Osprey Bitcoin Trust: Form 10-Q for the period ended Sep 30, 2021

The following discussion and analysis of our financial condition and results of operations should be read together with, and is qualified in its entirety by reference to, our unaudited financial statements and related notes included elsewhere in this Quarterly Report, which have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”). The following discussion may contain forward-looking statements based on assumptions we believe to be reasonable. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those set forth under Part II, Item 1A. Risk Factors in this Quarterly Report.

Trust Overview

The Trust is a passive investment vehicle and its assets will not be actively managed. As a result, it will not engage in any activities designed to obtain a profit from, or to ameliorate losses caused by, changes in the market prices of Bitcoins.

The investment objective of the Trust is for the Units to reflect the performance of Bitcoin as measured by reference to the Index, less the aggregate Trust expenses and other liabilities. The Units are intended to constitute a cost-effective and convenient means of gaining investment exposure to Bitcoin. However, an investment in the Units may operate and perform differently over time, and at any given time, than an investment directly in Bitcoin due to such factors as Trust fees and expenses, the quantity of Units available for trading, and the relative liquidity, and differences in the markets trading Bitcoin from the markets trading the Units (e.g. hours of operation, marketplace rules, clearance and settlement, market participants). Although the Units will not be the exact equivalent of a direct investment in Bitcoin, they provide investors with an alternative that constitutes a relatively cost-effective way to participate in Bitcoin markets through the securities market.

The activities of the Trust are limited to (i) issuing Units in exchange for cash or Bitcoin transferred to the Trust as consideration in connection with the issuance of those Units, (ii) transferring or selling Bitcoin (including forks in the Bitcoin Network) as necessary to pay the 0.49% Management Fee, audit fees, index license fees, aggregate legal fees in excess of $50,000 and the fees of the Custodian (collectively, the “Excluded Expenses”) and certain extraordinary expenses of the Trust, including but not limited to taxes and governmental charges, expenses and costs, expenses and indemnities related to any extraordinary services performed by the Sponsor (or any other service provider, including the Trustee) on behalf of the Trust to protect the Trust or the interest of Unitholders, indemnification expenses, fees and expenses related to public quotation on OTCQX (collectively, the “Extraordinary Expenses”), (iii) transferring Bitcoin in exchange for Units surrendered for redemption (at such time as redemptions from the Trust are permitted by the SEC and subject to the approval of the Sponsor), (iv) causing the Sponsor to sell Bitcoins upon the termination of the Trust, (v) making distributions of Bitcoin (including any Additional Currency (as defined below)) or cash from the sale thereof, and (vi) engaging in all administrative and security procedures necessary to accomplish such activities in accordance with the provisions of the Trust Agreement and the custodial services agreement.

At this time, the Trust is not operating a redemption program for Units and therefore Units are not redeemable by the Trust. In addition, the Trust may halt issuances of Units for extended periods of time. As a result, the value of the Units of the Trust may not approximate, and when traded on any secondary market, the Units may trade at a substantial premium over, or discount to, the Trust’s NAV per Unit.

Additional Currency

From time to time, the Trust may come into possession of rights incident to its ownership of Bitcoins, which permit the Trust to acquire, or otherwise establish dominion and control over, other virtual currencies. These rights are generally expected to arise in connection with forks in the Blockchain, airdrops offered to holders of Bitcoins and other similar events and arise without any action of the Trust or of the Sponsor or Trustee on behalf of the Trust. We refer to these rights as “Incidental Rights” and any such virtual currency acquired through Incidental Rights as “Additional Currency.” The Trust does not expect to take any Additional Currency it may hold into account for purposes of determining the Trust’s Bitcoin Holdings or the Bitcoin Holdings per Unit.

With respect to any fork, airdrop or similar event, the Sponsor may, in its discretion, decide to cause the Trust to distribute the Additional Currency in-kind to an agent of the Unitholders for resale by such agent, or to irrevocably abandon the Additional Currency. In the case of a distribution in-kind, the Unitholders’ agent would attempt to sell the Additional Currency, and if the agent is able to do so, remit the cash proceeds to Unitholders. There can be no assurance as to the price or prices for any Additional Currency that the agent may realize, and the value of the Additional Currency may increase or decrease after any sale by the agent. In the case of abandonment, the Trust would not receive any direct or indirect consideration for the Additional Currency and thus the value of the Units will not reflect the value of the Additional Currency.

