Bitcoin Risk Factors according to Winklevoss Bitcoin Trust

The US Securities and Exchange Commission (SEC) has received a registration for a Bitcoin Fund. In case you wonder what the risks are of investing in Bitcoin, here is the quite extensive list as noted in the fund prospectus:

Risk Factors Related to the Bitcoin Network and Bitcoins
The loss or destruction of a private key required to access a Bitcoin may be irreversible. The Trust’s loss of access to its private keys or its experience of a data loss relating to the Trust’s Bitcoins could adversely affect an investment in the Shares.

Bitcoins are controllable only by the possessor of both the unique public and private keys relating to the local or online digital wallet in which the Bitcoins are held, which wallet’s public key or address is reflected in the Bitcoin Network’s public Blockchain. The Trust publishes the public key relating to digital wallets in use by the Trust when it verifies the receipt of Bitcoin transfers and disseminates such information into the Bitcoin Network, but is required to safeguard the private keys relating to such digital wallets using the Security System. To the extent such private keys are lost, destroyed or otherwise compromised, the Trust will be unable to access the related Bitcoins and such private keys will not be capable of being restored by the Bitcoin Network. Any loss of private keys relating to digital wallets used to store the Trust’s Bitcoins could adversely affect an investment in the Shares.

The further development and acceptance of the Bitcoin Network and other Digital Math-Based Asset systems, which represent a new and rapidly changing industry, are subject to a variety of factors that are difficult to evaluate. The slowing or stopping of the development or acceptance of the Bitcoin Network may adversely affect an investment in the Shares.

Digital Math-Based Assets such as Bitcoins may be used, among other things, to buy and sell goods and services are a new and rapidly evolving industry of which the Bitcoin Network is a prominent, but not unique, part. The growth of the Digital Math-Based Assets industry in general, and the Bitcoin Network in particular, is subject to a high degree of uncertainty. The factors affecting the further development of the Digital Math-Based Assets industry, as well as the Bitcoin Network, include:

• Continued worldwide growth in the adoption and use of Bitcoins and other Digital Math-Based Assets;

• Government and quasi-government regulation of Bitcoins and other Digital Math-Based Assets and their use , or restrictions on or regulation of access to and operation of the Bitcoin Network or similar Digital Math-Based Asset systems;

• Changes in consumer demographics and public tastes and preferences;

• The availability and popularity of other forms or methods of buying and selling goods and services, including new means of using fiat currencies; and

• General economic conditions and the regulatory environment relating to Digital Math-Based Assets.

The Trust is not actively managed and will not have any strategy relating to the development of the Bitcoin Network. Furthermore, the Sponsor cannot be certain as to the impact of the creation of the Trust and the expansion of its Bitcoin holdings on the Digital Math-Based Assets industry and the Bitcoin Network. A decline in the popularity or acceptance of the Bitcoin Network would harm the price of the Shares.

Currently, there is relatively small use of Bitcoins in the retail and commercial marketplace in comparison to relatively large use by speculators, thus contributing to price volatility that could adversely affect an investment in the Shares.

As relatively new products and technologies, Bitcoins and the Bitcoin Network have not been widely adopted as a means of payment for goods and services by major retail and commercial outlets. Conversely, a significant portion of Bitcoin demand is generated by speculators and investors seeking to profit from the short—or long-term holding of Bitcoins. The relative lack of acceptance of Bitcoins in the retail and commercial marketplace limits the ability of end-users to pay for goods and services with Bitcoins. A lack of expansion by Bitcoins into retail and commercial markets, or a contraction of such use, may result in increased volatility or a reduction in the Blended Bitcoin Price, either of which could adversely impact an investment in the Shares.

The administrators of the Bitcoin Network’s source code could propose amendments to the Bitcoin Network’s protocols and software that, if accepted and authorized by the Bitcoin Network’s community, could adversely affect an investment in the Shares.

The Bitcoin Network is based on a cryptographic, algorithmic protocol that governs the end-user-to-end-user interactions between computers connected to the Bitcoin Network. The code that sets forth the protocol is managed by a development team that was appointed by the Bitcoin Network’s purported creator, Satoshi Nakamoto. The development team can propose amendments 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 Bitcoins, including the irreversibility of transactions and limitations on the mining of new Bitcoins. 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 Shares. If less than a significant majority of the users and miners on the Bitcoin Network install such software upgrade(s), the Bitcoin Network could “fork.” See “Risk Factors—The acceptance of Bitcoin Network software patches or upgrades by a significant, but not overwhelming, percentage of the users and miners in the Bitcoin Network could result in a ‘fork’ in the Blockchain….”

