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trtra

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2022

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 000-56270

 

Bitwise 10 Crypto Index Fund

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

 

Delaware

82-3002349

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

 

400 Montgomery Street, Suite 600

San Francisco, CA 94104

(Address of Principal Executive Offices, including zip code)

(415) 968-1843

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

 

 

 

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

None

N/A

N/A

 

 

 

 

Securities registered pursuant to Section 12(g) of the Act: Bitwise 10 Crypto Index Fund (BITW) Shares

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes No ☒

If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements.

Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b).

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No

The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was approximately $203,640,573 million, computed by reference to the closing sale price of the registrant’s common stock on the OTCQX, on June 30, 2022, the last business day of the registrant’s most recently completed second fiscal quarter.

Number of shares of the registrant’s common stock outstanding as of February 24, 2023: 20,241,947.

 

 


 

Table of Contents

 

Page

Part I

 

Item 1. Business.

1

Item 1a. Risk Factors.

37

Item 2. Properties.

84

Item 3. Legal Proceedings.

84

Item 4. Mine Safety Disclosures.

85

Part Ii

 

Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

86

Item 6. Reserved.

87

Item 7. Management’s Discussion and Analysis Of Financial Condition and Results Of Operations.

87

Item 7a. Quantitative and Qualitative Disclosures About Market Risk.

106

Item 8. Financial Statements and Supplementary Data.

106

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

106

Item 9a. Controls and Procedures.

106

Item 9b. Other Information.

107

Item 9c. Disclosure Regarding Foreign Jurisdictions That Prevent Inspections.

107

Part Iii

 

Item 10. Directors, Executive Officers and Corporate Governance.

107

Item 11. Executive Compensation.

116

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

117

Item 13. Certain Relationships and Related Transactions, and Director Independence.

118

Item 14. Principal Accountant Fees and Services.

120

Part Iv

 

Item 15. Exhibit and Financial Statement Schedules.

122

Item 16. Form 10-K Summary.

121

Signatures

122

 

i


 

Statement Regarding Forward-Looking Statements

 

This Annual Report on Form 10-K contains “forward-looking statements” with respect to the financial conditions, results of operations, plans, objectives, future performance and business of Bitwise 10 Crypto Index Fund (BITW) (the “Trust”). Statements preceded by, followed by or that include words such as “may,” “might,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of these terms and other similar expressions are intended to identify some of the forward-looking statements. All statements (other than statements of historical fact) included in this Annual Report on Form 10-K that address activities, events or developments that will or may occur in the future, including such matters as changes in market prices and conditions, the Trust’s operations, the plans of Bitwise Investment Advisers, LLC (the “Sponsor”) and references to the Trust’s future success and other similar matters are forward-looking statements. These statements are only predictions. Actual events or results may differ materially from such statements. These statements are based upon certain assumptions and analyses the Sponsor made based on its perception of historical trends, current conditions and expected future developments, as well as other factors appropriate in the circumstances. Whether or not actual results and developments will conform to the Sponsor’s expectations and predictions, however, is subject to a number of risks and uncertainties, including, but not limited to, those described in “Item 1A. Risk Factors.” Forward-looking statements are made based on the Sponsor’s beliefs, estimates and opinions on the date the statements are made and neither the Trust nor the Sponsor is under a duty or undertakes an obligation to update forward-looking statements if these beliefs, estimates and opinions or other circumstances should change, other than as required by applicable laws. Investors are therefore cautioned against relying on forward-looking statements. Factors which could have a material adverse effect on the Trust's business, financial condition or results of operations and future prospects or which could cause actual results to differ materially from the Trust's expectations include, but are not limited to:

the extreme volatility of trading prices that many Crypto Assets, including Bitcoin, have experienced in recent periods and may continue to experience, which could have a material adverse effect on the value of the Shares of the Trust;
the recentness of the development of Crypto Assets and the uncertain medium-to-long term value of the Shares due to a number of factors relating to the capabilities and development of Blockchain technologies and to the fundamental investment characteristics of Crypto Assets;
the value of the Shares depending on the acceptance of Crypto Assets and Blockchain technology, a new and rapidly evolving industry;
the unregulated nature and lack of transparency surrounding the operations of Blockchain technologies and Crypto Assets, which may adversely affect the value of Portfolio Crypto Assets and the Shares;
the limited history of the Index;
risks related to the COVID-19 outbreak, which could negatively impact the value of the Trust’s holdings and significantly disrupt its operations;
the possibility that the Shares may trade at a price that is at, above or below the Trust’s NAV Per Share;
regulatory changes or actions by the U.S. Congress or any U.S. federal or state agencies that may affect the value of the Shares or restrict the use of one or more Crypto Assets, Mining activity or the operation of their networks or the markets for the Portfolio Crypto Assets in a manner that adversely affects the value of the Shares;
changes in the policies of the U.S. Securities and Exchange Commission (the “SEC”) that could adversely impact the value of the Shares;
the possibility that the Trust or the Sponsor could be subject to regulation as a money service business or money transmitter, which could result in extraordinary expenses to the Trust or the Sponsor and also result in decreased liquidity for the Shares;
regulatory changes or interpretations that could obligate the Trust or the Sponsor to register and comply with new regulations, resulting in potentially extraordinary, nonrecurring expenses to the Trust;
potential delays in mail reaching the Sponsor when sent to the Trust at its registered office;

ii


 

possible requirements for the Trust to disclose information, including information relating to investors, to regulators;
potential conflicts of interest that may arise among the Sponsor or its affiliates and the Trust;
the potential discontinuance of the Sponsor’s continued services, which could be detrimental to the Trust;
the Custodian’s possible resignation or removal by the Sponsor; and
additional risk factors discussed in “Item 1A. Risk Factors” and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K, as well as those described from time to time in our future reports filed with the SEC.

