto Asset. Such adverse impacts can include, but are not limited to, technical bugs, hacks, 51% attacks or network congestion due to, among other issues, high fees.
Currently, Decentralized Finance protocols are primarily built on top of the Ethereum network and therefore most Decentralized Finance protocols rely on the Ethereum network to operate their protocol. If in the future a different blockchain network proves to be a better fit for the development of Decentralized Finance applications, some Decentralized Finance protocols might transition to a different underlying blockchain network. Such transition could be difficult and could have material adverse effects on the Decentralized Finance protocol’s business, operations, and financial position. In addition, a Decentralized Finance protocol that transitioned to a new underlying blockchain network might experience technical, business or other issues with operating its Decentralized Finance protocol on the new blockchain network. Any of these issues could have a material adverse effect on the Decentralized Finance protocol’s business, operations and financial position, which could have a negative impact on the price of the Decentralized Finance Crypto Asset. If the price of a Decentralized Finance protocol’s Crypto Asset that is included in the Bitwise Decentralized Finance Crypto Index price declines, that could result in a negative impact on the Trust’s Portfolio.
Certain Portfolio Crypto Assets utilize DeFi protocols, and such protocols permit holders of the protocol’s native Crypto Asset to participate in activities such as governance voting, staking, lending and liquidity provision, in exchange for compensation. If the Trust is unable to engage in such activities, or elects not to engage in such activities, its holdings can be diluted in favor of other Crypto Asset holders.
The Trust holds certain Portfolio Crypto Assets that utilize DeFi protocols. To date, several Blockchain networks allow for some level of staking at the option of the holder. Chainlink is a crypto application built on top of the Ethereum network which provide DeFi services through its protocols in which the holder can choose to engage, including governance, voting, staking assets, lending assets, and liquidity provision options. DeFi protocols choose to incentivize holders of the protocol’s native Crypto Asset to actively participate in the protocol by directing rewards, such as newly minted Crypto Assets, transaction fees, or other mechanisms, to the Crypto Asset holder if the Crypto Asset holder participates in certain activities. These activities can vary across protocols and may include, but are not limited to, governance voting, staking assets, lending assets or providing collateral or liquidity to the protocol.
These rewards can represent a significant share of the total supply of the Crypto Asset, and, if the Trust is unwilling or unable to engage in such activities, the holdings of these specific assets can be diluted in favor of other Crypto Asset holders who opt to engage in such activities.
If the Trust decides to engage in activities allowed by some DeFi protocols such as governance voting, staking, lending and liquidity provision, the Trust may experience losses.
The Index has not participated in any DeFi protocols, including governance, voting, lending assets and liquidity provisions. To the extent that the Trust participates in any decentralized finance protocols, the Trust anticipates only participating in such protocols where the Trust has made a direct investment in the relevant DeFi Crypto Asset. While the Trust currently does not participate in any staking activities, it may in the future engage in further staking activities if the Trust deems such activity to be in the best interests of shareholders.
Decentralized Finance protocols are operated by a series of complex smart contracts that interact with each other and such technology can be vulnerable to technical or economic exploitation that can negatively impact the functioning of the Decentralized Finance protocol and therefore the price of the Decentralized Finance’s Crypto Asset.
Decentralized Finance protocols are vulnerable to technical and economic exploitation of any weaknesses in their systems, and any such exploitation could have a negative effect on the protocol’s Crypto Asset. Decentralized Finance protocols are operated by a series of complex smart contracts that interact with each other. Smart contracts are comprised of a variety of complex pieces of software code, and this software code may not be fully or professionally tested before being deployed for use by the users of a Decentralized Finance protocol. As a result, users of a Decentralized Finance protocol can, intentionally or unintentionally, trigger malfunctioning behavior on the Decentralized Finance protocol, which can have a negative impact on the price of its Crypto Asset and can also result in the complete loss or theft of the Decentralized Finance’s Crypto Asset.
The smart contracts that underlie Decentralized Finance protocols are subject to a wide range of exploitation, including both technical exploitation, which can utilize flaws in the computer code that underlies the smart contract, and economic exploitation, which can occur if network participants use the network in a way that was not expected by its designers. Such exploitation can take place even on networks that have gone through extensive security audits by specialized firms; such firms may not be able to anticipate all the potential threats such complex systems can face in the real world. Any of these issues could have a material adverse effect on a Decentralized Finance protocol’s business, operations, and financial position, which could have a negative impact on the price of the Decentralized Finance Crypto Asset. If the price of a Decentralized Finance protocol’s Crypto Asset that is included in the Index price declines, that could result in a negative impact on the Trust’s Portfolio.
Decentralized Finance protocols rely on software code that is distributed in an open-source fashion, which opens the possibility of others replicating (“forking”) the code and creating protocol competitors with relative ease.
The open-source paradigm for software development is a decentralized process that allows for open collaboration through licenses that allows the public use and redistribution of the underlying software code. This is one of the foundational principles of public blockchain networks, including both Decentralized Finance protocols and the underlying blockchain networks they are based upon. This paradigm makes it possible for users to copy a Decentralized Finance protocol’s software code, edit it to include features that are different from the original software code, and relaunch it as a new Decentralized Finance protocol. The new Decentralized Finance protocol could have a different native Crypto Asset, and if the new protocol were to be successful and the price of its new native Crypto Asset was to rise, holders of the original protocol’s Crypto Asset may not be able to participate in the success of the new Decentralized Finance protocol. In addition, if the new Decentralized Finance protocol’s Crypto Asset was not included in the Index, the Portfolio and the Trust would not benefit from any success of the new protocol.
Many Decentralized Finance protocols have governance structures that are, to varying degrees, controlled by the holders of the protocol’s native Crypto Asset. As a result, holders of the native Crypto Asset have the power to, intentionally or unintentionally, propose and approve changes to the protocol, and such changes could be detrimental to the proper functioning of the protocol.
Many Decentralized Finance protocols grant certain governance rights to the holders of the protocol’s native Crypto Asset. The extent of these rights varies across different protocols. For some Decentralized Finance protocols, these rights can include: the ability to alter parameters that the network relies on to operate; the ability to alter the source code upon which the protocol is built; the ability to make decisions regarding the allocation of funds held in the protocol treasury; and other key operational and design decisions regarding the Decentralized Finance protocol. As a result, holders of a protocol’s native Crypto Asset may have the ability, intentionally or unintentionally, to propose or approve changes to the protocol that may impair the function of the Decentralized Finance protocol. If the functioning of a Decentralized Finance protocol is impaired, this could affect the price of its native Crypto Asset. If the price of a Decentralized Finance protocol’s Crypto Asset that is included in the Bitwise Decentralized Finance Crypto Index price declines, that could result in a negative impact on the Trust’s Portfolio.
Some Decentralized Finance protocols depend on reliable price feeds for the systems to work correctly. Intentional or unintentional interruptions or distortions of such feeds can lead to improper behavior of the system and have a negative impact on the price of its native Crypto Asset.
Due to the reliance by blockchain networks on systems that provide the network with outside information, disruption of such systems can lead to negative impacts on the blockchain network and the protocols that operate on the blockchain network, which can have a negative impact on the price of a Decentralized Finance protocol’s Crypto Asset.
Blockchain networks are unaware of the events that take place outside the network. As a result, blockchain networks rely on “feeds,” also called “oracles,” to execute any transactions that rely on information that is derived from sources outside of the blockchain. This includes sources such as external asset prices on the open market. Some blockchain networks build their own oracle systems, while others access networks that produce oracles in a decentralized method that allows for general access. If these oracle systems malfunction, the blockchain network may not be able to receive certain information or may receive the wrong information. This in turn could affect protocols that operate on that blockchain network, including Decentralized Finance protocols.
If the functioning of a Decentralized Finance protocol is impaired, this could affect the price of its native Crypto Asset. If the price of a Decentralized Finance protocol’s Crypto Asset that is included in the Index price declines, that could result in a negative impact on the Trust’s Portfolio.
DeFi is a nascent field and an understanding of how DeFi protocols and staking activity fit into regulatory frameworks is still developing.
The provision of financial services is a highly regulated activity. DeFi protocols are structured to provide financial services in a novel and decentralized manner, including through the use of staking. As a result, the regulations regarding DeFi protocols are not yet clear. There are a number of regulators that may exercise jurisdiction over activities such as a staking that take place on decentralized finance protocols, including but not limited to, the U.S.
Securities and Exchange Commission (SEC), the Office of the Comptroller of the Currency (OCC), the Internal Revenue Service (IRS), the Financial Crimes Enforcement Network (FinCEN) and state securities regulators.
Regulators have not provided much information on the regulation of DeFi protocols, and it is unclear how regulators are currently thinking about this market, or how regulators’ considerations and concerns may evolve in the future. It is possible that in the future one or more regulators could advance rulings that would have a negative impact on the price of the DeFi protocol’s native Crypto Assets. Such rulings could, among other things, preclude the Trust from holding these assets, disincentivize users to participate in the protocol, or determine that activities such as staking are financial activities that are subject to relevant financial regulations.
In addition, the fact that DeFi protocols, including staking, are global and permit users from around the world to access the protocols could result in regulation occurring outside of the U.S. which could affect DeFi protocols. Any of these issues could have a material adverse effect on a DeFi protocol’s business, operations and financial position, which could have a negative impact on the price of the DeFi Crypto Asset. If the price of a DeFi protocol’s Crypto Asset that is included in the Index declines, that could result in a negative impact on the Trust. In addition, to the extent that DeFi activities are determined to be subject to regulation as financial activities, the Trust could be subject to regulation if it had participated in such activities.
DeFi protocols may require one or more outside Crypto Assets that are not its native Crypto Asset to be used as collateral in order to operate certain functionality. A sudden or significant drop in the value of the Crypto Asset used as collateral could have negative implications for the functioning of the DeFi protocol and therefore could affect the price of its native Crypto Asset.
Certain DeFi protocols require users to post collateral in the form of a Crypto Asset in order to borrow other assets from the protocol. In order to protect users who lend their Crypto Assets to borrowers, if the collateral price were to fall, the protocols are usually overcollateralized, that is, the protocol will require more collateral than is necessary. If the price of the collateral were to fall, over-collateralization would allow the DeFi protocol to liquidate the posted collateral so as to ensure that the user who lent the Crypto Assets is made whole.
It is possible that certain situations might occur which would cause the DeFi protocol to become undercollateralized and put the users who are borrowing assets in a potential position of loss. Such situations could include, but are not limited to, sudden or significant falls in the price of the Crypto Asset used as the collateral. These falls could be driven by many factors, including but not limited to technical bugs, illiquidity, competition from other assets, regulatory actions, fraud, or other factors. Depending on the rules of the protocol, these losses may be borne by the holders of Crypto Assets through mechanisms such as, among others, dilution through the issuance of new Crypto Assets to cover the losses or confiscation of staked assets. This could in turn cause a sudden or significant drop in the value of the Crypto Asset used as collateral, which could have negative implications for the functioning of the DeFi protocol and therefore could affect the price of its native Crypto Asset. If the price of a DeFi protocol’s Crypto Asset that is included in the Index declines, that could result in a negative impact on the Trust’s Portfolio.
Staking activity may require withdrawals of Portfolio Crypto Assets and such withdrawals may result in the Portfolio Crypto Assets being vulnerable to security breaches, including hacking and other efforts to obtain the Portfolio Crypto Assets.