If a malicious actor or botnet obtains control in excess of 50 percent of the processing power active on the Bitcoin Network, such actor or botnet could manipulate the source code of the Bitcoin Network or the Blockchain in a manner that adversely affects an investment in the Shares or the ability of the Trust to operate.
To the extent that a malicious actor or botnet (a volunteer or hacked collection of computers controlled by networked software coordinating the actions of the computers) obtains a majority of the processing power on the Bitcoin Network, it could alter the source code and Blockchain on which the Bitcoin Network and all Bitcoin transactions rely. To the extent that such malicious actor or botnet does not yield its majority control of the processing power on the Bitcoin Network, reversing any changes made to the source code or Blockchain may not be possible. Such changes could adversely affect an investment in the Shares or the ability of the Trust to operate.

As the number of Bitcoins awarded for solving a block in the Blockchain decreases, the incentive for miners to continue to contribute processing power to the Bitcoin Network will transition from a set reward to transaction fees. The requirement from miners of higher transaction fees in exchange for recording transactions in the Blockchain may decrease demand for Bitcoins and prevent the expansion of the Bitcoin Network to retail merchants and commercial businesses, resulting in a reduction in the Blended Bitcoin Price.

If transaction fees paid for the recording of transactions in the Blockchain become too high, the marketplace may be reluctant to accept Bitcoins as a means of payment and existing users may be motivated to switch from Bitcoins to another Digital Math-Based Asset or back to fiat currency. Decreased use and demand for Bitcoins may adversely affect their value and result in a reduction in the Blended Bitcoin Price.

If the award of Bitcoins for solving blocks and transaction fees for recording transactions are not sufficiently high to incentivize miners, miners may cease expending processing power to solve blocks and confirmations of transactions on the Blockchain could be slowed. A reduction in the processing power expended by miners on the Bitcoin Network could increase the likelihood of a malicious actor or botnet obtaining control in excess of 50 percent of the processing power active on the Bitcoin Network or the Blockchain, permitting such actor or botnet to manipulate the source code of the Bitcoin Network in a manner that adversely affects an investment in the Shares or the ability of the Trust to operate.

If transaction fees are not sufficiently high, miners may not have an adequate incentive to continue mining and may cease their mining operations. Miners ceasing operations would reduce the collective processing power on the Bitcoin Network, which would adversely affect the confirmation process for transactions and make the Bitcoin Network more vulnerable to a malicious actor or botnet obtaining control in excess of 50 percent of the processing power on the Bitcoin Network. Any reduction in confidence in the confirmation process or processing power of the Bitcoin Network may adversely impact an investment in the Shares.

The acceptance of Bitcoin Network software patches or upgrades by a significant, but not overwhelming, percentage of the users and miners in the Bitcoin Network could result in a “fork” in the Blockchain, resulting in the operation of two separate networks until such time as the forked Blockchains are merged. The temporary or permanent existence of forked Blockchains could adversely impact an investment in the Shares.

Bitcoin is an open source project and, although there is an influential group of leaders in the Bitcoin Network community including developers, there is no official developer or group of developers that formally controls 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 software downloads and upgrades. However, miners and users must consent to those software modifications by downloading the altered software or upgrade implementing the changes; otherwise, the changes do not become a part of the Bitcoin Network. Since the Bitcoin Network’s inception, changes to the Bitcoin Network have been accepted by the vast majority of users and miners, ensuring that the Bitcoin Network remains a coherent economic system. However, 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 population of participants in the Bitcoin Network. In such a case, a 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). Such a fork in the Blockchain typically would be addressed by community-led efforts to merge the forked Blockchains, and several prior forks have been so merged. This kind of split in the Bitcoin Network could materially and adversely affect the Blended Bitcoin Price (and thus the value of the Shares) and, in the worst case scenario, harm the sustainability of the Bitcoin economy.