 

Unless otherwise stated or the context otherwise requires, the terms “we,” “our” and “us” in this Annual Report on Form 10-K refer to the Sponsor acting on behalf of the Trust.

 

iii


 

Glossary

This glossary highlights some of the industry and other terms used elsewhere in this Annual Report on Form 10-K but is not a complete list of all the terms used herein. Each of the following terms has the meaning set forth below:

Airdrops” – mean a method to promote the launch and use of new Crypto Assets by providing a small amount of such new Crypto Assets to the private wallets or exchange accounts that support the new Crypto Asset and that hold existing related Crypto Assets.

Bitcoin” or “BTC” – means a type of Crypto Asset based on an open-source cryptographic protocol existing on the Bitcoin network, comprising one type of the Crypto Assets underlying the Trusts’ Shares. The native Crypto Asset for the Bitcoin network is Bitcoin.

Blockchain” – means the public transaction ledger of a Crypto Asset’s network on which transactions are recorded.

Consensus Algorithm” – means the algorithm at the heart of the Blockchain system that enforces that all ledgers converge over time.

Crypto Assets” – means a Crypto Asset designed to work as a store or value and/or medium of exchange wherein individual coin ownership records are stored in a ledger, a computerized database using cryptography to secure transaction records, to control the creation of additional coins and to verify the transfer of coin ownership.

Crypto Asset Network” – means the online, end user to end user network hosting the public transaction ledger, known as the Blockchain, and the source code comprising the basis for the cryptographic and algorithmic protocols governing the Crypto Asset’s network.

Crypto Asset Exchanges” – means a dealer market, a brokered market, principal to principal market or exchange market on which Crypto Assets are bought, sold, and traded.

Custodial Account” – means a segregated custody account to store private keys, which allow for the transfer of ownership or control of the Trust’s Portfolio Crypto Assets, on the Trust’s behalf. Under the Custodian Agreement, the Custodian controls and secures the Trust’s Custodial Account.

Custodian Fee” – means an annualized fee charged monthly that is a percentage of the Trust’s monthly assets under custody.

Custodial Services” – means the services provided by the Custodian including, (i) allowing Portfolio Crypto Assets to be deposited from a public Blockchain address to the Trust’s Custodial Account and (ii) allowing the Trust or Sponsor to withdraw Portfolio Crypto Assets from the Trust’s Custodial Account to a public Blockchain address the Trust or Sponsor controls.

Custodian” – means Coinbase Custody Trust Company, LLC. On behalf of the Trust, the Custodian holds the Portfolio Crypto Assets.

DEX” – means “decentralized” exchange, where there is no central facilitator of trade and trading rules.

Eligible Crypto Assets” – means those Crypto Assets that passed required considerations for inclusion in the Bitwise 10 Large Cap Crypto Index.

Emissions” – mean regular awards provided to holders of Crypto Assets in the form of Crypto Asset grants, and often in the form of the “gas” that powers transactions on the relevant Crypto Asset Network.

Extraordinary Expenses” – means expenses outside of the Trust’s normal business operations which includes, but is not limited to, any non-customary costs and expenses including indemnification and extraordinary costs of the

iv


 

Administrator and Auditor, costs of any litigation or investigation involving Trust activities, and financial distress and restructuring and indemnification expenses.

 

Hard Fork” – occurs when there is a change in the set of rules governing a Blockchain that makes it more restrictive than the previous set of rules in place.

Index” – means the Bitwise 10 Large Cap Crypto Index.

Index Components” – mean the Index is comprised of the top 10 coins selected and weighted by float adjusted market capitalization.

Index Provider” – means Bitwise Index Services, LLC, an affiliate of the Trust that is controlled by the same parent entity as the Sponsor. The Index Provider administers the Index.

Market-Capitalization Weighted” – means the top 10 Crypto Assets in the Bitwise 10 Crypto Index are selected and held in proportion to their valuation.

Miners” – means stakeholders that help process transactions and ensure that the distributed ledgers that make up a proof of work Blockchain network stay consistent with one another.

Mining” – means the act of solving computational puzzles through which transactions with Crypto Assets are verified and added to a proof of work Blockchain digital ledger in exchange for a Crypto Asset as a reward.

NAV” – means net asset value.

"NAV of the Trust" – means the sum of the assets and liabilities of the Trust.

NAV Per Share” – means the NAV of the Trust calculated on a per Share basis.

Oracles” – means the reliable data source used by a Blockchain application whenever it needs to interact with external data.

Portfolio Crypto Assets” – means the group of selected Crypto Assets that are held by the Trust.

PoS” – means proof of stake and is a structure wherein entities can provide network verification services for the Blockchain network and, in turn, receive rewards in the form of Crypto Assets. PoS systems require entities to lock up and put at risk (aka, “stake”) a certain amount of the Crypto Asset associated with the relevant Blockchain in order to process transactions. These staked assets are lost if a network verifier processes a transaction in a way that is fraudulent or violates the rules of the underlying Blockchain. PoS is a newer structure that, among other things, seeks to avoid the heavy energy consumption that PoW systems typically require.