Staking activity may require withdrawals of its Portfolio Crypto Assets by the Sponsor in order venues to make certain types of trades or to deposit certain Portfolio Crypto Assets within various protocols. While the ability to gain temporary control of even a portion of the Portfolio Crypto Assets is restricted to a limited number of authorized personnel of the Sponsor, once the Custodian processes the transaction, the Sponsor has the ability to send the withdrawn Portfolio Crypto Assets to the delivery address of trading counterparties or trading venues. During any such transfer, the Portfolio Crypto Assets may be vulnerable to security breaches, including hacking and other efforts to obtain the Portfolio Crypto Assets, as well as the risk that while Portfolio Crypto Assets are under the Sponsor’s control, an employee of the Sponsor could access and obtain the Portfolio Crypto Assets. Some of these attempts to obtain the Portfolio Crypto Assets may be successful, and the Sponsor may lose some or all of the transferred Portfolio Crypto Assets. In addition, Portfolio Crypto Assets transferred to exchanges or other trading venues or protocols, such as smart-contracts that facilitate staking or other reward-generating activity, are subject to increased risk of loss or theft due to reliance on the security procedures of the trading venue or protocol (when the
Portfolio Crypto Assets are no longer in the custody of the Custodian) or the risk of the smart-contract operating appropriately, and because the same withdrawal procedures required by the Custodian, which are designed to reduce the risk of error or theft, may not be required by trading venues. Portfolio Crypto Assets transferred for the purposes of lending, staking, or participating in other network activities are subject to increased risk of loss, theft, or technological complication that could result in the loss of Portfolio Crypto Assets in their entirety.
Certain staking activities require a Portfolio Crypto Asset to be restricted within a protocol for a specific period of time, and such restrictions may result in the Trust being unable to rebalance its holdings.
If the Trust decides to pursue staking activities that require Portfolio Crypto Assets to be restricted within a protocol for a specific period of time, the Trust may be unable to rebalance its holdings in accordance with the monthly rebalancing of the Index. The inability of the Trust to rebalance in accordance with the Index could cause deviations between the Trust and the Index, and such deviations could create performance differences between the Trust and the Index. If the Trust was unable to rebalance its holdings in accordance with the monthly rebalancing of the Index, the Trust would include this information on its website, as the current Portfolio and any relevant information regarding the Portfolio is always provided on the Trust's website.
Risks Related to Index Investing
The Bitwise 10 Crypto Index has a fairly limited history.
The Index was created in 2017 and has a fairly limited history. The Committee has substantial discretion at any time to change the methodology used to calculate the Index and guidelines used to select public exchanges from which Crypto Asset trading data is sourced for inclusion in the Index. The Committee does not have any obligation to take the needs of the Trust, the Trust’s Shareholders, or anyone else into consideration in connection with such changes. There is no guarantee that the methodology currently used in calculating the Index will appropriately track the price of Crypto Assets comprising the Index in the future.
The Index is based on various inputs which may include price data from various third-party exchanges and markets as well as supply data. The Committee does not guarantee the validity of any of these inputs, which may be subject to technological error, manipulative activity, or fraudulent reporting from their initial source. The Committee is not required to publicize or explain the changes to the Index, nor to alert the Trust to such changes. Shareholders in the Trust may not be aware of what inputs the Committee uses to calculate the Index, when the Committee changes the inputs, or when the Committee changes the methodology to calculate the Index, even when material to the calculation of the Index. The Index could be calculated now or in the future in a way that adversely affects an investment in the Trust.
The methodology for determining the Index established by the Index Provider, which is an affiliate of the Sponsor, is relatively new.
The methodology for determining the Index established by the Index Provider, which is an affiliate of the Sponsor, is relatively new. Such methodology is based on a flexible set of rules that were designed by the Sponsor and its affiliates. Should any material change be made to the Index Methodology that results in a material change to the composition of the Index and, as part of the Trust’s monthly rebalancing process, results in a material change to the composition of the Trust the Trust will notify Shareholders of such material change by filing a Form 8-K with the SEC. The Trust defines a material change as any change of 10% or more to the composition of the Index. Certain assumptions included in the methodology may be flawed and may adversely impact the Index’s ability to accurately establish or maintain an Index of top Crypto Assets. The failure of one or more of the assumptions built into the Index Methodology could have an adverse effect on the Trust and on the value of an investment in the Trust. For example, such methodology relies on facts and circumstances as known to the Committee from time to time, however, such facts and circumstances as known to the Committee may later prove to be false or incomplete or the Committee may have given undue weight to information deemed by the Committee to be material at the time but which may later be found to be immaterial. For more detailed information on the Index Methodology, see “Item 1. Business—Overview of the Index—Summary of the Index Methodology—Index Methodology.”
The Trust’s investment policies are rules-driven, which may lead the Trust’s portfolio to be underrepresented with respect to Crypto Assets that are increasing in value and/or overrepresented with respect to Crypto Assets that are declining in value.
As described under “Item 1. Business—Overview of the Index—Purpose of the Index,” the Trust seeks to invest in a Portfolio of Crypto Assets in accordance with the Index. The Index and investment strategy of the Trust may, however, create undesirable outcomes for Shareholders. At any given time, for example, the Trust’s portfolio may be underrepresented with respect to Crypto Assets that are increasing in value and/or overrepresented with respect to Crypto Assets that are declining in value. Should this be the case, the Trust may underperform relative to other investment options that do invest in such Crypto Assets and do not follow similar investment policies. Moreover, the Sponsor will only rebalance the Trust’s Portfolio on a monthly basis, meaning that rebalancing that could achieve more favorable results for Shareholders may only occur upon delay. This could have an adverse effect on the Trust and on the value of an investment in the Trust.
The development and commercialization of the Index is highly competitive, and the Trust may not be commercially successful.
The Trust faces competition with respect to the creation and maintenance of a competing Crypto Asset index fund. Much of the information used to construct and maintain the Index is within the public domain. Competitors could develop a similar, competing Crypto Asset index or fund. Many of the Sponsor’s competitors have significantly greater financial, technical and human resources than the Sponsor has and superior expertise in fund operation and management, and thus may be better equipped than the Sponsor to develop and commercialize an index. These competitors also compete with the Sponsor in recruiting and retaining qualified personnel. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. Accordingly, the Sponsor’s competitors may commercialize an index involving Crypto Assets more rapidly or effectively than the Sponsor is able to, which would adversely affect the Sponsor’s competitive position, the likelihood that the Index will achieve initial market acceptance and the Sponsor’s ability to generate meaningful revenues from the Trust.
The Trust will not track the Index exactly and the Trust’s investments may diverge from those comprising the Index.
It is not possible to invest directly in an index. The Trust will invest its assets to closely track the Index but will not be able to or may not desire to track the Index exactly. In certain instances, the Sponsor, in its sole discretion, may choose to diverge the Trust’s investments from those comprising the Index. For example, the Index may include a Crypto Asset that the Trust’s custodian cannot custody, and the Trust therefore would not include that particular Crypto Asset. The Trust will have losses, liabilities and expenses that will offset its income and gains and therefore the Trust’s performance may be below the Index’s performance. In addition, the performance of the Trust and the Index may vary somewhat due to other factors such as imperfect correlation between the Trust’s investments and Index composition, regulatory restrictions, high portfolio turnover rate, rounding of prices and timing differences associated with additions to and deletions from the Index.
The Sponsor is solely responsible for determining the value of the NAV Per Share, and any errors, discontinuance or changes in such valuation calculations may have an adverse effect on the value of the Shares.
The Sponsor is responsible for determining the value of the Trust’s NAV Per Share. The Sponsor and its affiliates will use the applicable rules-based methodology to calculate and disseminate the Index on a daily basis. The composition of the Index is dependent on data from one or more third parties and/or the application of such data within the rules of the Index Methodology, which may be based on assumptions or estimates. To the extent that this is incorrectly calculated, the Sponsor may not be liable for any error and such misreporting of valuation data could adversely affect an investment in the Shares.
The value of the Shares will be adversely affected if the Trust is required to indemnify the Sponsor, the Trustee or the Custodian.
Each of the Sponsor, the Trustee, the Custodian, and certain other service providers, has a right to be indemnified by the Trust under certain circumstances. In order to satisfy these obligations, the Trust may be required to sell some Portfolio Crypto Assets in order to cover losses or liability suffered by it. Any sale of that kind would reduce the Portfolio Crypto Assets of the Trust and the value of the Shares.
The Index may be unable to meet its stated purpose of tracking a basket of Crypto Assets that represents the majority of Crypto Assets by market capitalization if the size of the constituent assets continues to decrease relative to the total market capitalization.
The Index tracks only the top ten Crypto Assets by market capitalization, and as more new Crypto Assets are created, this decreases the percentage of total market capitalization that the Index is tracking. The total market capitalization of Crypto Asset is equal to the sum of the market capitalization of all Crypto Assets that are in existence. If new Crypto Assets are created, the addition of new Crypto Assets to the total overall market capitalization can cause the size of any single Crypto Asset relative to the total overall market capitalization to decrease. It is possible that so many new Crypto Assets could be created, that an index that tracked the top ten Crypto Assets by each Crypto Asset's market capitalization would track a basket of assets that may together constitute only a very small percentage of the total market capitalization. If that were to occur, the Index would not be able to meet its purposes of tracking a basket of Crypto Assets that represented a majority of Crypto Assets, even if the Index was still comprised of the top ten Crypto Assets by market capitalization.
Risks Related to Trust and Portfolio Investments
Because of the holding period under Rule 144 and the lack of an ongoing redemption program for Shareholders who invest directly into the Trust (as opposed to Shareholders who acquire Shares in the public secondary trading market) there is no arbitrage mechanism to keep the price of the Shares closely linked to the value of the underlying Portfolio Crypto Assets and the Shares may trade at a substantial premium over, or substantial discount to, the value of the NAV Per Share.
Because of the holding period under Rule 144 and the lack of an ongoing redemption program for Shareholders who invest directly into the Trust, the Trust cannot rely on arbitrage opportunities resulting from differences between the price of the Shares and the price of the relevant Crypto Asset to keep the price of the Shares closely linked to the relevant Portfolio Crypto Assets. As a result, the value of the Shares may not approximate, and the Shares may trade at a substantial premium over, or discount to, the value of the Portfolio Crypto Assets held by the Trust, less the Trust’s expenses and other liabilities, on the OTCQX secondary trading market.
The Trust has limited operating history upon which an investor may base its investment decision.
The Trust has limited operating history upon which an investor may base its investment decision. There can be no assurance that the Trust will be able to successfully implement its business plan. The success of the Trust should be considered in light of the problems, expenses, difficulties, complications, and delays frequently encountered in connection with the inception of a business, operation in a competitive industry, and the continued development of advertising and a corresponding investor base. For these and other unforeseeable factors, there can be no assurance that the Trust will achieve or sustain profitable operations. The performance of prior investment entities and business ventures associated with the principals is not necessarily indicative of the Trust’s future performance.
There are significant costs associated with the Trust's status as a reporting issuer under the Exchange Act.
As the sponsor of a trust fully reporting under the Exchange Act, the Sponsor will incur significant legal, accounting and other expenses. In addition, the Exchange Act imposes various requirements on issuers that require the Sponsor’s management and other personnel to devote a substantial amount of time to compliance initiatives which may result in less time being devoted to day-to-day management activities.