Trust Expenses

The Trust’s only ordinary recurring expenses are expected to be the Management Fee, index license fees and custody fees. The Trust is also responsible for annual legal fees in excess of $50,000, and audit fees. The Management Fee is assessed at an annual rate of 0.49% of the daily NAV of the Trust and will accrue solely in Bitcoins and will be payable at the Sponsor’s sole discretion, in Bitcoins or U.S. dollars and valued at the Bitcoin Market Price (as defined below) in effect for such Bitcoin at the time of such payment. The Management Fee is payable to the Sponsor monthly in arrears. If the Trust holds any Additional Currency, the Trust may pay the Management Fee, in whole or in part, with such Additional Currency by entering into an agreement with the Sponsor and transferring such Additional Currency to the Sponsor at a value to be determined in accordance with the terms of such agreement, but only if such agreement and transfer do not conflict with the terms of the Trust Agreement.

The Trust’s NAV is calculated daily, by reference to the Bitcoin market price as measured at 4:00 p.m., New York time available at https://pro.coinbase.com/trade/BTC-USD (the “Bitcoin Market Price”). The administrator, on behalf of the Trust, accrues the custody and Management Fees on a daily basis. Expenses are accrued in Bitcoin, and the accrual balance is evaluated daily, based on the fluctuations in the Bitcoin Market Price. Custody fees are calculated based on the total Bitcoins held in the Trust as of the end of the day and according to the agreed upon fee schedule with the Custodian. Management Fees are calculated daily net of the current day-accrued Custody fees. All expenses are allocated pro rata based on the number of Units issued and outstanding.

To cause the Trust to pay Trust Expenses, the Sponsor will instruct the Custodian to (i) withdraw from the Bitcoin account the number of Bitcoins equal to the accrued but unpaid Fees and (ii) transfer such Bitcoins to the Sponsor’s account at such times as the Sponsor determines in its absolute discretion.

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As partial consideration for its receipt of the Management Fee, the Sponsor has assumed the obligation to pay the fees paid to the Trustee, the Transfer Agent, and the Custodian (“Assumed Expenses”). The Sponsor has not assumed the obligation to pay Assumed Expenses.

After payment of the Assumed Expenses for the Trust, the Sponsor may use the remaining portion of the Management Fee received from the Trust at its discretion, which may include the payment of fees from time to time for the referral of new investors in the Trust.

The number of Bitcoins represented by a Unit will decline each time the Trust pays the Management Fee or any Assumed Expenses by transferring or selling Bitcoins.

Critical Accounting Policies and Estimates

Investment Transactions and Revenue Recognition

The Trust considers investment transactions to be the receipt of Bitcoin for Units creations and the delivery of Bitcoin for Units redemptions or for payment of expenses in Bitcoin. At this time, the Trust is not accepting redemption requests from unitholders. The Trust records its investment transactions on a trade date basis and changes in fair value are reflected as net change in unrealized appreciation or depreciation on investments. Realized gains and losses are calculated using the specific identification method. Realized gains and losses are recognized in connection with transactions including settling obligations for the Sponsor Fee in Bitcoin.

Principal Market and Fair Value Determination

To determine which Bitcoin market will serve as the Trust’s principal market (or in the absence of a principal market, the most advantageous market) for purposes of calculating the Trust’s NAV, the Trust follows Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820-10, which outlines the application of fair value accounting. ASC 820-10 determines fair value to be the price that would be received for Bitcoin in a current sale, which assumes an orderly transaction between market participants on the measurement date. ASC 820-10 requires the Trust to assume that Bitcoin is sold in its principal market to market participants or, in the absence of a principal market, the most advantageous market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact.

The Trust purchases Bitcoin directly from various counterparties, such as Galaxy Digital, Jane Street, and Cumberland DRW LLC, and does not itself transact in any Bitcoin markets. Therefore, the Trust looks to these counterparties when assessing entity-specific and market-based volume and the level of activity in the Bitcoin markets. The Trust utilizes the Bitcoin Market Price to determine the value of Bitcoin at any given time. The Trust evaluates its principal market selection (or in the absence of a principal market the most advantageous market) at least annually and conducts a quarterly analysis to determine (i) if there have been recent changes to each Bitcoin market’s trading volume and level of activity in the trailing twelve months, (ii) if any Bitcoin markets have developed that the Trust has access to, or (iii) if recent changes to a Bitcoin market’s price stability have occurred that would materially impact the selection of the principal market and necessitate a change in the Trust’s determination of its principal market. The Trust does not anticipate changing its principal market more frequently than annually, in connection with its annual evaluation of its principal market selection and annual financial audit. Each annual evaluation will take into account the findings from the Trust’s quarterly reviews.

The cost basis of a Trust investment in Bitcoin recorded by the Trust for financial reporting purposes is the fair value of the Bitcoin at the time of contribution to the Trust. The Bitcoin cost basis recorded by the Trust may differ from the value of the proceeds collected by the Sponsor from the sale of the corresponding Units to investors.

Investment Company Considerations

The Trust is an investment company for GAAP purposes and follows accounting and reporting guidance in accordance with the FASB ASC Topic 946, Financial Services – Investment Companies. The Trust uses fair value as its method of accounting for Bitcoin in accordance with its classification as an investment company for accounting purposes. The Trust is not a registered investment company under the Investment Company Act of 1940. GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results could differ from those estimates and these differences could be material.