PoW” – means proof of work and is a structure in which Miners provide a Mining service for the Blockchain network and receive payment. PoW is the first and most established scheme and involves computers competing to solve complicated cryptographic puzzles that require a substantial amount of energy as a way of securing the network and processing transactions.

"Shareholders" – means holders of common units of fractional undivided beneficial interest of the Trust.

Soft Fork” – occurs when there is a change in the set of rules governing a Blockchain that makes it less restrictive than the previous set of rules in place.

Staking” – means the act of committing capital in the form of the PoS Blockchain’s native Crypto Asset to participate in verifying and adding transactions to the Blockchain digital ledger, and in securing the network in exchange for a Crypto Asset as a reward.

v


 


Validators” – means stakeholders that help process transactions and ensure that the distributed ledgers that make up a PoS Blockchain network stay consistent with one another.


 

51% Attacks” – occur when an attacker controls a majority of computing power (for PoW Blockchains) or staked Crypto Assets (for PoS Blockchains) 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 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 sustainably to the Blockchain.
 

 

vi


 

part i.

Item 1. Business.

History of the Trust and the Shares

The Bitwise 10 Crypto Index Fund (the “Trust”) is a Delaware Statutory Trust that issues common units of fractional undivided beneficial interest (“Shares”), which represent ownership in the Trust. The Trust’s current standing in Delaware is active. The Trust was formed by the filing of a Certificate of Trust with the Delaware Secretary of State in accordance with the provisions of the Delaware Statutory Trust Act (the “DSTA”) and the adoption of a Trust Agreement (the “Trust Agreement”). The Trust operates pursuant to the Trust Agreement.

Bitwise Investment Advisers, LLC is the Sponsor of the Trust (the “Sponsor”). Bitwise Asset Management, Inc. (“Bitwise”), the parent company of the Sponsor maintains a corporate website, www.bitwiseinvestments.com, which contains general information about the Trust and the Sponsor. The reference to the Bitwise website is an interactive textual reference only, and the information contained on the Bitwise website shall not be deemed incorporated by reference herein.

The Trust had previously issued Shares, which represented common units of fractional undivided beneficial interest in, and ownership of, the Trust, on a periodic basis to certain “accredited investors” within the meaning of Rule 501(a) of Regulation D under the Securities Act. Shares purchased directly from the Trust are restricted securities that may not be resold except in transactions exempt from registration under the Securities Act and state securities laws and any such transaction must be approved in advance by the Sponsor. In determining whether to grant approval, the Sponsor will specifically look at whether the conditions of Rule 144 under the Securities Act and any other applicable laws have been met. Any attempt to sell Shares without the approval of the Sponsor in its sole discretion will be void ab initio. The Shares are quoted on OTCQX Best market (the "OTCQX") under the ticker symbol “BITW.” Shares that have become unrestricted in accordance with Rule 144 under the Securities Act may trade on OTCQX. On November 18, 2021, the Sponsor closed sales of Shares directly from the Trust, pursuant to its rights under Sections 5 and 6 of the Trust Agreement. At this time, the Sponsor has no plans to reopen such sales.

The Trust’s principal investment objective is to invest in a portfolio (“Portfolio”) of Crypto Assets (each, a “Portfolio Crypto Asset” and collectively, “Portfolio Crypto Assets”) that tracks the Bitwise 10 Large Cap Crypto Index (the “Index”) as closely as possible with certain exceptions determined by the Sponsor in its sole discretion, as described more fully below in the section entitled “—Business of the Trust.” In addition, in the event the Portfolio Crypto Assets being held by the Trust present opportunities to generate returns in excess of the Index (for example, Airdrops, Emissions, forks, or similar network events) the Sponsor may also pursue these incidental opportunities on behalf of the Trust as part of the investment objective if in its sole discretion the Sponsor deems such activities to be possible and prudent.

The Trust believes that it has met its principal investment objective, however, because the Trust does not operate a redemption program for the Shares, because of the holding period required under Rule 144 for the sale of the Shares purchased from the Trust, and because the Trust may from time to time halt Share subscriptions.

There can be no assurance that the value of the Shares will reflect the value of the Trust’s NAV Per Share, and the Shares may trade at a substantial premium over, or a substantial discount to, the value of the Trust’s NAV Per Share, and as such, there can be no assurance that an investor will achieve a return on investment that tracks the performance of the Index. As of December 31, 2022, there was a correlation of 99.99% between the Portfolio Crypto Assets and the assets included in the Index. The Trust is aware that the market price of the Trust’s shares may deviate from the net asset value (“NAV”) of the Shares, that to date the Shares traded on the secondary market have not closely tracked the NAV of the Shares and that the market price of the Shares has been and may continue to be significantly above or below the net asset value per share (“NAV Per Share”). However, the Trust does not have control over an investor’s ability to achieve a return on investment that tracks the performance of the Index. The trading price of the Shares is determined by the market, and at times the Shares will trade at a premium or a discount to the NAV Per Share). Regardless of the Trust or Sponsor’s methods of managing the underlying portfolio, the price an investor will pay on the secondary market could differ significantly from the NAV Per Share. The Trust does not seek to track the performance of the trading of Shares on the secondary market and the trading price of Shares. The price an investor will pay on the secondary market may be significantly different from the NAV

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Per Share. Furthermore, under Regulation M, the Trust, as the issuer of the Shares, is not legally permitted to take the types of actions that might help to reconcile the NAV Per Share and the market price per Share.