The Trust depends, in part, on the Sponsor’s ability to attract and retain key personnel and the Trust’s failure to do so may negatively impact the commercial success of the Trust.
The Trust depends, in part, on the Sponsor’s ability to attract and retain key personnel. The Trust’s future also depends on the continued contributions of the executive officers and other key Bitwise personnel, each of whom would be difficult to replace. In particular, Hunter Horsley, Teddy Fusaro, Katherine Dowling, Matthew Hougan, and Hong Kim (together, the "Executives") are critical to the management of the Trust’s business and operations and the Trust’s strategic direction. The loss of the services of the Executives, or other key personnel of Bitwise or the Sponsor, and the process to replace them would involve significant time and expense and may significantly delay or prevent the achievement of the Trust’s business objectives.
The Trust does not maintain key man life insurance on key personnel.
The Trust is dependent on the Executives in order to manage its investments and operations, maintain the Index and execute on the Trust’s investment strategy. Neither Bitwise nor the Sponsor has, however, purchased any insurance policies with respect to those individuals in the event of their death or disability. Therefore, if any of the Executives die or become disabled, neither Bitwise nor the Sponsor will receive any compensation to assist with such person’s absence. The loss of such person could negatively affect the Trust and its investments.
Shareholders are expected to rely entirely on the Sponsor to conduct and manage the affairs of the Trust and will not be able to actively participate in management.
Shareholders are expected to rely entirely on the Sponsor to conduct and manage the affairs of the Trust. Shareholders do not participate in the management of the Trust or in the conduct of their business. Moreover, Shareholders have no right to influence the management of the Trust, whether by voting or otherwise, other than in the limited fashion as set forth in the Trust Agreement. The Sponsor will have exclusive responsibility for the Trust’s activities. Other than as may be set forth in the Trust Agreement, Shareholders will not be able to make investment or any other decisions in the management of the Trust. In general, the Shareholders will have no opportunity to control or participate in the day-to-day operations, including investment and disposition decisions, of the Trust. As such, Shareholders will not have an opportunity to evaluate for themselves the investment decisions made by the Trust, and instead will be relying on the ability of the Sponsor to select investments to be made and rebalance the Trust’s portfolio using the Index. Accordingly, the success of the Trust will depend in large part upon the skill and expertise of the Sponsor, and other investment professionals employed by the Sponsor. There can be no assurance that these professionals will continue to be associated with the Sponsor throughout the life of the Trust.
Further, if the Sponsor were to lack funds to continue to manage the Trust, the Index, and/or other investment-related operations essential to the Trust, it may be difficult or impossible for the Trust to secure other, similarly-skilled management for the Trust. If the Sponsor were to lack such funds or were to discontinue its business for any other reasons, this could have a material adverse effect on the Trust and the value of an investment in the Trust.
Investors may experience the complete loss of their investment.
An investment in the Trust is suitable only for certain sophisticated investors for whom such investment does not constitute a complete investment program and that fully understand, are willing to assume, and have the financial resources necessary to withstand, the risks involved in the Trust’s investment strategy, and that can bear the potential loss of their entire investment in the Trust. There is no assurance as to whether the Trust will be profitable or meet its expenses and liabilities. Any investment made in the Trust may result in a total loss of the investment.
If Shareholders enter into share lending arrangements with respect to shares of the Trust, Shareholders may experience various risks associated with these arrangements.
Certain lending entities may be willing to provide loans to Shareholders in the Trust. Neither the Trust, the Sponsor nor any of their affiliates recommend or endorse any such lending arrangements. The decision to enter into such a lending arrangement is solely the decision of the Shareholder, and the Shareholder should consult with its legal and financial advisers before doing so. The Trust, the Sponsor, and their affiliates disclaim any and all liability from any such lending arrangements, including without limitation any liability for losses or adverse consequences that may be incurred by the lender, the Shareholder, or any other person or entity.
In some cases, these lending arrangements may be entered into without the knowledge or the involvement of the Trust or the Sponsor. In other cases, the parties to such a lending transaction may ask the Trust and/or the Sponsor to be a party to an agreement in which the Trust and/or the Sponsor is asked to provide certain assurances or non-objections to such a lending transaction.
There are several factors the Sponsor will consider in providing assurances and non-objections to the lending arrangements with regard to the Trust’s shares. First, the Trust will only grant consent to allow for the Trust’s shares to be used in lending arrangements for shares purchased by the prospective pledgor directly from the Trust, and that are “restricted securities” within the meaning of Rule 144 (“Rule 144”) under the Securities Act of 1933, as amended (“Securities Act”), and consent will not be granted by the Trust for lending arrangements involving any shares that the pledgor purchases from any person other than the Trust and for any shares of the Trust that are not “restricted securities” within the meaning of Rule 144. Second, in order for the Trust to grant consent to the proposed lending arrangement, the pledgor and the secured party must both agree to remain in full compliance with all obligations and responsibilities under the subscription agreement with the Trust, with regard to all organizational documents of the Trust, and with all applicable laws, rules and regulations relating to these Trust obligations. Third, neither the pledgor nor the secured party may be an affiliate of the Trust, or any affiliate of the Trust, and may not become an affiliate at any time during the term of the lending arrangement. And fourth, the Trust will only consent to the lending arrangement if the secured party agrees that any sale of the collateral will only be made in transactions registered under the Securities Act, or in transactions for which the secured party delivers an opinion of counsel to the Trust that such transactions are exempt from registration under the Securities Act, and will only be made in transactions and to purchasers that are eligible to be holders of the Trust in accordance with the Trust’s organizational documents and are otherwise in compliance with all applicable securities laws.
The Trust and the Sponsor are under no obligation to enter into any such agreement, and may or may not do so in their sole discretion. Neither the Trust, the Sponsor nor any of their affiliates will receive any compensation from any party under or pursuant to such an agreement.
The Trust is a passive investment vehicle and the Sponsor will generally not actively manage the Crypto Assets held by the Trust.
While the Sponsor reserves the right to engage in staking, lending and similar activities with Trust assets if the Sponsor determines that any such activities are in the best interest of the Trust and its shareholders, the Sponsor will generally not actively manage the Crypto Assets held by the Trust. Instead, the Trust will hold investments that track the Index, regardless of the current or projected performance of the Index or of the actual Crypto Assets included in the Index. This is different from an actively managed fund, which would seek to outperform a benchmark index and means that the Trust’s net asset value may be adversely affected by losses that, if the Trust had been actively managed, might have been possible to avoid. Accordingly, the Sponsor will not sell Crypto Assets at times when their price is high, or acquire Crypto Assets at low prices in the expectation of future price increases, or take any other action that may be available to Crypto Asset investors to attempt to reduce the risk of losses resulting from Crypto Asset price decreases and conversely, maximize gains resulting from Crypto Asset prices increases. Any losses sustained by the Trust will adversely affect an investment in the Trust.
The Trust is subject to additional risks due to its concentration of investments in a single asset class.
Unlike other funds that may invest in diversified assets, the Trust’s investment strategy is concentrated in a single asset class: broad based Crypto Assets. This concentration maximizes the degree of the Trust’s exposure to a variety of market risks associated with Crypto Assets. By concentrating its investment strategy solely in Crypto Assets, any losses suffered as a result of a decrease in the value of Crypto Assets, can be expected to reduce the value of Shares in the Trust and will not be offset by other gains if the Trust were to invest in underlying assets that were diversified.
The Trust may not have adequate sources of recovery if its Crypto Assets are lost, stolen or destroyed.
If the Trust’s Crypto Assets are lost, stolen or destroyed under circumstances rendering a party liable to the Trust, the responsible party may not have the financial resources sufficient to satisfy the Trust’s claim.
The Trust and Sponsor must comply with applicable laws and regulations relating to privacy, data protection, and cybersecurity, and may experience material negative effects to their business and financial condition if they do not comply.
Along with the Trust’s and Sponsor’s confidential data and information in the normal course of the Trust’s activities, the Sponsor, on behalf of the Trust, collects and retains certain types of data, some of which are subject to certain laws and regulations relating to privacy, data protection, and cybersecurity. For example, the data collected from Shareholders and potential investors includes personally identifiable information. The Trust and Sponsor must comply with applicable federal and state laws and regulations governing the collection, retention, processing, storage, disclosure, access, use, security, and privacy of such information in addition to the Trust’s information security and privacy policies and other actual and asserted obligations, including contractual obligations and applicable industry standards. The legal, regulatory, and contractual environment surrounding the foregoing continues to evolve and may be challenging to comply with, and there has been an increasing amount of focus on privacy, data protection, and cybersecurity issues with the potential to affect the Trust’s activities. These laws and regulations, contractual requirements, industry standards, and other actual and asserted obligations could increase the Trust’s cost of doing business, and any actual or alleged failure to comply with these laws, regulations, contractual requirements, and other obligations could result in government investigations, enforcement actions, and other proceedings (which could include civil or criminal penalties), private claims, demands, and litigation, damages and other liabilities, and/or adverse publicity.
The Trust and Sponsor have incurred, and may continue to incur, significant expenses in an effort to comply with privacy, data protection, and cybersecurity standards and protocols imposed by law, regulation, industry standards, or contractual obligations. The various privacy, data protection, and cybersecurity legal obligations that apply to the Trust and Sponsor may evolve in a manner that relates to its policies or practices, and the Trust and Sponsor and the Trust and Sponsor may be required to take additional measures to comply with the new and evolving obligations. Such efforts may not be successful or may have other negative consequences. In particular, with laws and regulations imposing new and relatively burdensome obligations and with substantial uncertainty over the interpretation and application of these and other laws and regulations, the Trust and Sponsor may face challenges in addressing their requirements and making necessary changes to applicable policies and practices and may incur significant costs and expenses in an effort to do so. Despite the efforts of the Trust and Sponsor to comply with applicable laws, regulations, and other actual or asserted obligations relating to privacy, data protection and cybersecurity, it is possible that their interpretations of the law, practices, policies, or platform or other services or offerings could be inconsistent with, or fail or be alleged to fail to meet all requirements of, such laws, regulations, or obligations.
Any failure, or consequences associated with efforts to comply with applicable laws or regulations or any other obligations relating to privacy, data protection, or cybersecurity, or any compromise of security that results in unauthorized access to, or use or other processing of individuals, any failures by the Trust’s third-party service providers, partners, or vendors to comply with applicable obligations, or the perception that any of the foregoing types of failure or compromise has occurred, could damage the Trust’s and Sponsor’s reputation, and may subject the Trust and Sponsor to governmental fines, penalties, and other obligations and liabilities, individual and class action claims, damages and other liabilities, remediation expenses, and/or harm to reputation, and the Trust’s activities, reputation, returns, and cash flows could be materially adversely affected.
The Trust is subject to the risk of cybercrime and security breaches and incidents.
The Trust and the Sponsor rely on information technologies and infrastructure to manage the Trust and Index, including digital storage of Trust assets, marketing strategies and information relating to Shareholders and other individuals. Data maintained in digital form is subject to the risk of intrusion, tampering and theft. The incidence of malicious technology-related events, such as cyberattacks, computer hacking, computer viruses, worms, ransomware or other destructive or disruptive software, denial of service attacks or other malicious activities is on the rise worldwide. Power outages, equipment failure, natural disasters (including extreme weather), terrorist activities or human error may also affect our systems and those of our third-party service providers, and result in disruption of our services or loss or improper disclosure of personal data, business information or other confidential information.