Intellectual property rights claims may adversely affect the operation of the Bitcoin Network.
Third parties may assert intellectual property claims relating to the operation of Digital Math-Based Assets and their source code relating to the holding and transfer of such assets. Regardless of the merit of any intellectual property or other legal action, any threatened action that reduces confidence in the Bitcoin Network’s long-term viability or the ability of end-users to hold and transfer Bitcoins may adversely

affect an investment in the Shares. Additionally, a meritorious intellectual property claim could prevent the Trust and other end-users from accessing the Bitcoin Network or holding or transferring their Bitcoins, which could force the Trustee to terminate the Trust and liquidate the Trust’s Bitcoins (if such liquidation of the Trust’s Bitcoins is possible). As a result, an intellectual property claim against the Trust could adversely affect an investment in the Shares.
Risk Factors Related to the Bitcoin Exchange Market and the Bitcoin Blended Price
The value of the Shares relates directly to the value of the Bitcoins held by the Trust and fluctuations in the price of Bitcoins could adversely affect an investment in the Shares.

The Shares are designed to mirror as closely as possible the performance of the Blended Bitcoin Price, and the value of the Shares relates directly to the value of the Bitcoins held by the Trust, less the Trust’s liabilities (including estimated accrued but unpaid fees and expenses). The price of Bitcoins has fluctuated widely over the past three years. Several factors may affect the Blended Bitcoin Price, including, but not limited to:

• Global Bitcoin supply;

• Global Bitcoin demand, which is influenced by the growth of retail merchants’ and commercial businesses’ acceptance of Bitcoins as payment for goods and services, the security of online Bitcoin Exchanges and digital wallets that hold Bitcoins, the perception that the use and holding of Bitcoins is safe and secure, and the lack of regulatory restrictions on their use;

• Investors’ expectations with respect to the rate of inflation;

• Interest rates;

• Currency exchange rates, including the rates at which Bitcoins may be exchanged for fiat currencies;

• Investment and trading activities of large investors, including private and registered funds, that may directly or indirectly invest in Bitcoins;

• Monetary policies of governments, trade restrictions, currency devaluations and revaluations;

• Regulatory measures, if any, that restrict the use of Bitcoins as a form of payment;

• Global or regional political, economic or financial events and situations; and

• Expectations among Bitcoin economy participants that the value of Bitcoins will soon change.

In addition, investors should be aware that there is no assurance that Bitcoins will maintain their long-term value in terms of purchasing power in the future or that the acceptance of Bitcoin payments by mainstream retail merchants and commercial businesses will continue to grow. In the event that the price of Bitcoins declines, the Sponsor expects the value of an investment in the Shares to decline proportionately.

The value of Bitcoins as represented by the Blended Bitcoin Price may be subject to momentum pricing whereby the current Blended Bitcoin Price may account for speculation regarding future appreciation in value. Momentum pricing of Bitcoins may subject the Blended Bitcoin Price to greater volatility and adversely affect an investment in the Shares.

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 Blended Bitcoin Price is determined using data from various Bitcoin Exchanges that are selected by the Sponsor. The Sponsor believes that momentum pricing of Bitcoins has resulted, and may continue to result, in speculation regarding future appreciation in the value of Bitcoins, inflating and making more volatile the Blended Bitcoin Price. As a result, Bitcoins may be more likely to fluctuate in value due to changing investor confidence in future appreciation in the Blended Bitcoin Price, which could adversely affect an investment in the Shares.

The Blended Bitcoin Price is based on the daily average of the high and low trading prices on various Bitcoin Exchanges in the Bitcoin Exchange Market chosen by the Sponsor. Pricing on any Bitcoin Exchange on the Bitcoin Exchange Market can be volatile and can adversely affect an investment in the Shares.
The Blended Bitcoin Price has a limited history and is based on a weighted average daily price of Bitcoins, using the average of the high and low trading prices on various Bitcoin Exchanges chosen by the Sponsor. The Blended Bitcoin Price will be calculated as of 3:00 p.m. New York time on each Evaluation Day using data collected from the selected Bitcoin Exchanges for the prior [ ] hours.

The price of Bitcoins on public Bitcoin Exchanges has a limited, three-year history. During such history, Bitcoin prices on the Bitcoin Exchange Market as a whole, and on Bitcoin Exchanges individually, have been volatile and subject to influence by many factors including the levels of liquidity on Bitcoin Exchanges. Even the largest Bitcoin Exchanges have been subject to operational interruption (e.g., the temporary shutdown of Mt. Gox due to distributed denial of service attacks (“DDoS Attacks”) by hackers and/or malware), limiting the liquidity of Bitcoins on the Bitcoin Exchange Market and resulting in volatile prices and a reduction in confidence in the Bitcoin Network and the Bitcoin Exchange Market.