The Shares may also trade at a substantial premium over, or a substantial discount to, the NAV Per Share as a result of price volatility, trading volume and closings of the exchanges on which the Sponsor purchases Portfolio Crypto Assets on behalf of the Trust due to fraud, failure, security breaches or otherwise. As a result of the foregoing, the price of the Shares as quoted on OTCQX has varied significantly from the value of the Trust’s Portfolio Crypto Assets Per Share since the Shares were approved for quotation on December 9, 2020.

 

The following charts show the percentage of Premium/(Discount) of the Shares as quoted on OTCQX and the Trust’s NAV and a comparison of the NAV of the Trust vs the market price as quoted on OTCQX:


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From December 9, 2020 to December 31, 2022, the Shares of BITW traded at an average premium, based on closing prices at 4:00 pm ET, and estimated, un-audited, NAV Per Share of 5.21%. During that same period, the highest premium was 649.38% on December 16, 2020, and the lowest premium was 0.27% on August 4, 2021. During that same period, the highest discount was 67.80% on December 28, 2022, and the lowest discount was 0.09% on September 24, 2021. Given the lack of an ongoing redemption program and the holding period under Rule 144, there is no arbitrage mechanism to keep the Shares closely linked to the value of the Trust’s underlying holdings that may continue to have an adverse impact on investments in the Shares.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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The following chart shows a comparison of the cumulative returns of the Index compared to the NAV of the Trust:

 

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Emerging Growth Company Status

The Trust is an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). For as long as the Trust is an emerging growth company, unlike other public companies, it will not be required to, among other things:

provide an auditor’s attestation report on management’s assessment of the effectiveness of our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002; or
comply with any new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise.

The Trust will cease to be an “emerging growth company” upon the earliest of (i) it having $1.0 billion or more in annual revenues, (ii) it becoming a “large accelerated filer,” as defined in Rule 12b-2 of the Exchange Act, (iii) it issuing more than $1.0 billion of non-convertible debt over a three-year period or (iv) the last day of the fiscal year following the fifth anniversary of its initial public offering.

In addition, Section 107 of the JOBS Act also provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. The Trust has chosen not to “opt out” of such extended transition period, and as a result, the Trust will take advantage of such extended transition period.

Business Development

The Trust has not been in, and is not in the process of, any bankruptcy, receivership or any similar proceeding since its inception.

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Other than the conversion of the Trust from a Delaware limited liability company into a Delaware Statutory Trust, the Trust has not undergone any material reclassification, merger, consolidation, or purchase or sale of a significant amount of assets since its inception.

The Trust has not experienced any default of the terms of any note, loan, lease, or other indebtedness or financing arrangement requiring the Trust to make payments since its inception.

The Trust has not experienced any change of control since its inception.

The Trust has only one class of outstanding equity securities. The Trust has experienced increases of more than 10% of the Shares since inception of the Trust (September 18, 2017). The Trust is a Delaware statutory trust that has no limit on the number of Shares that can be issued.

Other than the conversion of the Trust from a Delaware limited liability company into a Delaware Statutory Trust and the associated share split, there are no past or pending share splits, dividends, recapitalizations, mergers, acquisitions, spin-offs, or reorganizations since the Trust’s inception.

There has not been any delisting of the Shares by any securities exchange or deletion from the OTC Bulletin Board.

Competitive Business Conditions

The Crypto Asset industry is rapidly developing, and there are significant uncertainties with respect to the development, acceptance, and success of the digital networks underlying the Portfolio Crypto Assets. See “Item 1A. Risk Factors—Risks Related to Crypto AssetsThe 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” for additional information. While the Crypto Assets that are Portfolio Crypto Assets have enjoyed some acceptance and use in their limited history, it is possible that other Crypto Assets may grow more rapidly in acceptance and adoption for use as compared to Portfolio Crypto Assets, and while the Index may, over time, change to include more successful Crypto Assets, the Index may not capture the growth in value of more rapidly growing Crypto Assets.

Business of the Trust

The Sponsor expects the market price of the Shares to fluctuate over time in response to the market prices of Portfolio Crypto Assets. In addition, because the Shares reflect the estimated accrued but unpaid expenses of the Trust, the number of Portfolio Crypto Assets represented by a Share will gradually decrease over time as the Trust’s Portfolio Crypto Assets are used to pay the Trust’s expenses.

The Trust’s Portfolio Crypto Assets are held by Coinbase Custody Trust Company, LLC (the “Custodian“) on behalf of the Trust. The Trust’s Portfolio Crypto Assets are transferred only in the following circumstances: (i) sales made in connection with monthly rebalancing in order to more closely track the Index, (ii) sales to pay expenses of the Trust, (iii) sales on behalf of the Trust in the event the Trust terminates and liquidates its assets or as otherwise required by law or regulation, and (iv) transfers to pursue Airdrops, forks, Emissions, or other similar network events as deemed necessary by the Sponsor. Each delivery or sale of Portfolio Crypto Assets for purposes of rebalancing the Trust’s Portfolio Crypto Assets to track the Index will be a taxable event for Shareholders. See “Certain U.S. Federal Income Tax Considerations.” See “Item 1A. Risk FactorsRisks Related to Crypto AssetsThe 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.” In addition, each sale of Portfolio Crypto Assets by the Trust to pay the expenses of the Trust will be a taxable event for Shareholders.