Likewise, the foregoing activities, including cyberattacks, hacking, and other malicious activities, and various other causes, including employee and contractor error, negligence, and malfeasance may lead to security breaches or incidents suffered by the Trust, the Sponsor, or their respective service providers. Security breaches and incidents, as well as improper use of social media, by employees and others may pose a risk that sensitive data, such as personal information, strategic plans and trade secrets, could be exposed to third parties or to the general public or otherwise lost, stolen, rendered unavailable, or accessed, altered, used, disclosed, or otherwise processed in unauthorized manners. The Trust and Sponsor utilize third parties, including third-party “cloud” computing services, to store, transfer or process data, and system failures or network disruptions or breaches or incidents impacting the systems of such third parties could adversely affect the reputation or business of the Trust and Sponsor and lead to the same or similar consequences as a breach or incident suffered by the Trust or Sponsor. Any such breaches, incidents, breakdowns, or disruptions, or the perception that any of these has occurred, could result in legal claims, investigations or proceedings by governmental entities or private parties, adverse publicity and harm to reputation, a loss of Shareholders, and fines, penalties, damages, and other liabilities, under laws, regulations, and other actual and asserted obligations relating to privacy, data protection, and cybersecurity. In addition, breaches and incidents and other inappropriate access can be difficult to detect, and any delay in identifying them and responding to or otherwise remediating them may lead to increased harm of the types described above. Efforts to develop, implement and maintain security measures are costly, may not be successful in preventing these events from occurring and require ongoing monitoring and updating as technologies change and efforts to overcome security measures become more sophisticated. Further, significant resources could be required to be expended to remediate and otherwise respond to security breaches and incidents, including in connection with making notifications to individuals or entities in connection with any actual or suspected security breaches or incidents or implementing additional security measures. Security risks also are heightened with many employees and contractors of the Trust, the Sponsor, and their respective service providers working remotely.
The Trust invests in Crypto Assets that are not expected to be considered to be securities under the U.S. securities laws and therefore do not have the regulatory protections afforded to securities under the U.S. securities laws.
The Trust invests in Crypto Assets that are not expected to be considered to be securities under the U.S. securities laws. Accordingly, Shareholders in the Trust do not have the regulatory protections afforded under the U.S. securities laws regarding the Trust’s assets.
Crypto Assets held by the Trust will not have FDIC or SIPC protections.
The Trust is not a banking institution or otherwise a member of the Federal Deposit Insurance Corporation (“FDIC”) or the Securities Investor Protection Corporation (“SIPC”). Accordingly, deposits or assets held by the Trust are not subject to the protections enjoyed by depositors with FDIC or SIPC member institutions. The undivided interest in the Trust’s Crypto Assets and other assets represented by Shares in the Trust may not be insured.
The Trust is not subject to Sarbanes-Oxley regulations and lacks the financial controls and safeguards required of public companies.
The Trust does not have the internal infrastructure necessary, and is not required, to complete an attestation about its financial controls similar to those required under Section 404 of the Sarbanes-Oxley Act of 2002. There can be no assurance that there are no significant deficiencies or material weaknesses in the quality of the Trust’s financial controls. The Trust expects to incur additional expenses and diversion of management’s time if and when it becomes necessary to perform the system and process evaluation, testing and remediation required in order to comply with the management certification and auditor attestation requirements.
The Trust Agreement includes provisions that limit Shareholders’ voting rights and restrict Shareholders’ rights to bring a derivative action.
Under the Trust Agreement, Shareholders have limited voting rights and the Trust will not have regular Shareholder meetings. Shareholders take no part in the management or control of the Trust. Accordingly, Shareholders do not have the right to authorize actions, appoint service providers or take other actions as may be taken by Shareholders of other trusts or companies where shares carry such rights. The Shareholders’ limited voting rights give almost all control under the Trust Agreement to the Sponsor and the Trustee. The Sponsor may take actions in the operation of the Trust that may be adverse to the interests of Shareholders and may adversely affect the value of the Shares.
Moreover, pursuant to the terms of the Trust Agreement, the Shareholders’ statutory right under Delaware law to bring a derivative action (i.e., to initiate a lawsuit in the name of the Trust in order to assert a claim belonging to the Trust against a fiduciary of the Trust or against a third-party when the Trust’s management has refused to do so) is restricted. Under Delaware law, a beneficial owner of a Delaware statutory trust may bring a derivative action if the beneficial owner is a beneficial owner at the time the action is brought and either (i) was a beneficial owner at the time of the transaction at issue or (ii) acquired the status of beneficial owner by operation of law or the Trust’s governing instrument from a person who was a beneficial owner at the time of the transaction at issue. Additionally, Section 3816(e) of the DSTA specifically provides that a “beneficial owner’s right to bring a derivative action may be subject to such additional standards and restrictions, if any, as are set forth in the governing instrument of the statutory trust, including, without limitation, the requirement that beneficial owners owning a specified beneficial interest in the statutory trust join in the bringing of the derivative action.” In addition to the requirements of applicable law and in accordance with Section 3816(e) of the DSTA, the Trust Agreement provides that no Shareholder will have the right, power or authority to bring or maintain a derivative action, suit or other proceeding on behalf of the Trust unless two or more Shareholders who (i) are not affiliates of one another and (ii) collectively hold at least 10.0% of the outstanding Shares join in the bringing or maintaining of such action, suit or other proceeding.
This provision applies to any derivative actions brought in the name of the Trust other than claims under the federal securities laws and the rules and regulations thereunder.
Due to this additional requirement, a Shareholder attempting to bring or maintain a derivative action in the name of the Trust will be required to locate other Shareholders with which it is not affiliated and that have sufficient Shares to meet the 10.0% threshold based on the number of Shares outstanding on the date the claim is brought and thereafter throughout the duration of the action, suit or proceeding. This may be difficult and may result in increased costs to a Shareholder attempting to seek redress in the name of the Trust in court. Moreover, if Shareholders bringing a derivative action, suit or proceeding pursuant to this provision of the Trust Agreement do not hold 10.0% of the outstanding Shares on the date such an action, suit or proceeding is brought, or such Shareholders are unable to maintain Share ownership meeting the 10.0% threshold throughout the duration of the action, suit or proceeding, such Shareholders’ derivative action may be subject to dismissal. As a result, the Trust Agreement limits the likelihood that a Shareholder will be able to successfully assert a derivative action in the name of the Trust, even if such Shareholder otherwise believes that he or she has a valid derivative action, suit or other proceeding to bring on behalf of the Trust.
If the Trust were to end its ability to take on new subscribers, it is possible that the number of Portfolio Crypto Assets represented by each share of the Trust would decrease as the Trust’s Portfolio Crypto Assets are used to pay the Trust’s expenses.
Each Share of the Trust represents an amount of Portfolio Crypto Assets. The Trust sells Portfolio Crypto Assets to pay for the Trust's expenses. If the Trust no longer was able to replenish the amount of Portfolio Crypto Assets, the number of Portfolio Crypto Assets represented by each share of the Trust would decline, as Portfolio Crypto Assets were sold in order to pay the Trust’s expenses. This could occur because the Trust had decided to no longer take on new subscribers, so that no new Crypto Assets were being added to the Trust’s holdings. If the number of Portfolio Crypto Assets represented by each share of the Trust declined, that would have a negative effect on the Trust’s holdings.
Risks Related to Potential Conflicts of Interest
The Sponsor will manage the affairs of the Trust. Conflicts of interest may arise among the Sponsor and its affiliates, including the Index Provider and the authorized participants, on the one hand, and the Trust and its Shareholders, on the other hand. As a result of these conflicts, the Sponsor may favor its own interests and the interests of its affiliates over the Trust and its Shareholders. These potential conflicts include, among others, the following:
The Trust has agreed to indemnify the Sponsor and its affiliates pursuant to the Trust Agreement;
The Sponsor is responsible for allocating its own limited resources among different clients and potential future business ventures, to each of which it owes fiduciary duties;
The Sponsor and its staff also service affiliates of the Sponsor, including several other Crypto Asset investment vehicles, and their respective clients and cannot devote all of its, or their, respective time or resources to the management of the affairs of the Trust;
The Sponsor, its affiliates and their officers and employees are not prohibited from engaging in other businesses or activities, including those that might be in direct competition with the Trust; and
By purchasing the Shares, Shareholders agree and consent to the provisions set forth in the Trust Agreement. See “Item 10. Directors, Executive Officers and Corporate Governance—Description of the Trust Agreement.”
For a further discussion of the conflicts of interest among the Sponsor and the Trust, see “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
Shareholders cannot be assured of the Sponsor’s continued services, the discontinuance of which may be detrimental to the Trust.
Shareholders cannot be assured that the Sponsor will be willing or able to continue to serve as sponsor to the Trust for any length of time. If the Sponsor discontinues its activities on behalf of the Trust and a substitute sponsor is not appointed, the Trust will terminate and liquidate its Portfolio Crypto Assets.
Appointment of a substitute sponsor will not guarantee the Trust’s continued operation, successful or otherwise. Because a substitute sponsor may have no experience managing a Crypto Asset financial vehicle, a substitute sponsor may not have the experience, knowledge or expertise required to ensure that the Trust will operate successfully or continue to operate at all. Therefore, the appointment of a substitute sponsor may not necessarily be beneficial to the Trust and the Trust may terminate. See “Item 13. Certain Relationships and Related Transactions, and Director Independence.”
Although the Custodian is a fiduciary with respect to the Trust’s assets, it could resign or be removed by the Sponsor, which would trigger early termination of the Trust.
The Custodian is a fiduciary under § 100 of the New York Banking Law and a qualified custodian for purposes of Rule 206(4)-2(d)(6) under the Advisers Act and is licensed to custody the Trust’s Portfolio Crypto Assets in trust on the Trust’s behalf. However, during the initial term, the Custodian may terminate the Custodian Agreement for
Cause (as defined in “Item 10. Directors, Executive Officers and Corporate Governance—The Custodian and the Custodial Services Agreement—Description of the Trust Company Custodial Agreement—Termination”) at any time, and after the initial term, the Custodian can terminate the Agreement for any reason upon the notice period of thirty days provided under the Custodian Agreement. If the Custodian resigns or is removed and no replacement custodian acceptable to the Sponsor is engaged, the Trust will dissolve in accordance with the terms of the Trust Agreement.
The Sponsor has consulted with counsel, accountants and other advisers regarding the formation and operation of the Trust. No counsel was appointed to represent investors in connection with the formation of the Trust or the establishment of the terms of the Trust Agreement and the Shares. Moreover, no counsel has been appointed to represent Shareholders in connection with an investment in the Shares. Accordingly, an investor should consult his, her or its own legal, tax and financial advisers regarding the desirability of an investment in the Shares. Lack of such consultation may lead to an undesirable investment decision with respect to an investment in the Shares.
Potential conflicts of interest may arise among the Sponsor or its affiliates, including the Index Provider and the Committee, and the Trust.
The composition of the Committee is selected by the Index Provider, which is under the control of the parent of the Sponsor. The Sponsor and its affiliates, including the Committee and the Index Provider, have no fiduciary duties to the Trust and its Shareholders other than as provided in the Trust Agreement, which may permit them to modify or manage the Index to favor their own interests to the detriment of the Trust and its Shareholders.