The Blended Bitcoin Price is designed to have limited exposure to Bitcoin Exchange interruption by [ ] using data from various Bitcoin Exchanges selected by the Sponsor. The methodology for calculating the Blended Bitcoin Price calls for the periodic updating of the constituent Bitcoin Exchanges used for the Blended Bitcoin Price and for the substitution of a constituent Bitcoin Exchange to the extent that one of the [ ] constituent Bitcoin Exchanges does not report transactions for 24 consecutive hours. Despite efforts to ensure accurate, weighted pricing, the Blended Bitcoin Price, and the price of Bitcoins generally, remains subject to volatility experienced by the Bitcoin Exchanges. Such volatility can adversely affect an investment in the Shares.

The Bitcoin Exchanges on which Bitcoins trade are relatively new and largely unregulated and may therefore be more exposed to fraud and failure than established, regulated exchanges for other products. To the extent that the Bitcoin Exchanges representing a substantial portion of the volume in Bitcoin trading are involved in fraud or experience security failures or other operational issues, such Bitcoin Exchanges’ failures may result in a reduction in the Blended Bitcoin Price and can adversely affect an investment in the Shares.

The Bitcoin Exchanges on which the Bitcoins trade are new and largely unregulated. The Blended Bitcoin Price on which the NAV of the Shares is based utilizes data from Bitcoin Exchanges selected by the Sponsor to determine the weighted average price for Bitcoins. For a further discussion of the Bitcoin Exchange Market and the selection of Bitcoin Exchanges for inclusion in the Blended Bitcoin Price, see “Overview of the Bitcoin Industry and Market—Bitcoin Value” and “—Uses of Bitcoins.”
Over the past three years, many Bitcoin Exchanges have been closed due to fraud, failure or security breaches. In many of these instances, the customers of such Bitcoin Exchanges were not compensated or made whole for the partial or complete losses of their account balances in such Bitcoin Exchanges. While smaller Bitcoin Exchanges are less likely to have the infrastructure and capitalization that make larger Bitcoin Exchanges more stable, larger Bitcoin Exchanges are more likely to be appealing targets for hackers and “malware” (i.e., software used or programmed by attackers to disrupt computer operation, gather sensitive information or gain access to private computer systems).

A lack of stability in the Bitcoin Exchange Market and the closure or temporary shutdown of Bitcoin Exchanges due to fraud, business failure, or hackers or malware may reduce confidence in the Bitcoin Network and result in greater volatility in the Blended Bitcoin Price. Furthermore, the closure or temporary shutdown of a constituent Bitcoin Exchange used in calculating the Blended Bitcoin Price may result in a loss of confidence in the Trust’s ability to determine NAV on a daily basis. These potential consequences of a Bitcoin Exchange’s failure could adversely affect an investment in the Shares.

Since there is no limit on the number of Bitcoins that the Trust may acquire, the Trust itself, as it grows, may have an impact on the supply and demand of Bitcoins that ultimately may affect the price of the Shares in a manner unrelated to other factors affecting the global market for Bitcoins.

The Trust Agreement places no limit on the number of Bitcoins the Trust may hold. Moreover, the Trust may issue an unlimited number of Shares, subject to registration requirements, and therefore acquire an unlimited number of Bitcoins. The global market for Bitcoins is characterized by supply and demand constraints that generally are not present in the markets for commodities or other assets such as gold and silver. The Bitcoin Network’s mathematical protocols under which Bitcoins are created or “mined” permit the creation of a limited, predetermined number of Bitcoins not to exceed 21 million. Furthermore, the rate of creation or issuance of Bitcoins cannot be increased ahead of the protocol’s schedule. As of [ ], 2013, [11, , ] Bitcoins had been created.

If the number of Bitcoins acquired by the Trust is large enough relative to global Bitcoin supply and demand, further in-kind creations and redemptions of Shares could have an impact on the supply and demand of Bitcoins in a manner unrelated to other factors affecting the global market for Bitcoins. Such an impact could affect the Blended Bitcoin Price, which would directly affect the price at which Shares are traded on the [EXCHANGE] or the price of future Baskets created or redeemed by the Trust.

As of [ ], 2013, the Trust held approximately [ ] Bitcoins that it acquired in the sale of the Initial Baskets on [ ], 2013, representing approximately 0.[ ] percent of the [ ], 2013 world Bitcoin supply. The Trust and the Sponsor cannot provide any assurance that increased Bitcoin holdings by the Trust in the future will have no long-term impact on the Blended Bitcoin Price, thereby affecting Share trading prices.
The Shares may trade at a discount or premium in the trading price relative to the NAV per Share as a result of non-concurrent trading hours between the [EXCHANGE] and the Bitcoin Exchange Market.

