Blockchain ETFs: a way to gain bitcoin exposure?

Blockchain ETFs have become very popular recently. Tom Bailey takes a closer look at them. 

One of the hottest exchange-traded funds (ETFs) right now is the Invesco Elwood Blockchain ETF (LSE:BCHN). In February this year, the ETF surpassed $1billion in assets under management thanks to strong performance and inflows throughout 2020 and into 2021.

Customers on interactive investor contributed to these inflows, with the ETF appearing on the top 10 most-purchased ETFs list in February in third place.

Investors in this ETF have so far enjoyed excellent returns. Between January 2020 and 10 March 2021, the ETF returned almost 160%, in sterling terms. Over the course of 2020, the ETF provided returns just shy of 90%.

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Driving these inflows, in my view, is the hype around bitcoin and other cryptocurrencies. As readers will be aware, the price of bitcoin and some other lesser-known cryptocurrencies have been on a roll since mid-2020, with bitcoin reaching several new all-time highs.

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Meanwhile, institutional backing for the cryptocurrency seems to be gaining ground, with Tesla (NASDAQ:TSLA) recently announcing that it had bought coins. The defensive investment trust Ruffer (LSE:RICA) also recently announced its portfolio had 2.5% bitcoin exposure in late 2020.

But, as the tech-savvy might point out, the ETF’s name suggests it is focused on blockchain, not bitcoin. While bitcoin uses blockchain technology, many companies that have little or nothing to do with bitcoin or cryptocurrencies have been developing uses for blockchain over the past few years. Simply put, blockchain is a system in which a record of transactions are maintained across several computers that are linked in a peer-to-peer network. One of the supposed key benefits to this is that records cannot be tampered with or changed.

That is true. But while the ETF’s name suggests its focus is on blockchain companies, the ETF tracks the Elwood Blockchain Global Equity Index. The index’s literature makes it clear that companies explicitly involved with cryptocurrencies are also included. For example, the index describes itself as giving exposure to “listed companies that participate or have the potential to participate in the blockchain or cryptocurrency ecosystem”.

As a result, the ETF does have significant exposure to bitcoin and cryptocurrency. Indeed, in this latest quarterly review of the index, Elwood’s analysts explicitly cited the price of bitcoin as driving the returns of the index. They noted: “The index had a strong quarter, driven by the appreciation of cryptocurrency prices.”

Elwood went on to list the companies that contributed the most to performance on the back of this theme. For instance, they note that MicroStrategy (NASDAQ:MSTR) was a big contributor, driven by its “raw bitcoin exposure”.

This company appears to have been added to the index for this very reason in 2020. Last year, the company announced that it had adopted bitcoin as its “primary treasury reserve asset”, acquiring several thousand coins for hundreds of millions of dollars.

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The most recent quarterly report also noted that a big contributor to performance at the end of 2020 was Monex (not listed on ii), which owns Coincheck, a bitcoin exchange operator based in Japan. Also mentioned was Ethereum miner Hive (TSX:HIVE), bitcoin miner Hut 8 (TSE:HUT) and German bitcoin exchange Bitcoin Group (XETRA:ADE).

Looking down the list of holdings, it is easy to spot several other companies that are part of the bitcoin and cryptocurrency theme. For example, the US financial services company Square (NYSE:SQ), founded by Twitter’s Jack Dorsey is in the portfolio. This company, like MicroStrategy, has used corporate cash to gain bitcoin exposure on its balance sheet. Another holding is GMO Internet (not listed on ii), a Japanese tech company that is partly involved in cryptocurrency mining.

The ETF’s largest holding as of 10 March was Canaan Creative (NASDAQ:CAN), accounting for over 11% of the portfolio. This company creates and sells the computer parts needed for cryptocurrency and bitcoin mining. Thanks to the surge in cryptocurrency prices and therefore crypto mining, the company’s share price is up over 300% year-to-date. The ETF regularly rebalances, so that holding will come back down eventually.

Commenting on Canaan Creative in January 2020, analysts at Elwood noted that it was “a pure play cryptocurrency company and sales can be very volatile, as many mining operating entities only commit to new orders during periods of sharp cryptocurrency price appreciation”.

So it is clear that the ETF certainly has plenty of bitcoin and cryptocurrency exposure. However, it is still by no means a bitcoin or cryptocurrency “pure play”. As both the ETF and index’s literature make clear, companies deemed to have the potential to participate in the “blockchain ecosystem”, but that do not have any direct involvement with bitcoin or cryptocurrencies, are also included.

As a result, the portfolio has exposure to seemingly more conventional companies which are developing some sort of blockchain-based component of their business. For example, it has exposure to Oracle (NYSE:ORCL), Mitsubishi (NYSE:MUFG), Santander (LSE: BNC) and Rio Tinto (LSE: RIO). It should be noted, however, that the share prices of these companies are likely largely uncorrelated with general sentiment around either blockchain or bitcoin. While their development of blockchain uses may one day stand them in good stead if blockchain adoption comes to be seen as the norm for businesses, for now their share prices are moved by very different things.

The Invesco ETF is not the only one that offers exposure to the blockchain theme. Also available on ii is the First Trust Indxx Innovative Transaction & Process UCITS ETF (LSE: BLOK), which tracks the Indxx Blockchain Index.

I suspect this ETF has proven less popular than the Invesco one, in part, due to not having blockchain in its name. However, it also has much more conventional exposure. Unlike the Invesco ETF, it does not have a lot of exposure to cryptocurrency miners, crypto exchanges, companies with balance sheets stuffed with bitcoin or other such direct cryptocurrency plays.

Instead, the index looks much more focused on companies developing business uses for blockchain technology. So it is more of a direct thematic play on blockchain rather than a combination of blockchain and cryptocurrencies.

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As a result, a lot of the ETF’s holdings are conventional tech companies. So, for example, the ETF has Chinese tech giant Baidu (NASDAQ:BIDU). This company is often called the Google of China, being China’s most popular search engine. However, the company also has a blockchain service for businesses, called Xuperchain, which explains its presence in the index. What it does not have, however, is any direct exposure to bitcoin.

Another large holding is Moller Maersk (not listed on ii). This company has partnered with Microsoft (NASDAQ:MSFT), which is also in the index, to process marine insurance using blockchain technology. Mining giant BHP (LSE:BHP) is also in the portfolio. The company is apparently using blockchain to track ESG (environmental, social and corporate governance) attributes and verify supplier identities.

Also prominent on the list are semiconductor manufacturers and banks.

All this has made for much more mixed performance. Over the course of 2020, the ETF returned in sterling terms around 15%. Not bad, but way behind the Invesco ETF. Largely this is because the company has had no exposure to the sort of bitcoin-related high-flyers found in the Invesco ETF.

However, also likely holding back performance was the amount of banks found in the portfolio. This makes sense from a thematic perspective. Banks have attempted to develop blockchain applications and, generally, financial services integrate new technology faster than other sectors. But in a year like 2020, that’s led to a drag on performance due to bank shares being highly cyclical.

Other holdings added to performance, but also for non-blockchain reasons. For example, the ETF has a large number of semiconductor companies. Semiconductor chips are vital components in electronics and computers and were in strong demand in 2020. For example, Taiwan Semiconductor Manufacturing (NYSE:TSM), a member of the index, saw its share price increase by about 50% in 2020.

This further underlines the point that while many of the companies in the index are developing blockchain uses, their prices are driven by other factors.