The Trust is not registered as an investment company under the Investment Company Act of 1940, as amended (the “Investment Company Act”) and the Sponsor believes that the Trust is not required to register under the Investment Company Act. See “Item 1A. Risk Factors—Risks Related to Regulatory and Compliance” and “—Overview of Government Regulation” for additional information. In addition, the Trust will not hold or trade in commodity futures contracts or other derivative contracts regulated by the Commodity Exchange Act (the “CEA”),

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as administered by the Commodities Future Trading Commission (the “CFTC”). The Sponsor believes that the Trust is not a commodity pool for purposes of the CEA, and that neither the Sponsor nor the Trustee is subject to regulation as a commodity pool operator or a commodity trading adviser in connection with the operation of the Trust.

The Trust has no fixed termination date. The Trust is a passive entity with no operations, and no employees. The Sponsor administers and manages the Trust as described below. The Trust has not at any time been a “shell company.” The Trust and the Sponsor have entered into a limited, non-exclusive, revocable license agreement with Bitwise Index Services, LLC (the “Index Provider”), an affiliate of the Trust that is controlled by the same parent entity as the Sponsor, at no cost to the Trust or the Sponsor allowing the Trust to use the Index for the purpose of using as the benchmark index for the Trust (the “License Agreement”).

Activities of the Trust

The Trust seeks to make it easier for an investor to invest in the Crypto Asset market as a whole, without having to pick specific tokens, manage a portfolio, or constantly monitor ongoing news and developments. Although the Shares will not be the exact equivalent of a direct investment in Crypto Assets, they provide investors with an alternative that constitutes a relatively cost-effective, professionally managed way to participate in Crypto Asset markets.

The Trust notes that an indirect investment in Crypto Assets through Shares may operate and perform differently from a direct investment in Crypto Assets, and such differences may include, among other things: the holding period under Rule 144 for the resale of the Shares purchased from the Trust, the risk that the Shares may trade at a substantial premium over or a substantial discount to the NAV Per Share, the risk that over time the number of Portfolio Crypto Assets represented by a Share will gradually decrease as the Portfolio Crypto Assets are used to pay the Trust’s expenses, the ability to invest in Shares via an investor’s equity retirement accounts such as a 401(k) or individual retirement account, which do not provide the ability to invest directly in Crypto Assets; the convenience of not having to open and maintain a Crypto Asset wallet; the potential ability to participate in decentralized finance (“DeFi”) protocols including governance, voting, staking assets and lending assets; and the ability of an investor to rely on the Bitwise Crypto Index Committee (the “Committee”) to choose the Portfolio Crypto Asset composition and balance of the assets. To date, the only DeFi protocol that the Trust has participated in, including governance, voting, staking assets, lending assets and liquidity provisions, was in staking Tezos. The Index has not participated in any other DeFi protocols, including governance, voting and lending assets. 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 decentralized finance 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. The Trust will determine whether engaging in further staking activities is in the best interests of the shareholders on a case-by-case basis. In making such a determination, the Trust will consider whether the staking activities present possible and prudent opportunities to generate additional returns for shareholders in excess of the Index, the risks associated with the staking activities, the potential for the loss of all or part of the staked amounts, and whether or not the activity is supported by the Trust’s custodian.
 

In addition, the Trust must pay certain expenses which would not be charged for a direct investment in Crypto Assets, including a Management Fee payable monthly, in arrears, in an amount equal to 2.5% per annum (1/12th of 2.5% per month) of the net asset value of the Trust’s assets at the end of each month.

In furtherance of its objective, the activities of the Trust include: (i) issuing Shares in exchange for subscriptions, (ii) selling or buying Portfolio Crypto Assets in connection with monthly rebalancing, (iii) selling Portfolio Crypto Assets as necessary to cover the Management Fee (as defined below) and/or any Organizational Expenses (as defined below), (iv) causing the Sponsor to sell Portfolio Crypto Assets upon any potential future termination of the Trust, and (v) engaging in all administrative and security procedures necessary to accomplish such activities in accordance with the provisions of the Trust Agreement, and the Custodian Agreement (as defined below). In addition, the Trust may engage in any lawful activity necessary or desirable in order to facilitate these activities, provided that such activities do not conflict with the terms of the Trust Agreement.

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Crypto Assets are purchased 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” desks ("OTC Desks") with the goal of purchasing Crypto Assets at or near the prices used to calculate the Trust's NAV Per Share and used to calculate the Index while also seeking to minimize execution slippage compared to the benchmark price while simultaneously promoting operational risk management and efficient management of the Trust’s assets.

The Trust does not utilize a single principal market to convert Crypto Assets to U.S. dollars and to purchase Crypto Assets. The Sponsor evaluates counterparties, trading venues, and execution tools on an ongoing basis. The Trust utilizes multiple venues to acquire and dispose of Crypto Assets, including trading venues (known as exchanges), OTC Desks, and trading technology solutions that aggregate liquidity from multiple trading venues. The Sponsor exercises judgment to determine on which venue to trade.