The Sponsor’s parent controls the Index Provider, which selects the composition of the Committee. Conflicts of interest may arise among the Sponsor and its affiliates, including the Index Provider and the Committee, on the one hand, and the Trust and its Shareholders, on the other hand. As a result of these conflicts, the Index Provider and the Committee may modify or manage the Index to favor their own interests and the interests of their affiliates over the Trust and its Shareholders and/or in a manner adverse to the Trust and its Shareholders.
Risks Related to Trading on the OTCQX
The Shares may trade on the OTCQX at a price that is at, above or below the Trust’s NAV Per Share.
The price of the Trust’s NAV Per Share fluctuates with changes in the market value of the Portfolio Crypto Assets, and the Sponsor expects the trading price of the Shares to fluctuate in accordance with changes in market supply and demand. However, the Shares traded on the OTCQX may trade at, above or below the Trust’s NAV Per Share for a variety of reasons. For example, because OTCQX will be open for trading in the Shares for a limited period each day, but the Portfolio Crypto Assets may trade in 24-hour marketplaces. During periods when OTCQX is closed but markets for the Portfolio Crypto Assets are open, significant changes in the price of Portfolio Crypto Assets on the markets trade in Portfolio Crypto Assets could result in a difference in performance between the value of Portfolio Crypto Assets and the most recent NAV Per Share or closing trading price. Even during periods when OTCQX is open, large marketplaces for the Portfolio Crypto Assets (or a substantial number of smaller marketplaces) may be lightly traded or be closed for any number of reasons, which could increase trading spreads and widen any premium or discount on the Shares. If the price of Portfolio Crypto Assets drops significantly during the hours OTCQX is closed, Shareholders may not be able to sell their Shares until after the “gap” down has been fully realized, resulting in an inability to mitigate losses in a rapidly worsening market. These premiums or discounts may have an adverse effect on an investment in the Shares if a Shareholder sells or acquires its Shares during a period of discount or premium, respectively.
Due to the fact that the Shares may trade on the OTCQX at a price that is at, above or below the Trust’s NAV Per Share, investors who purchase Shares on the secondary market may pay more than or less than the NAV Per Share paid by Shareholders who invest directly in the Trust.
As described above, the Shares available for purchase on the OTCQX may trade at, above or below the Trust’s NAV Per Share. As a result, investors who purchase Shares on OTCQX may pay more or less for a Share than Shareholders who purchase Shares directly from the Trust at NAV Per Share. The historical difference between the prices quoted on the OTCQX and the NAV Per Share has ranged from a difference of -67.80% to a difference of 649%. Shares traded on OTCQX have traded at both a premium over NAV Per Share and a discount under NAV Per Share. As a result, some investors have paid a premium for the Shares purchased on OTCQX and some investors have paid a discount for the Shares purchased on OTCQX. It is possible that such deviations between the price quoted on the OTCQX and the NAV Per Share may result in a decline in demand for Shares of the Trust, which could then result in a decline in the price of the Shares.
If we fail to meet the continued listing standards of the OTCQX, our Shares may no longer be permitted to trade, which may adversely affect the market price and liquidity of the Shares.
The Shares are currently quoted for trading on the OTCQX. In order to continue trading on the OTCQX, we must maintain a minimum per share bid price, a minimum amount of market capitalization, minimum net tangible assets, and a minimum public float, among other requirements. If we are unable to comply with the OTCQX rules, this could result in an inability of our Shares to trade on this platform, resulting in adverse consequences for our Shareholders, including limited availability of market quotations for our Shares and reduced liquidity for the trading of the Shares.
There is no guarantee that an active trading market for the Shares will continue to develop.
The Shares are qualified for public trading on OTCQX and an active trading market for the Shares has developed. However, there can be no assurance that such trading market will be maintained or continue to develop. In addition, OTCQX can halt the trading of the Shares for a variety of reasons. To the extent that OTCQX halts trading in the Shares, whether on a temporary or permanent basis, investors may not be able to buy or sell Shares, which could adversely affect the value of the Shares. If an active trading market for the Shares does not continue to exist, the market prices and liquidity of the Shares may be adversely affected.
It is possible that the SEC or a court may determine that the Trust’s redemption program, which ended prior to the quotation of the Shares on OTCQX, violated Regulation M.
Regulation M prohibits the issuer of a security from simultaneously engaging in both the sale and purchase of the issuer’s securities. Prior to the approval by OTCQX for the quotation of the Shares, the Trust permitted redemptions of the Shares. The Trust ended its redemption program on October 7, 2020 and OTCQX approved the Shares for quotation on December 9, 2020. The Trust has taken the position that its ceasing the redemption program approximately two months prior to the date on which the Shares were approved for quotation on OTCQX is consistent with the guidance set out by the SEC in the Spotify Technology S.A. No-Action Letter (March 23, 2018), as well as consistent with general market practice by other funds that undertake redemption programs prior to having shares listed or approved for quotation. It is possible, however, that the SEC or the courts may disagree with the Trust’s position and may deem the Trust to have violated Regulation M.
Risks Related to the Market and Investment
An investment in the Trust involves a high degree of risk, including the risk that the entire amount invested may be lost.
An investment in the Trust involves a high degree of risk, including the risk that the entire amount invested may be lost. No guarantee or representation is made that the Trust’s investment program will be successful. The Sponsor will be investing, in accordance with the Index and in line with the investment policies of the Trust, substantially all of the Trust’s assets in Crypto Assets, some of which may be particularly sensitive to economic, market, industry and other variable conditions. The Crypto Asset market in which the Trust expects to invest has in recent years experienced and continues to be susceptible to significant volatility and losses. No assurance can be given as to when or whether adverse events might occur that could cause immediate and significant losses to the Trust.
The success of the Trust’s activities will be affected by general economic and market conditions, which could have a negative effect on the Trust’s activities.
The success of the Trust’s activities will be affected by general economic and market conditions, such as interest rates, availability of credit, credit defaults, inflation rates, economic uncertainty, changes in laws (including laws relating to taxation of the Trust’s investments), trade barriers, currency exchange controls, and national and international political circumstances (including hostilities or the perception that hostilities may be imminent, military conflict and acts of war, including an escalation of the situation in the Middle East or Ukraine and related responses, including sanctions or other restrictive actions, by the United States and/or other countries, terrorism or security operations). These factors may affect, among other things, the level and volatility of Crypto Asset prices and the availability of certain Crypto Assets and investments. Volatility or illiquidity could impair the Trust’s profitability or result in losses. The Trust’s trading positions can be materially adversely affected by the level of volatility in the financial markets—the larger the positions, the greater the potential for loss.
In recent years global markets have experienced significant volatility and illiquidity. The effects thereof may continue and there can be no assurance that the Trust will not be materially adversely affected. Due to these conditions, extensive governmental interventions have in certain cases been implemented on an “emergency” basis, suddenly and substantially eliminating market participants’ ability to continue to implement certain strategies or manage the risk of their outstanding positions. In addition—as one would expect given the complexities of the financial markets and the limited time frame within which governments have felt compelled to take action—these interventions have typically been unclear in scope and application, resulting in confusion and uncertainty. It is impossible to predict what additional interim or permanent governmental restrictions may be imposed on the markets and/or the effect of such restrictions on the Sponsor’s strategies. Further, it is impossible to predict how the reduction and/or cessation of such governmental restrictions, and other governmental market interventions such as quantitative easing, may affect global markets.
Demand for the Trust’s Shares is related to general economic conditions and if conditions are poor, demand may decline.
A substantial portion of the Trust’s subscriptions is derived from discretionary spending by individuals, which typically falls during times of economic instability. Declines in economic conditions in the U.S. or in other countries may adversely impact the Trust’s value.
If the Trust invests in securities, the success of the Trust may depend on the value of such securities.
While the Trust does not currently intend to invest in assets or Crypto Assets that are considered to be “securities” under U.S. securities laws, in the rare event that it does invest in securities, the success of the Trust will be dependent upon the value of these securities. Such value generally will vary with the performance of the issuer and movements in the securities markets. As a result, the Trust may suffer losses if it invests in securities of issuers whose performance diverges from the Sponsor’s expectations or if equity markets generally move in a downward direction.
The Trust intends to make investments that are concentrated in Crypto Assets and does not currently intend to diversify its investments beyond Crypto Assets.
The Trust intends to make investments that are concentrated in Crypto Assets. The Sponsor does not currently intend to engage in hedging transactions, engaging in short selling, or investing in non-publicly traded securities. The Trust may experience lower investment returns than if it had engaged in these activities. In the event that the Sponsor determines to engage in these activities, the Trust may face additional risks, not limited to liquidity risk and counterparty risk, which could adversely affect the Trust’s performance.
The Trust will select investments for the Trust in large part on the basis of information and data provided in the Index, which relies on financial reporting by third parties and such reporting may be subject to financial fraud.
The Trust will select investments for the Trust in large part on the basis of information and data provided in the Index. The Index is dependent upon the integrity of public Crypto Asset exchanges and the reporting processes in general of such exchanges. The Sponsor will not confirm the completeness, genuineness or accuracy of such information and data. Instances of fraud and other deceptive practices committed by public Crypto Asset exchanges may negatively affect the composition of the Index and the valuation of the Trust’s investments. The Sponsor will not be conducting any additional due diligence with respect to the Index.
The Trust’s investment strategy is focused on the long-term performance of the Crypto Assets in which the Trust invests.
While there is no average period of time in which the Trust expects to hold any of its positions, the investment strategy is focused on the long-term performance of the Crypto Assets in which the Trust invests. Shareholders should expect that the Trust may hold its positions in Crypto Assets for a period of years, and for differing time periods than one may potentially expect from other long-only funds.
There is no assurance that all of the Trust’s transactions will be executed with optimal quality and due to the degree of trading, total commission charges and other transaction costs may be expected to be high.
Generally, the Trust’s portfolio is rebalanced and revised monthly in the sole discretion of the Sponsor by tracking changes to the Index, and such changes may be frequent, resulting in significant transaction costs to the Trust. Should any material change be made to the Index Methodology that results in a material change to the composition of the Index and, as part of the Trust’s monthly rebalancing process, results in a material change to the composition of the Trust the Trust will notify Shareholders of such material change by filing a Form 8-K with the SEC. The Trust defines a material change as any change of 10% or more to the composition of the Index. The successful application of the Trust’s investment strategy will therefore depend, in part, upon the quality of execution of transactions. Although the Trust will seek to utilize professional trade execution techniques, work with trading counterparties and use multiple trading venues that will afford superior execution capability to the Trust, there is no assurance that all of the Trust’s transactions will be executed with optimal quality. Furthermore, due to the degree of trading, total commission charges and other transaction costs may be expected to be high. As stated above, many of the Crypto Asset exchanges are in their nascent stages and subject to light regulatory oversight. There is no guarantee that the Sponsor will be able to ascertain the accurate price, cost, speed, likelihood of execution and settlement. Crypto Asset exchanges may also provide a limited selection of market orders, further limiting the Sponsor’s ability to obtain the best possible execution. Furthermore, due to the degree of trading, total commission charges and other transaction costs may be expected to be high. The level of transaction charges, as an expense of the Trust, may therefore be expected to be a factor in determining future profitability of the Trust.
Intellectual property rights claims may adversely affect the Trust and an investment in the Shares.