Review of Financial Results (unaudited)

Financial Highlights for the Three and Nine Months Ended September 30, 2021 and 2020

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Net realized and unrealized gain on investment in Bitcoin for the three months ended September 30, 2021 was $24,809,981 which includes a realized loss of $11,480 on the transfer of Bitcoins to pay the Sponsor’s Fee and other expenses and net change in unrealized appreciation on investment in Bitcoin of $24,821,461. Net realized and unrealized gain on investment in Bitcoin for the period was driven by Bitcoin price appreciation from $34,764.81 per Bitcoin as of June 30, 2021 to $43,529.16 per Bitcoin as of September 30, 2021. Net increase in net assets resulting from operations was $24,577,170 for the three months ended September 30, 2021, which consisted of the net realized and unrealized gain on investment in Bitcoin, less the Sponsor’s Fee of $146,014 and other expenses of $86,797, net of waivers. Net assets increased to $123,291,217 at September 30, 2021, a 25% increase for the period. The increase in net assets resulted from the aforementioned Bitcoin price appreciation and capital contribution of approximately 9.55 Bitcoin with a value of $384,982 to the Trust in connection with Units issuance during the period, which was partially offset by the Trust’s Net expenses of $232,811 for the period.

Net realized and unrealized gain on investment in Bitcoin for the three months ended September 30, 2020 was $2,222,669 which includes a realized loss of $4,175 on the transfer of Bitcoins to pay the Sponsor’s Fee and other expenses to the Sponsor and net change in unrealized appreciation on investment in Bitcoin of $2,226,844. Net realized and unrealized gain on investment in Bitcoin for the period was driven by Bitcoin price appreciation from $9,140.27 per Bitcoin as of June 30, 2020 to $10,721.92 per Bitcoin as of September 30, 2020. Net increase in net assets resulting from operations was $2,166,767 for the three months ended September 30, 2020, which consisted of the net realized and unrealized gain on investment in Bitcoin, less the Sponsor’s Fee of $37,441 and Other expenses of $18,461. Net assets increased to $15,175,464 at September 30, 2020, a 19% increase for the period. The increase in net assets resulted from the aforementioned Bitcoin price appreciation and the contribution of approximately 28.03 Bitcoin with a value of $280,001 to the Trust in connection with Units issuance during the period, which was partially offset by the Trust’s Net expenses of $55,902 for the period.

Net realized and unrealized gain on investment in Bitcoin for the nine months ended September 30, 2021 was $10,194,503 which includes a realized loss of $72,220 on the transfer of Bitcoins to pay the Sponsor’s Fee and other expenses and net change in unrealized appreciation on investment in Bitcoin of $10,266,723. Net realized and unrealized gain on investment in Bitcoin for the period was driven by Bitcoin price appreciation from $29,026.66 per Bitcoin as of December 31, 2020 to $43,529.16 per Bitcoin as of September 30, 2021. Net increase in net assets resulting from operations was $9,557,239 for the nine months ended September 30, 2021, which consisted of the net realized and unrealized gain on investment in Bitcoin, less the Sponsor’s Fee of $410,107 and Other expenses of $227,157, net of waivers. Net assets increased to $123,291,217 at September 30, 2021, a 175% increase for the period. The increase in net assets resulted from the aforementioned Bitcoin price appreciation and the contribution of approximately 1,299.49 Bitcoin with a value of $68,827,296 to the Trust in connection with Units issuance during the period, which was partially offset by the Trust’s Net expenses of $637,264 for the period.

Net realized and unrealized gain on investment in Bitcoin for the nine months ended September 30, 2020 was $4,940,233 which includes a realized gain of $22,780 on the transfer of Bitcoins to pay the Sponsor’s Fee and other expenses to the Sponsor and net change in unrealized appreciation on investment in Bitcoin of $4,917,453. Net realized and unrealized gain on investment in Bitcoin for the period was driven by Bitcoin price appreciation from $7,153.37 per Bitcoin as of December 31, 2019 to $10,721.92 per Bitcoin as of September 30, 2020. Net increase in net assets resulting from operations was $4,821,457 for the nine months ended September 30, 2020, which consisted of the net realized and unrealized gain on investment in Bitcoin, less the Sponsor’s Fee of $94,941 and Other expenses of $23,835. Net assets increased to $15,175,464 at September 30, 2020, an 54% increase for the period. The increase in net assets resulted from the aforementioned Bitcoin price appreciation and the contribution of approximately 52.84 Bitcoin with a value of $516,872 to the Trust in connection with Units issuance during the period, which was partially offset by the Trust’s Net expenses of $118,776 for the period.