Calculation of Valuation

For all periods through the quarterly period ended June 30, 2021, the NAV Per Share, the NAV of the Trust, and the fair valuations for each Portfolio Crypto Asset were calculated by the Trust's Administrator in reliance on the fair value of each Portfolio Crypto Asset based on a blended average approach for calculating the price of a Crypto Asset (the "Blended Bitwise Crypto Asset Price"), which the Sponsor was responsible for calculating. The Sponsor provided this price to the Administrator, and the Administrator used this price (multiplied by the Trust’s holdings) for each asset to determine the fair value of the Trust’s assets. The Administrator then subtracted the Trust’s liabilities to determine the Trust’s NAV. The administrator then divided this value by the Trust’s shares outstanding in order to determine the NAV Per Share. As a result of the Sponsor’s responsibility in this regard, any errors, discontinuance or changes in such valuation calculations may have had an adverse effect on the value of the Shares. The Sponsor instituted this valuation policy in order to generate fair value estimates because it determined that such policy was in the best interest of Shareholders, as it would avoid misstatements in valuation of the assets potentially arising from deviations in pricing across the Crypto Asset market, and because of the fragmented nature of the Crypto Asset trading ecosystem. As a result, management applied this valuation technique which it determined to be appropriate given the circumstances.

Following the filing of its Form 10, the Sponsor conducted a complete review of its process for determining fair valuation in the presentation of its financial statements and calculation of NAV. In this process, the Sponsor evaluated whether or not the identification of a principal market for each of the Trust’s assets for valuation purposes, during each period for which the Trust created and had audited its financial statements, would have created a material difference in the Trust’s estimated fair value or assets. In conjunction, the Sponsor determined to undertake a change in valuation policy for the fair valuation of Crypto Asset held in the Trust. As a result, the Sponsor developed a revised process for the determination of a principal market for each asset based on this consideration and disclosed and implemented this change in valuation policy and accounting policy prior to the creation of financial statements for the period ending September 30, 2021. The Blended Bitwise Crypto Asset Price is no longer used for any calculations by the Trust, including NAV Per Share, NAV of the Trust or fair valuations for any Portfolio Crypto Asset.

The process that the Sponsor developed for identifying a principal market, as described in Financial Accounting Standards Board Accounting Standards Codification 820-10, which outlines the application of fair value accounting, was to begin by identifying publicly available, well-established and reputable Crypto Asset exchanges selected by the Sponsor and its affiliates in their sole discretion, including BitFlyer, Binance, Bitstamp, Bittrex, Coinbase, itBit, Kraken, Gemini and LMAX, and then calculating, on each valuation period, the highest volume exchange during the 60 minutes prior to 4:00 pm ET for each asset. In evaluating the markets that could be considered principal markets, the Trust considered whether or not the specific markets were accessible to the Trust, either directly or through an intermediary, at the end of each period.

In the process of its review, the Sponsor also retroactively applied this process for identifying a principal market to the prior periods of reported financial results, including the fiscal years 2019 and 2020, to determine whether or not any material or significant differences would have resulted from the application of a different valuation policy in the creation of each financial statement (e.g., comparing the fair value prices determined using the existing and previous valuation methodology to the hypothetical fair value prices using an identified principal market for each asset) and

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to consider whether management’s use of the existing valuation policy would have created any material departures from a valuation policy of identifying a principal market.

As set out in more detail in the tables in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Significant Accounting PoliciesInvestments and Valuation—Calculation of Valuation,” the Sponsor’s results conclude that there are no material or significant differences in valuation or the financial statements as presented when using the policy of identifying a principal market described above as compared to the existing valuation methodology for any period since the Trust commenced operations, as the average difference in valuation prices was in all cases less than 0.05% or five one hundredths of one percent for each asset for each period measured, and that such differences are immaterial in all cases.

 

Statements, Filings, and Reports

The Trust endeavors to comply with all reporting obligations required of companies with a class of securities registered under the Exchange Act, including timely filing Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other customary filings.

Shareholders can expect to receive annual audited financial statements for the Trust and any applicable tax reports (e.g., Schedules K-1) from the Sponsor. The Sponsor or the Administrator (as defined below) expect to issue Schedules K-1 directly to Shareholders that hold Shares or the custodian of such Shares, as applicable, for each taxable year or portion thereof.

The Trustee will make elections, file tax returns and prepare, disseminate and file tax reports, as advised by the Sponsor, the Trust’s counsel or accountants or as required by any applicable statute, rule or regulation.

Investment strategy

The Trust holds a Portfolio that generally tracks the Index. The Index is administered by Bitwise Index Services, LLC, an affiliate of the Sponsor (the “Index Provider”). The Trust rebalances monthly alongside the Index to stay current with changes. The Sponsor strives to minimize tracking error (e.g., divergence between the performance of the Trust and the Index) by managing costs and price slippage during trade execution, and holding the assets in the Index.