The Sponsor is not aware of any intellectual property rights claims that may prevent the Trust from operating and holding any Crypto Assets. However, third parties may assert intellectual property rights claims relating to the operation of the Trust and the mechanics instituted for the investment in, holding of and transfer of Crypto Assets. Regardless of the merit of an intellectual property or other legal action, any legal expenses to defend, or payments to settle, such claims would be Extraordinary Expenses that would be borne by the Trust in most cases through the sale or transfer of its Crypto Assets. Additionally, a meritorious intellectual property rights claim could prevent the Trust from operating and force the Sponsor to terminate the Trust and liquidate its Crypto Assets. As a result, an intellectual property rights claim against the Trust could adversely affect an investment in the Shares.
Risks Related to Regulatory and Compliance
A determination that any of the Portfolio Crypto Assets are a “security” may adversely affect the value of the Portfolio Crypto Assets and the value of the Shares, and result in potentially extraordinary, nonrecurring expenses to, or termination of, the Trust.
The SEC has stated that certain Crypto Assets may be considered “securities” under the federal securities laws. If any of the Portfolio Crypto Assets are determined to be a “security” under federal or state securities laws by the SEC or any other agency, or in a proceeding in a court of law or otherwise, it may have material adverse consequences for the Portfolio Crypto Assets, the Sponsor, the Trust, and the Shares. It may, for example, become more difficult for the Portfolio Crypto Assets to be traded, cleared and custodied as compared to other Crypto Assets that are not considered to be securities, which could in turn negatively affect the liquidity and general acceptance of the Portfolio Crypto Assets and cause users to migrate to other Crypto Assets. Further, if other Crypto Assets are determined to be “securities” under federal or state securities laws by the SEC or any other agency, or in a proceeding in a court of law or otherwise, it may have material adverse consequences for the Portfolio Crypto Assets due to negative publicity or a decline in the general acceptance of Crypto Assets. As such, any determination that the Portfolio Crypto Assets or any other Crypto Asset is a security under federal or state securities laws may adversely affect the value of the Portfolio Crypto Assets and, as a result, the value of the Shares.
While the Committee engages in a limited risk-based assessment of Crypto Assets when determining which Crypto Assets to include in the Index, such assessment does not preclude legal or regulatory action based on the presence of a security. Such risk-based assessment includes an evaluation of: 1) public information to determine if the SEC, any other US regulatory agency or any court has made any statements regarding the Crypto Asset, 2) public information regarding how the Crypto Asset markets view the Crypto Asset, including whether the Crypto Asset has been listed on entities such as Coinbase or other US exchanges that would have had access to a reasonable amount of information when making their determinations to list the Crypto Asset, 3) public information to undertake reasonable diligence into the structure and technology of the Crypto Asset, including reviewing the Crypto Asset’s whitepaper if available and speaking with the sponsor of the Crypto Asset, and 4) any other information gained from reputable sources that may impact the Committee’s view of the Crypto Asset. The Committee does not engage in legal analysis of any Crypto Assets or perform any analysis of Crypto Assets based upon any legal standards.
Since the Trust’s principal investment objective is to invest in a portfolio of Crypto Assets that tracks the Index as closely as possible, the Trust relies on the Index Methodology when the Trust determines which Crypto Assets it should invest in. The Trust, in the Sponsor’s sole discretion, may choose to immediately liquidate its position in any Portfolio Crypto Asset that it determines may be at undue risk of being in violation of U.S. federal securities laws or based on consideration of new public information available regarding the asset. The Sponsor makes its determination using the same process as the Committee, as set forth in “Item 1. Business—Eligibility of Crypto Assets.” Assets will lose eligibility and be removed from the Index at the next monthly reconstitution event if they violate any of the listed Eligibility Requirements for 30-consecutive days. Under extraordinary circumstances, assets may lose eligibility and be removed on a same-day basis by a unanimous vote of the quorum of members of the Committee. Such emergency removals will take place at 4:00 pm ET following the conclusion of the meeting and public posting of that notice on the Sponsor’s website.
For example, on December 22, 2020, the SEC instituted proceedings to enjoin Ripple Labs Inc., the creator of XRP, on the basis that the offer and sale of XRP was an unregistered, ongoing offering of securities in violation of Sections 5(a) and 5(c) of the Securities Act. On December 23, 2020, the Trust made a decision to liquidate its position in XRP based on consideration of new public information from the SEC’s complaint. The Trust immediately reinvested the proceeds from the liquidated position in other Portfolio Crypto Assets, primarily Bitcoin and Ethereum.
In addition, to the extent that any Portfolio Crypto Assets are determined to be a security, the Trust, and the Sponsor may also be subject to additional regulatory requirements, including under the Investment Company Act, and the Sponsor may be required to register as an investment adviser under the Investment Advisers Act.
See “Item 1. Business—Overview of Government Regulation” for further information. If the Sponsor determines not to comply with such additional regulatory and registration requirements, the Sponsor will terminate the Trust. Any such termination could result in the liquidation of the Trust’s Portfolio Crypto Assets at a time that is disadvantageous to Shareholders.
There are uncertainties related to the regulatory regimes governing Blockchain technologies, Crypto Assets, Crypto Assets, and new regulations, interpretations or policies may materially adversely affect the value of Portfolio Crypto Assets and the Shares.
Regulation of assets like the Portfolio Crypto Assets and related technologies and actors (such as Blockchains and Crypto Asset exchanges) involves uncertainty as to how existing law will apply; is likely to rapidly evolve as government agencies take greater interest and develop new approaches to regulation of these assets and technologies; and varies significantly among international, federal, state and local jurisdictions.
There is significant uncertainty regarding the regulatory classification of assets like the Portfolio Crypto Assets. Several state and federal regulatory agencies have asserted jurisdiction over virtual currencies such as the Portfolio Crypto Assets which may disrupt Crypto Asset trading, and have a negative impact on their value.
The technologies underlying the Portfolio Crypto Assets are novel technologies and relatively untested, and the application of U.S. federal and state securities laws to aspects of these technologies and the Portfolio Crypto Assets is unclear in certain respects. Because of the novelty of the Portfolio Crypto Assets and their underlying Blockchain technologies, it is possible that securities regulators may interpret laws in a manner that adversely affects the value of the Portfolio Crypto Assets and the Shares. Various legislative and executive bodies in the United States and in other countries may, in the future, adopt laws, regulations, or guidance, or take other actions that could severely or materially impact the permissibility of the operation of the Blockchain networks underlying the Portfolio Crypto Assets and the Trust. It is difficult to predict how or whether regulatory agencies may apply existing or new regulation with respect to this technology and its applications. In addition, self-regulatory bodies may be established that set guidelines regarding Crypto Assets, tokens like the Portfolio Crypto Assets, which could have similar effects to new policies adopted by government bodies. For example, on March 8, 2022, President Biden announced an executive order on cryptocurrencies which seeks to establish a unified federal regulatory regime for cryptocurrencies. Because we are unable to influence or predict future regulatory actions taken by governments in China, the United States, or elsewhere, we may have little opportunity or ability to respond to rapidly evolving regulatory positions which may have a materially adverse effect on our industry and, therefore, our business and results of operations. On November 23, 2022, the governor of New York signed into law a two-year moratorium on new or renewed permits for certain electricity-generating facilities that use fossil fuel and provide energy for proof-of-work digital asset mining operations. While this action does not directly impact our current operations, it may be the beginning of a new wave of climate change regulations aimed at preventing or reducing the growth of Bitcoin mining in jurisdictions in the United States, including potentially jurisdictions in which we now operate or have investors or may in the future operate or have investors. The above-described developments could also demonstrate the beginning of a regional or global regulatory trend in response to environmental and energy preservation or other concerns surrounding crypto assets, and similar action in a jurisdiction in which we operate or have investors or in general could have an adverse effect on our operations. If further regulatory action is taken by various governmental entities, our business may suffer and investors in our securities may lose part or all of their investment.
Any future regulatory actions applicable to the Portfolio Crypto Assets, the Blockchain networks underlying them, the Shares, and our related activities could severely impact us, and the value of the Portfolio Crypto Assets and the Shares. It could also result in negative publicity. Regulatory change could even potentially result in certain operations of our operations being viewed as impermissible, which could negatively affect the value of the Portfolio Crypto Assets and the Shares. If the Sponsor determines not to comply with such additional regulatory and registration requirements, the Sponsor may terminate the Trust, and any such termination could result in the liquidation of the Trust’s Portfolio Crypto Assets at a time that is disadvantageous to Shareholders.
Crypto Asset networks, Blockchain technologies, and Crypto Asset and token offerings also face an uncertain regulatory landscape in many foreign jurisdictions, including (among others) the European Union, China and Russia. Various foreign jurisdictions may, in the future, adopt laws, regulations or directives that affect the Portfolio Crypto Assets and the value of the Shares. The effect of any future regulatory change is impossible to predict, but any change could be substantial and materially adverse to the adoption and value of the Portfolio Crypto Assets and the Shares. For example, China has historically been the world’s largest producer of Bitcoin and has housed the large majority of the world’s crypto asset mining power (some observers estimate that China produced as high as 80% of the world’s crypto asset mining power at certain points in time). In May 2021, the Chinese government called for a crackdown on Bitcoin mining and trading. In September 2021, Chinese regulators instituted a blanket ban on all crypto mining and transactions, including overseas crypto exchange services taking place in China, effectively making all crypto-related activities illegal in China. In January 2022, the Central Bank of Russia called for a ban on cryptocurrency activities ranging from mining to trading. We cannot quantify the effects of these regulatory actions on our industry as a whole. If further regulation follows, it is possible that our industry may not be able to cope with the sudden and extreme loss of mining power.
New or changing laws and regulations or interpretations of existing laws and regulations, in the United States and other jurisdictions, may materially and adversely impact the Portfolio Crypto Assets and the Shares, including with respect to their value, their liquidity, the ability to access marketplaces or exchanges on which to trade the Portfolio Crypto Assets, and the structure, rights and transferability of Portfolio Crypto Assets.
It may be illegal now, or in the future, to mine, acquire, own, hold, sell or use Crypto Assets, participate in blockchains or utilize similar Crypto Assets in one or more countries, the ruling of which could adversely affect us.
Although currently Crypto Assets generally are not regulated or are lightly regulated in most countries, several countries, such as China, India and Russia, may continue taking regulatory actions in the future that could severely restrict the right to mine, acquire, own, hold, sell or use these Crypto Assets or to exchange for local currency. For example, in China and Russia (India is currently proposing new legislation), it is illegal to accept payment in Bitcoin and other cryptocurrencies for consumer transactions and banking institutions are barred from accepting deposits of cryptocurrencies. In addition, in March 2021, the governmental authorities for the Chinese province of Inner Mongolia banned Bitcoin mining in the province due to the industry’s intense electrical power demands and its negative environmental impacts. If other countries, including the U.S., implement similar restrictions, such restrictions may adversely affect us. For example, in New York State, a moratorium on certain Bitcoin mining operations that run on carbon-based power sources was signed into law on November 22, 2022. Such circumstances could have a material adverse effect on us, which could have a material adverse effect on our business, prospects or operations and potentially the value of any Crypto Assets held or otherwise acquired by the Trust.
The limited rights of legal recourse available to us expose us and our investors to the risk of loss of Crypto Assets for which no person is liable.