Off-Balance Sheet Arrangements

The Trust is not a party to any off-balance sheet arrangements.

Cash Resources and Liquidity

When selling Bitcoins and/or Additional Currency to pay Extraordinary Expenses, the Sponsor endeavors to sell the exact number of Bitcoins and/or Additional Currency needed to pay expenses in order to minimize the Trust’s holdings of assets other than Bitcoin. As a consequence, the Sponsor expects that the Trust will not record any cash flow from its operations and that its cash balance will be zero at the end of each reporting period.

In exchange for the Sponsor Fee, the Sponsor has agreed to assume most of the expenses incurred by the Trust. As a result, the only ordinary expense of the Trust during the periods covered by this Quarterly Report was the Sponsor Fee. The Trust is not aware of any trends, demands, conditions or events that are reasonably likely to result in material changes to its liquidity needs.

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Selected Operating Data

* Units have been adjusted retroactively to reflect the 4:1 stock split effective January 5, 2021.

Historical Digital Asset Holdings and Bitcoin Prices

As movements in the price of Bitcoins will directly affect the price of the Units, investors should understand recent movements in the price of Bitcoin. Investors, however, should also be aware that past movements in the Bitcoin price are not indicators of future movements. Movements may be influenced by various factors, including, but not limited to, government regulation, security breaches experienced by service providers, as well as political and economic uncertainties around the world.

The following chart illustrates the movements in the NAV and the Bitcoin Market Price (referred to in the chart as “Market Price”) from the beginning of the Trust’s operations on January 3, 2019 to September 30, 2021.

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The table below illustrates the movements in the Bitcoin Market Price since the beginning of the Trust’s operations on January 3, 2019. Since the beginning of the Trust’s operations to September 30, 2021 the Bitcoin Market Price has ranged from $3,358.67 to $63,333.68, with the straight average being $18,862.34. The Sponsor has not observed a material difference between the Bitcoin Market Price and average prices from the constituent Bitcoin exchanges individually or as a group.

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Secondary Market Trading

The Trust’s Units have been quoted on OTC Markets since February 12, 2021, and on OTCQX under the symbol OBTC since February 26, 2021. The price of the Units as quoted on OTCQX (and OTC Markets) has varied significantly from the NAV per Unit. From February 12, 2021 to September 30, 2021, the maximum premium of the closing price of the Units quoted on OTCQX (and OTC Markets) over the value of the Trust’s NAV per Unit was approximately 240% and the average daily premium since the Units were first traded on OTC Markets on February 12, 2021 was approximately 19%. As of September 30, 2021, the Trust’s Units were quoted on OTCQX at a discount of approximately 12% to the Trust’s NAV per Unit.

The historical premium of the closing price of the Units quoted on OTCQX and OTC Markets as compared with the NAV per Unit has varied, from a high of 240% on February 16, 2021 (closing price $56.39 per Unit on OTCQX (and OTC Markets) and NAV per Unit $16.58) to a low (i.e., discount) of -13% on September 20, 2021 (closing price $12.97 per Unit on OTCQX (and OTC Markets) and NAV per Unit $14.89). The historical premiums and discounts at times reflect a material deviation from the Bitcoin Market Price.

The following table sets out the range of high and low closing prices for the Units as reported by OTCQX, the Trust’s NAV per Unit and the Trust’s Bitcoin Holdings per Unit for the period from February 12, 2021 to September 30, 2021.

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The Trust Agreement does not authorize the Trustee to borrow for payment of the Trust’s ordinary expenses. The Trust does not engage in transactions in foreign currencies which could expose the Trust or holders of Units to any foreign currency related market risk. The Trust does not invest in derivative financial instruments and has no foreign operations or long-term debt instruments.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in company reports filed or submitted under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer (who serves as our principal executive officer) and Chief Financial Officer (who serves as our principal financial and accounting officer), to allow timely decisions regarding required disclosure.

As required by Rules 13a-15 and 15d-15 under the Exchange Act, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of September 30, 2021. Based upon their evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective due to ineffective oversight of the Trust’s financial reporting by management, which resulted in a revision of our December 31, 2020 financial statements and our March 31, 2021 financial statements.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2021, covered by this Quarterly Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We determined that the circumstances that led to the revision of our financial statements described in this Quarterly Report, were due solely to human error, which should be addressed by the following personnel and policy changes. Due solely to the events that led to our revision of our financial statements, management has identified a material weakness in internal controls related to net assets presentation in the statement of assets and liabilities. In light of the revision of our financial statements, we are in the process of remediating the material weakness by enhancing our oversight over financial reporting to ensure that our Financial statements are presented in accordance with GAAP. The enhancements include hiring additional qualified accounting and financial reporting personnel, providing greater access to accounting literature, research materials and documents and increased communication among our personnel and third-party professionals with whom we consult regarding financial statements presentation.

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