The value of a Share may be influenced by non-concurrent trading hours between the [EXCHANGE] and various Bitcoin Exchanges, including those that represent components of the Blended Bitcoin Price. While the [EXCHANGE] is open for trading in the Shares for a limited period each day, the Bitcoin Exchange Market is a 24-hour marketplace; however, trading volume and liquidity on the Bitcoin Exchange Market is not consistent throughout the day and Bitcoin Exchanges, including the larger-volume markets, have been known to shut down temporarily or permanently due to security concerns, directed denial of service attacks and DDoS Attacks and other reasons. As a result, during periods when the [EXCHANGE] is open but large Bitcoin Exchanges (or a substantial number of smaller Bitcoin Exchanges) are either lightly traded or are closed, trading spreads and the resulting premium or discount on the Shares may widen and, therefore, increase the difference between the price of the Shares and the NAV per Share. 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.

A possible “short squeeze” due to a sudden increase in demand for the Shares that largely exceeds supply may lead to price volatility in the Shares.
Investors may purchase Shares to hedge existing Bitcoin or other Digital Math-Based Assets, commodity or currency exposure or to speculate on the price of Bitcoins. Speculation on the price of Bitcoins may involve long and short exposures. To the extent that aggregate short exposure exceeds the number of Shares available for purchase (for example, in the event that large redemption requests by Authorized Participants dramatically affect Share liquidity), investors with short exposure may have to pay a premium to repurchase Shares for delivery to Share lenders. Those repurchases may, in turn, dramatically increase the price of the Shares until additional Shares are created through the creation process. This is often referred to as a “short squeeze.” A short squeeze could lead to volatile price movements in the Shares that are not directly correlated to the price of Bitcoins.

Purchasing activity in the Bitcoin Exchange Market associated with Basket creations or selling activity following Basket redemptions may affect the Blended Bitcoin Price and Share trading prices. These price changes may adversely affect an investment in the Shares.

Purchasing activity associated with acquiring Bitcoins required for deposit with the Trust in connection with the creation of Baskets may increase the market price of Bitcoins on the Bitcoin Exchange Market, which will result in higher prices for the Shares. Increases in the market price of Bitcoins may also occur as a result of the purchasing activity of other market participants. Other market participants may attempt to benefit from an increase in the market price of Bitcoins that may result from increased purchasing activity of Bitcoins connected with the issuance of Baskets. Consequently, the market price of Bitcoins may decline immediately after Baskets are created. If the Blended Bitcoin Price declines, the trading price of the Shares will also decline.

Selling activity associated with sales of Bitcoins withdrawn from the Trust in connection with the redemption of Baskets may decrease the market price of Bitcoins on the Bitcoin Exchange Market, which will result in lower prices for the Shares. Decreases in the market price of Bitcoins may also occur as a result of the selling activity of other market participants. If the Blended Bitcoin Price declines, the trading price of the Shares will also decline.
An investment in the Shares may be adversely affected by competition from other methods of investing in Bitcoins.

The Trust will compete with direct investments in Bitcoins and other potential financial vehicles, including securities backed by or linked to Bitcoins and DMBA ETPs similar to the Trust. Market and financial conditions, and other conditions beyond the Sponsor’s control, may make it more attractive to invest in other financial vehicles or to invest in Bitcoins directly, which could limit the market for the Shares and reduce the liquidity of the Shares.
The Blended Bitcoin Price may be affected by the sale of DMBA ETPs tracking the price of Bitcoins.

To the extent DMBA ETPs tracking the price of Bitcoins are formed and represent a significant proportion of demand for Bitcoins, large redemptions of the securities of these DMBA ETPs could negatively affect the Blended Bitcoin Price and the price and NAV of the Shares.

Political or economic crises may motivate large-scale sales of Bitcoins, which could result in a reduction in the Blended Bitcoin Price and adversely affect an investment in the Shares.

As an alternative to fiat currencies that are backed by central governments, Digital Math-Based Assets such as Bitcoins, 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 may motivate large-scale acquisitions or sales of Bitcoins either globally or locally. Large-scale sales of Bitcoins would result in a reduction in the Blended Bitcoin Price and adversely affect an investment in the Shares.

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