At this time, there is no specifically enumerated U.S. or foreign governmental, regulatory, investigative or prosecutorial authority or mechanism through which to bring an action or complaint regarding missing or stolen cryptocurrency; though law enforcement agencies like the FBI have recovered stolen Crypto Assets, that recovery has required significant amounts of time. To the extent that we are unable to recover our losses from such action, error or theft, such events could have a material adverse effect on our business, prospects or operations of and potentially the value of any Crypto Assets we held or otherwise acquired by the Trust.
The Trust is not registered as a money transmitter or money services business, and our operations may be adversely affected if it is required to do so.
The Sponsor and the Trust believe that the Trust is not a money transmitter or money services business. If it is deemed to be a money transmitter and/or money services business, the Trust would be subject to significant additional regulation and costs. This could lead to significant changes with respect to operations of the Trust, and suspensions of operations. It could also lead to a decrease in the value of the Shares.
Shareholders in the Trust do not have the protections associated with ownership of interests in an investment company registered under the Investment Company Act, even while our company is subject to the risk of possibly becoming an investment company under the Investment Company Act.
The Investment Company Act is designed to protect investors by preventing insiders from managing investment companies to their benefit and to the detriment of public investors, such as: the issuance of securities having inequitable or discriminatory provisions, the management of investment companies by irresponsible persons, the use of unsound or misleading methods of computing earnings and asset value, changes in the character of investment companies without the consent of investors, and excessive leveraging. To accomplish these ends, the Investment Company Act requires the safekeeping and proper valuation of fund assets, restricts greatly transactions with affiliates, limits leveraging, and imposes governance requirements as a check on fund management. The Trust is not subject to regulation under the Investment Company Act and therefore is not registered as an investment company under the Investment Company Act. Consequently, Shareholders in the Trust do not have the regulatory protections afforded to investors in registered investment companies.
To the extent that Crypto Assets are deemed to fall within the definition of a security for U.S. securities laws purposes, the Sponsor may be required to register and comply with additional regulation under the Investment Company Act. Such additional regulation may result in extraordinary costs to the Trust and Bitwise, thereby materially and adversely impacting the value of the Trust. If the Sponsor determines in its sole discretion not to comply with such additional regulatory and registration requirements, it may terminate the Trust. Any such termination could result in the liquidation of the Trust’s Crypto Asset portfolio at a time that is disadvantageous to Shareholders in the Trust.
Registration under the Investment Company Act would require the Trust to comply with a variety of substantive requirements that impose, among other things:
limitations on capital structure;
restrictions on specified investments;
restrictions on leverage or senior securities;
restrictions on unsecured borrowings;
prohibitions on transactions with affiliates; and
compliance with reporting, record keeping, voting, proxy disclosure and other rules and regulations that would significantly increase the Trust’s operating expenses.
If the Trust was required to register as an investment company but failed to do so, the Trust could be prohibited from engaging in its business, and criminal and civil actions could be brought against the Trust, Sponsor or any of their affiliates. Registration with the SEC as an investment company would be costly, would subject the Trust to a host of complex regulations and would divert attention from the conduct of the Trust’s business, which could materially and adversely affect the Trust.
In addition, the Trust will not be subject to the various statutory and SEC regulatory requirements applicable to registered investment companies. For example, the Trust is not required to maintain custody of its securities or place its securities in the custody of a bank or a member of a U.S. securities exchange in the manner required of registered investment companies under rules promulgated by the SEC. The Trust generally will maintain such accounts at brokerage or custodial firms that do not separately segregate such assets as would be required in the case of registered investment companies. Under the provisions of the U.S. Securities Investor Protection Act, the bankruptcy of any such brokerage firms might have a greater adverse effect on the Trust than registered investment companies. It is possible in the future that the regulatory environment for hedge funds and their Sponsors could change. This could result in new laws or regulations that could, for example, impose restrictions on the operation of the Trust and its affiliates; impose disclosure or other obligations on those entities; or restrict the offering, sale or transfer of Shares. Accordingly, any such laws or regulations could adversely affect the investment performance of the Trust or its access to additional capital, create additional costs and expenses for the Trust or otherwise have an adverse impact on the Trust.
The Shares are not insured by any governmental or private agency and the Trust is not regulated or subject to examination in the same manner as commercial banks and thrift institutions.
The Shares offered hereby are not insured by any governmental or private agency, and they are not guaranteed by any public or private entity other than the Trust. Likewise, the Trust is not regulated or subject to examination in the same manner as commercial banks and thrift institutions.
The Trust is not a commercial bank or savings/thrift institution. The Trust is dependent upon proceeds from the acquisition and management of the Trust’s portfolio to make distributions to the Trust’s Shareholders and to conduct their ongoing operations. The Trust’s revenues from operations, including the acquisition, servicing and management of its portfolio and the Trust’s working capital represent the sources of funds for distributions to the Trust’s Shareholders.
The Sponsor may be required to provide certain information in order to comply with anti-money laundering requirements and public disclosure obligations.
In response to increased regulatory concerns by U.S. and international authorities with respect to the sources of funds used in investment activities, the Sponsor may request Shareholders to provide additional documentation verifying, among other things, such Shareholders’ identity and source of funds used to purchase Shares. The Sponsor may decline to accept a subscription if this information is not provided, or on the basis of such information provided. Requests for documentation and additional information may be made at any time by Sponsor during which a Shareholder holds Shares in the Trust. The Sponsor may be required to provide this information, or report the failure to comply with requests for such information, to appropriate governmental authorities, in certain circumstances without notifying Shareholders that the information has been provided. Each of the Sponsor and the Trust will take steps that it determines are necessary to comply with applicable law, regulations, orders, directives or special measures, which may include prohibiting a Shareholder from making further contributions of capital to the Trust, depositing distributions to which a Shareholder would otherwise be entitled in an escrow account or causing the redemption of all or any portion of a Shareholder’s Shares.
Further, the Trust may be required to disclose confidential information relating to the Trust, the Trust’s investments, the Trust’s financial results and the Trust’s Shareholders to third parties that may request such information if and to the extent required by federal, state or local law or regulation or the laws or regulations of any other jurisdiction applicable to the Trust or any of the Trust’s Shareholders, including any Shareholders who are public agencies or governmental bodies. There can be no assurance that such information will not be disclosed either publicly or to regulators, or otherwise. In addition, in order to comply with regulations and policies to which the Trust, the Sponsor or service providers (including financial institutions) are or may become subject, or to satisfy regulatory or other requirements in connection with transactions, the Trust or the Sponsor may be required to disclose information about Shareholders, including their identities. Such disclosure obligations may adversely affect certain Shareholders, particularly Shareholders who are not otherwise subject to public disclosure of information relating to the private holdings of funds in which they invest.
If regulatory changes or interpretations of the Trust’s or the Sponsor’s activities require registration of the Trust or the Sponsor as a money service business under the regulations promulgated by FinCEN under the authority of the U.S. Bank Secrecy Act, or as a money transmitter (or its equivalent) or virtual currency business (or its equivalent) under state regulatory regimes for the licensing of such businesses, the Trust or the Sponsor may be required to register and/or obtain state licensure and comply with such regulations, which could result in extraordinary, recurring and/or nonrecurring expenses to the Trust or Sponsor, thereby reducing the liquidity of the Shares.
To the extent that the activities of the Trust cause it to be deemed a “money services business,” particularly a “money transmitter,” under the regulations promulgated by FinCEN under the authority of the U.S. Bank Secrecy Act, the Trust may be required to comply with FinCEN regulations, including those that would mandate the Trust register as a money services business, implement an anti-money laundering program, make certain reports to FinCEN, and maintain certain records. Such additional regulatory obligations may cause the Trust to incur Extraordinary Expenses, possibly affecting an investment in the Shares in a material and adverse manner. Additionally, certain states require a virtual currency business (or its equivalent) to register at the state level as a money transmitter (or its equivalent), and/or as a virtual currency business (or its equivalent). Similarly, the activities of the Trust or the Sponsor may require it to be licensed at the state level as a money transmitter (or its equivalent) and/or as a virtual currency business (or its equivalent), such as under New York's Department of Financial Services’ BitLicense regulatory regime.
Such additional regulatory obligations may cause the Trust or the Sponsor to incur Extraordinary Expenses. If the Trust or the Sponsor decide to seek the required registration or licenses, there is no guarantee that they will timely receive them. The Sponsor may decide to terminate the Trust in response to the changed regulatory circumstances, and possibly at a time that is disadvantageous to the Shareholders. Additionally, to the extent the Trust or the Sponsor is found to have operated without appropriate state licenses or federal registration, it may be subject to investigation, administrative or court proceedings, and civil or criminal monetary fines and penalties, all of which would harm the reputation of the Trust or the Sponsor, decrease the liquidity, and have a material adverse effect on the price of, the Shares.
We may be subject to a variety of foreign laws and regulations that involve matters central to our business.
We may also be subject to a variety of foreign laws and regulations that involve matters central to our business. These could include, for example, regulations related to privacy, Blockchain technology, data protection, and intellectual property, among others. In certain cases, foreign laws may be more restrictive than those in the United States. Although we believe we are operating in compliance with the laws of jurisdictions in which we operate, foreign laws and regulations are constantly evolving and can be subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain, particularly in the new and rapidly evolving industry in which we operate. As a result, Crypto Asset networks, Blockchain technologies, and Crypto Asset and token offerings such as those we are involved in face an uncertain regulatory landscape in many foreign jurisdictions, including but not limited to the European Union, China and Russia. Other foreign jurisdictions may also, in the near future, adopt laws, regulations or directives that affect Portfolio Crypto Assets and the Shares.
While we believe that we are in compliance with the laws that apply to us as we understand them, the growth of our business and its expansion outside of the United States may increase the potential of violating foreign laws or our own internal policies and procedures. The risk of us being found in potential violation of applicable laws and regulations is further increased by the fact that many of them are open to a variety of interpretations given the absence of formal interpretation by regulatory authorities or the courts.
Any action brought against us by a foreign regulator or in a private action based on foreign law could cause us to incur significant legal expenses and divert our management’s attention from the operation of the business. If our operations are found to be in violation of any laws and regulations, we may be subject to penalties associated with the violation, including civil and criminal penalties, damages and fines; we could be required to refund payments received by us; and we could be required to curtail or cease operations. Any of these consequences could seriously harm our business and financial results. In addition, existing and proposed laws and regulations can be costly to comply with and can delay or impede the development of new products, result in negative publicity, increase operating costs, require significant management time and attention, and subject us to claims or other remedies, including fines or demands that we modify or cease existing business practices. Any applicable foreign laws, regulations or directives may also conflict with those of the United States. The effect of any future regulatory change is impossible to predict, but any change could be substantial and materially adverse to the value of Portfolio Crypto Assets and the Shares.
We may withhold certain information otherwise to be provided to a Shareholder under certain circumstances in order to prevent public disclosure of such information under the U.S. Freedom of Information Act.
The Sponsor may withhold all or any part of the information otherwise to be provided to a Shareholder (pursuant to the Trust Agreements or otherwise) under certain circumstances in order to prevent public disclosure of such information under the U.S. Freedom of Information Act (“FOIA”), any governmental public records access law, any state or other jurisdiction’s laws similar in intent or effect to FOIA, or any other similar statutory or regulatory requirement. Shareholders may be adversely impacted by such withholding of information, as they will not be able to monitor their investments in the Trust as closely as if there were no withholding of such information.