The Sponsor has the discretion, when possible and prudent, to take advantage of incidental opportunities to generate additional returns in excess of the Index that arise from the Portfolio Crypto Assets held by the Trust through, for example, Airdrops, staking, Emissions, Hard Forks, lending or similar network events and activities, if the Sponsor determines that any such activities are in the best interest of the Trust and its shareholders. The Sponsor does not consider these activities inconsistent with its investment objective to invest in a portfolio to track the Index or inconsistent with its disclosure that the Trust is managed as a passive investment vehicle. Accrual of additional returns through such activities may offset fees and fund expenses and allow the Trust to track the performance of the Index more closely. If the Sponsor accepts and liquidates Airdrops, Emissions, Hard Forks, or engages in staking, it will apply fair value to the assets received as described in the section “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Significant Accounting Policies—Investments and Valuation.

The Trust seeks to track the Index, and, therefore, to the extent that a Network Distribution Event, defined as an event that offers additional opportunities to engage with a Blockchain network and generate additional capital, occurs and such Network Distribution Event impacts the composition of the Index, the Trust will undertake its usual rebalancing process. The policies of the Index in regard to Network Distribution Events are described below in “—Overview of the IndexSummary of the Index MethodologyIndex Methodology.”

It is possible that a Network Distribution Event could occur that may result in an opportunity for the Trust to generate additional returns, such as if an asset that the Trust already held were to do an Airdrop that resulted in the Trust obtaining a different asset. If that were to occur, the Trust may seek to utilize the Network Distribution Event in such a way as to benefit the Shareholders of the Trust. For example, the Trust may choose to sell an Airdropped asset and return the proceeds to the Shareholders.

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Price and Cost Slippage

On days when the Sponsor accepts subscriptions, the Sponsor aggregates the dollar value of subscriptions into the Trust and uses quantitative portfolio management techniques to compare the Trust’s existing holdings and weightings to the constituents and weightings of the index in order to calculate the amounts and quantities of each Crypto Asset to purchase. On days when the Sponsor rebalances the Trust’s portfolio in order to pursue its investment objective of tracking the benchmark index, the Sponsor uses quantitative portfolio management techniques to compare the Trust’s existing holdings and weightings to the new and updated constituents and weightings of the index in order to calculate the amounts and quantities of each Crypto Asset to purchase so that the Trust’s holdings and weightings will, after trade execution, be closely aligned with the constituents and weightings of the benchmark index. In each case, the Sponsor has at its disposal multiple venues to acquire and dispose of Crypto Assets, including trading venues (known as exchanges), OTC Desks, and trading technology solutions that aggregate liquidity from multiple trading venues.

Trade execution and portfolio management is dynamic and complex, and the Sponsor must exercise judgement, assess multiple factors including recent experience and market conditions, as well as the size of the trades, settlement procedures at each venue, types of assets that need to be executed, as well as their availability on such platforms, prior to determining the best venue to execute each trade. The Sponsor attempts to purchase or sell each asset in each instance at a price that is close to the price used for calculating the Trust's NAV (and the Index’s daily price) at 4:00 pm ET, while also minimizing market impact and reducing operational and settlement risk. The Trust may choose to algorithmically execute a trade over time (for example, to execute a trade while only participating in a certain amount of volume), to execute a trade using a market order (e.g., purchasing or selling a Crypto Asset immediately at whatever price the entire order can be filled at), or by putting multiple OTC Desks into competition to provide the best price possible for a given amount and quantity of a Crypto Asset. Often, OTC Desks may be able to provide better prices than trading venues, and can also streamline and minimize operational complexity and settlement risk. There is no guarantee that the Sponsor will be able to trade Crypto Assets at or near the benchmark price, as there are a number of other factors aside from price slippage that inform best practices in trade execution, and market conditions change rapidly. Such factors include, but are not limited to, reputation of the trading venue, availability and support of personnel and coverage at the trading venue, settlement consistency or procedures, availability of assets and coin coverage, understanding of market dynamics, and perceived, disclosed, or reported regulatory compliance of the platform.

Staking Activities

The Index does not engage in staking. To the extent that the Trust participates in staking activity, such activity varies across protocols. 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. However, the Trust does not believe that at present its staking activities would affect its ability to rebalance its holdings on a monthly basis, as its staking activity is extremely limited, and the Trust does not currently have plans to significantly expand such activity.

Staking activity may require withdrawals of its Portfolio Crypto Assets by the Sponsor in order 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 hackings 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

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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.

The Trust records receipt of staking rewards when they are received if there is value to the Trust in doing so. Crypto Assets received from staking rewards have no cost basis and the Trust recognizes unrealized gains equal to the fair value of the new Crypto Asset received. To date, the only Crypto Asset that the Trust has staked was Tezos, which was part of the Index and the Trust’s Portfolio Crypto Assets from April 12, 2019 until February 26, 2021, when the coin’s market capitalization declined relative to other Crypto Assets and made it ineligible to be included in the Index. During 2020, the Trust participated in staking activities with Tezos which required the Trust to post certain Crypto Assets for a period of time to a “stakepool” and vote on certain items on the staking platform, in return for collecting the staking reward. The amount of rewards received from this activity was de minimis, and the Sponsor participated on behalf of the Trust due to the fact that the Trust’s Custodian was able to facilitate the process while retaining custody and safekeeping of the Trust’s Tezos while participating in the staking process. The Trust has not participated in any staking or reward generation activity other than with respect to Tezos in 2020. The Trust received $2,139 in total staking rewards in 2020 from its Tezos staking activities. These rewards were treated as investment income in the Trust’s audited financial statements for the fiscal year ended December 31, 2020 and December 31, 2021. 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 interest of shareholders. If the Trust makes material changes to its staking policy in the future, it will disclose such changes on Form 8-K.

