How Bitcoin could become bone fide collateral
This could unlock many diversification options for Bitcoin wealth
Bitcoin, the cockroach of the financial system, may become respectable soon.
“Respectable” is not my opinion.
Rather, it is the de facto opinion of nearly the entire traditional financial sector, which does not currently accept self-custodied/on-chain Bitcoin as collateral for margin loans.
Several large institutions are, in effect, saying, “We’re happy to broker Bitcoin transactions for you (and collect commissions!), but will not underwrite any risk, even if we custody for you.”
If Bitcoin were marginable, it could unlock liquidity for investors wishing to diversify via completion portfolios, long/short mandates, options collars, variable prepaid forwards, and more.
The holdup seems to be both risk and regulatory1, rather than technical2.
In any event, SEC permitting in-kind creation and redemption for Bitcoin and Ethereum exchange-traded products could, through some alchemy, make Bitcoin marginable.
One way Bitcoin could transition from on-chain (self-custody) to traditional custody could be via IRC Section 351.
If you’re curious how Section 351 works, see my book (I have about 20 physical copies left 😉).
The following infographic shows how this could work.
The idea is to combine a diversified stock portfolio with on-chain Bitcoin and then seed a new similarly-mandated Bitcoin ETF with those assets.
The new ETF would be marginable, just as IBIT is marginable3.
Seeding an ETF with self-custodied Bitcoin wasn’t possible before SEC permitted in-kind creation and redemption earlier this week.
This is still very much up in the air, so stay tuned for updates as the dust settles and the implementation mechanics become clearer.
There’s a chance we see a variety of mixed asset ETFs come to market to promote frictionless rebalancing and diversified, portfolio-level access to Bitcoin.
And there’s a possibility these ETFs are seeded in-kind.
Habit forming
Have a great weekend.
Regulation T governs credit extended by brokers in margin accounts, and since Bitcoin is a commodity, it is not marginable.
Interestingly, FTX, the now-defunct crypto exchange, used margin loans that liquidated positions automatically. No margin calls. No warnings. As Going Infinite notes, it was arguably the most brutal and efficient risk control imaginable. But it worked.
IBIT is a security and is therefore marginable. Interactive Brokers makes a passing reference to crypto in its Exposure Fee explainer.