Shareholders should carefully consider certain consequences under ERISA and the Code.
The following section sets forth certain consequences under ERISA and the Code which a fiduciary of an “employee benefit plan” as defined in and subject to the fiduciary responsibility provisions of ERISA, or of a “plan” as defined in and subject to Section 4975 of the Code, who has investment discretion should consider before deciding to invest the plan’s assets in the Trust (such “employee benefit plans” and “plans” being referred to herein as a “Plan,” and such fiduciaries with investment discretion being referred to herein as a “Plan Fiduciary”). The following summary is not intended to be complete, but only to address certain questions under ERISA and the Code that are likely to be raised by the Plan Fiduciary’s own counsel. Each Shareholder that is a Plan and the corresponding Plan Fiduciary, should consider the matters described in this section in determining whether to invest in the Trust. The Sponsor intends to operate the Trust such that less than twenty-five percent (25%) of the total interests are held by Benefit Plan Investors as defined below. The provisions of ERISA are complex and their application to an investment in the Trust should be reviewed by the appropriate representatives of any Shareholder that is a Plan.
EACH INVESTOR CONSIDERING ACQUIRING SHARES IN THE TRUST MUST CONSULT ITS OWN LEGAL AND TAX ADVISERS BEFORE DOING SO.
Shareholders should consider certain fiduciary matters and prohibited transactions.
In considering an investment in the Trust of a portion of the assets of any Plan and any entity whose underlying assets include plan assets by reason of an investment in such entity by a Plan (a “Benefit Plan Investor”), a Plan Fiduciary should consider, among other factors, (i) whether the investment is allowed by the documents governing the underlying Plan and related trust; (ii) whether the investment satisfies the diversification requirements of Section 404(a)(1)(C) of ERISA, if applicable, to minimize the risk of large losses; (iii) whether the investment provides sufficient liquidity to permit benefit payments to be made as they become due; (iv) whether the investment can meet any requirement that the Plan Fiduciary annually value the assets of the underlying plan; (v) whether the investment is a prudent investment for the Plan, since there is a high degree of risk in purchasing interests in the Trust and it is not expected that there will be any public market in which the interests may be sold or otherwise disposed of; (vi) whether the investment is being made for the exclusive purpose of providing benefits to participants and their beneficiaries; and (vii) whether an investment in the Trust will result in a transaction prohibited by Section 406 of ERISA or Section 4975 of the Code.
ERISA and the Code prohibit Plan Fiduciaries from engaging in various transactions (“Prohibited Transactions”) involving plan assets with persons who have certain relationships with respect to the Plan, such as other plan fiduciaries (a “Party In Interest”). Thus, for example, absent an exemption, the Plan Fiduciaries should not purchase interests in the Trust with assets of any Plan if the Sponsor or any of its affiliates or any of their respective employees either: (i) has investment discretion with respect to such Plan assets; or (ii) has the authority or responsibility to give or regularly gives individualized investment advice with respect to such plan assets, for a fee, where there is an understanding that it will serve as the primary basis for the investment decisions made with respect to such plan assets and that such advice will be based on the particular investment needs of the Plan; or (iii) is an employer maintaining or contributing to such Plan. A party that is described in clause (i) or (ii) of the preceding sentence is a fiduciary under ERISA and the Code with respect to the Plan, and any such purchase might result in a Prohibited Transaction under ERISA and the Code.
If the underlying assets of the Trust were deemed to be “Plan Assets” under ERISA, that could have certain negative consequences.
If the underlying assets of the Trust (as opposed to interests in the Trust alone) were deemed to be “plan assets” under ERISA, (i) the prudence and other fiduciary responsibility standards of Title I of ERISA would extend to investments made by the Trust; and (ii) certain transactions in which the Trust might seek to engage could constitute prohibited transactions.
Under a regulation (the “Plan Assets Regulation”) issued by the U.S. Department of Labor (“DOL”), the assets and properties of certain entities in which a Plan makes an equity investment (other than an investment in a publicly offered security or a security issued by an investment company registered under the Investment Company Act) would be deemed to be assets of the investing Plan unless, among other exceptions, equity participation by Benefit Plan Investors is less than 25% of any class of equity of the entity. Shares in the Trust will be neither publicly offered nor securities issued by an investment company registered under the Investment Company Act, within the meaning of the Plan Assets Regulation, and, although the Sponsor intends that less than 25% of the total interests are held by Benefit Plan Investors, it is possible that Benefit Plan Investors may purchase 25% or more of the interests in the Trust.
If the underlying assets of the Trust were deemed to be “Plan Assets” under ERISA and a non-exempt Prohibited Transaction were to occur, that could have certain negative consequences.
If the Trust’s assets were deemed to constitute “plan assets” subject to Title I of ERISA or Section 4975 of the Code and a non-exempt Prohibited Transaction were to occur, then the Sponsor, as a fiduciary and Party In Interest, and any other Party In Interest that engaged in the Prohibited Transaction could be required (i) to restore to the Plan any profit realized on the transaction and (ii) to reimburse the Plan for any losses suffered by the Plan as a result of such transaction. In addition, each Party In Interest involved could be subject to an excise tax equal to 15% of the amount involved in the Prohibited Transaction for each year such transaction continues and, unless such transaction were corrected within statutorily required periods, to an additional tax of 100%. Plan Fiduciaries who make the decision to invest in an interest in the Trust could, under certain circumstances, be liable as co-fiduciaries for actions taken by the Trust or the Sponsor. Furthermore, unless appropriate administrative exemptions were available or were obtained, the Trust could be restricted from acquiring an otherwise desirable investment or from entering into an otherwise favorable transaction, if such acquisition or transaction would constitute a Prohibited Transaction.
Except as otherwise set forth, the foregoing statements regarding the consequences under ERISA and the Code of an investment in the Trust are based on the provisions of the Code and ERISA as currently in effect, and the existing administrative and judicial interpretations thereunder. No assurance can be given that administrative, judicial or legislative changes will not occur that may make the foregoing statements incorrect or incomplete.
ALLOWING AN INVESTMENT IN THE TRUST IS NOT TO BE CONSTRUED AS A REPRESENTATION BY THE SPONSOR OR ANY OF ITS AFFILIATES, AGENTS OR EMPLOYEES THAT THIS INVESTMENT MEETS SOME OR ALL OF THE RELEVANT LEGAL REQUIREMENTS WITH RESPECT TO INVESTMENTS BY ANY PARTICULAR PLAN OR THAT THIS INVESTMENT IS APPROPRIATE FOR ANY SUCH PARTICULAR PLAN. THE PERSON WITH INVESTMENT DISCRETION SHOULD CONSULT WITH THE PLAN’S ATTORNEY AND FINANCIAL ADVISERS AS TO THE PROPRIETY OF AN INVESTMENT IN THE TRUST IN LIGHT OF THE CIRCUMSTANCES OF THE PARTICULAR PLAN, CURRENT TAX LAW AND ERISA.
The Shareholder may be subject to certain U.S. federal income tax risks.
It is anticipated that the Trust will be classified as a partnership for U.S. federal income tax purposes. Each Shareholder must take into account its allocable share of the partnership items of the Trust. The Trust, like all entities classified as partnerships for federal tax purposes, is subject to a risk of audit by the Internal Revenue Service (“Service”). Any adjustments made to the Trust’s information returns produced by such an audit might result in adjustments to the Shareholder’s tax returns, with respect not only to items related to the Trust, but also to unrelated items. Furthermore, federal, state and local tax laws are subject to change, and Shareholders could incur substantial tax liabilities as a result of changes thereto. Finally, various aspects of income taxation, including federal, state and local taxation and the alternative minimum tax, produce tax effects that can vary based on each taxpayer’s particular circumstances. See “Item 1. Business—Certain U.S. Federal Income Tax Considerations.”
We intend to continue to prorate our items of income, gain, loss and deduction for U.S. federal income tax purposes between transferors and transferees of our Shares on a weekly basis, instead of on the basis of the date a particular Share is transferred. The Service may challenge this treatment, which could change the allocation of items of income, gain, loss and deduction among our Shareholders.
We intend to continue to prorate our items of income, gain, loss and deduction for U.S. federal income tax purposes between transferors and transferees of our Shares on a weekly basis, instead of on the basis of the date a particular Share is transferred. The use of this proration method may not be permitted under existing Treasury regulations that provide for semi-monthly and monthly simplifying conventions and do not specifically authorize the use of the proration method we will adopt. If the Service were to challenge this method or new Treasury regulations were issued, we may be required to change the allocation of items of income, gain, loss and deduction among our Shareholders. See “Item 1. Business—Certain U.S. Federal Income Tax Considerations—Entity Classification and Partnership Taxation—Allocations Between Transferors and Transferees” and “Item 1. Business—Certain U.S. Federal Income Tax Considerations” for additional discussion regarding tax considerations generally.
Shareholders should consult their own tax advisors to determine the tax effects of an investment in the Trust, especially in light of their particular financial situations.
The Trust may, but is not required to, make distributions to Shareholders. Therefore, a Shareholder should not rely on distributions from the Trust to cover the Shareholder’s tax liability associated therewith, if any. Instead, a Shareholder will generally be required to realize the value of its investment in the Trust based on the value of any freely tradeable Shares sold on the OTCQX.
The Service could challenge the deductibility of expenses the Trust (directly or indirectly) incurs.
The Service could challenge the deductibility of expenses the Trust (directly or indirectly) incurs, including the Management Fee, for several reasons, including that those expenses constitute capital expenditures that, among other things, should be added to the Trust’s cost of acquiring its investments and amortized over a period of time or held in suspense until the Trust liquidates or dissolves.
The present U.S. federal income tax treatment of an investment in the Trust may be modified by legislative, judicial or administrative action at any time and any such action may affect investments and commitments previously made.
The present U.S. federal income tax treatment of an investment in the Trust may be modified by legislative, judicial or administrative action at any time and any such action may affect investments and commitments previously made. The overall impact of recent major changes to the Code enacted by the U.S. Congress remains uncertain. The U.S. federal income tax rules are constantly under review by persons involved in the legislative process and by the Service and the Treasury Department, resulting from time to time in the adoption of new Treasury regulations or changes to existing regulations, revised interpretations of established concepts, as well as statutory changes. The Service currently treats virtual currencies as property for U.S. federal income tax purposes, but such treatment may be subject to modification or changes. In addition, the Service recently released additional guidance to the effect that Hard Forks, Airdrops and similar occurrences with respect to digital currencies will under certain circumstances be treated as taxable events giving rise to ordinary income, however, there continues to be uncertainty with respect to the timing and amount of the income inclusions. Any changes in the U.S. federal tax laws or interpretations thereof could adversely affect the tax treatment of an investment in the Trust. Congress constantly scrutinizes the U.S. federal income tax treatment of private investment funds and hedge funds, and there can be no assurance that legislation will not be enacted that has an unfavorable effect on a Shareholder’s investment in the Trust.
The Trust may experience adverse tax consequences.
While the Trust is advised in tax matters by its accountants, the Service may not accept the tax positions taken by the Trust.
The Trust may experience audit risk.
The Service could audit the Trust and adjustments to the Trust’s tax returns could occur as a result. Any such adjustment could result in the Trust paying additional tax, interest and penalties, as well as incremental accounting and legal expenses.
The text of this filing, as the company filed it with the SEC, without its images or exhibits. This is not investment advice.