Overview of the Crypto Asset Industry

Digital or Crypto Assets are bearer assets whose ownership is secured by cryptographic protocols and incentives that operate on a network of computers. Crypto Assets are intended to allow for storage and transfer without the need of a trusted intermediary and therefore they have the potential to challenge and disrupt many types of financial and data activities, including traditional systems of value storage, value transfer, governance, and other important applications.

The first Crypto Asset, Bitcoin, was initially proposed in 2008 and launched in 2009 by a pseudonymous software developer, or group of software developers, under the name “Satoshi Nakamoto.” In the ensuing years, the number of Crypto Assets has increased dramatically. Well-known Blockchains that how their respective native Crypto Assets currently include Bitcoin, Ethereum and Polygon. Many other Crypto Assets exist, and more are likely to emerge in the future.

Crypto Assets are traded on trading venues around the world, as well as in over-the-counter and peer-to-peer markets. Crypto Assets can be converted to fiat currencies or into other Crypto Assets at rates determined by supply and demand on these markets. Derivative investment products, including futures, options, and swaps contracts, are also available that allow investors to build sophisticated investment and trading strategies focused around the most prominent Crypto Assets.

The number and diversity of market participants and companies operating in the Crypto Asset space has also increased dramatically over the past years. Currently, there is a wide range of companies that provide services related to Crypto Assets to retail investors. These include companies focused on providing trading venues, custody, investment funds, payment services, and others. More recently, companies focused on institutional investors, which have been increasingly more active in the space, have created or expanded their offerings. Products and services catered to the institutional market include institutional-grade custody and trading services, lending and collateral management, and prime brokerage.

The ownership of Crypto Assets is recorded in a digital ledger or database, called a Blockchain. Blockchains differ from traditional databases in that they are designed not to be controlled by any single party, but rather, to be maintained by a distributed network of computers, each of which maintains and updates its own copy of the ledger.

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Each participant in this network is heavily incentivized to process transactions according to a set of predetermined rules and to keep its ledger consistent with the rest of the network over time.

The exact method with which each Blockchain network processes and records transactions can, and usually does, vary from Blockchain to Blockchain. There are myriad architectural decisions participants either implicitly or explicitly agree to when they join a certain network, which includes the level of decentralization, privacy, throughput, and other features a network can provide. These decisions usually involve trade-offs and therefore each Blockchain network is typically optimized for specific capabilities, limitations, and target use cases.

As a nascent and fast-changing area, the Crypto Asset market carries significant risks and uncertainty. For instance, many Blockchains host a significant amount of capital while still remaining in the infrastrucutre buildout phase, some Blockchains have not yet found a dependable use case outside of speculation and some may never find such a use case. In addition, the regulatory, trading, media, and political environments surrounding Crypto Assets are ever-changing and could evolve in ways that could harm the ecosystem. As an emerging technology, Blockchains and their respective Crypto Assets are not free from technical risks, which include hacking, denial of service or other types of cyberattacks. Additionally, governments, traditional financial services firms, or other actors could work to disrupt the functioning of Blockchains or otherwise slow their growth.

 

Still, some consider Crypto Assets and Blockchain technology among the most important breakthroughs in computer science in recent decades, and believe they may be used to address multiple large markets in the future.

Typical Stakeholders in Blockchain Networks

Designing a Blockchain Network is similar to designing a digital economy, and the design of incentive systems that govern the relationship between different groups of stakeholders is sometimes referred to as crypto economics or token economics.

The following section provides an overview of the different groups of market participants which are present in most Blockchain networks and constitute much of the crypto economic system.

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Stakeholders: Stakeholders help process transactions and ensure that the distributed ledgers that make up a Blockchain network stay consistent with one another. They fall under two catagories: Miners, for PoW Blockchains, and Validators, for PoS Blockchains.

Stakeholders are typically compensated for providing this service in large part by algorithmic grants of the Crypto Asset associated with the Blockchain network they are helping to secure, although they may be compensated with transaction fees or in other means as well.

There are multiple schemes under which stakeholders can operate to provide this service and receive this payment, but the two most important are proof of work (“PoW”) and proof of stake (“PoS”).

Proof of work is the first and most established scheme and involves computers solving cryptographic puzzles that require a substantial amount of energy as a way of securing the network and processing transactions. The more computing power a Miner dedicates to solving this puzzle the more likely it will be the first to solve the problem and collect the rewards of newly minted Crypto Assets and transaction fees. By piling up computing power over time, transactions become increasingly hard to reverse and eventually can be considered “settled.” PoW is the scheme used by Bitcoin, as well as many other assets. One criticism of PoW systems is the high amount of energy they consume, which may have negative downstream environmental consequences, among other issues.
Proof of stake is a newer scheme that tries to avoid the heavy energy consumption that PoW systems typically require. PoS systems require Validators to lock up and put at risk (aka, “stake”) a certain amount of the Crypto Asset associated with a given Blockchain in order to process transactions. These staked assets are lost if a Validator processes a transaction in a way that is fraudulent or violates the rules of the underlying Blockchain. Newer Blockchain networks like Avalanche, Cardano and Solana use PoS. Additionally, Ethereum seamlessly transitioned for a PoW to a PoS Blockchain in September 2022, through an upgrade known as the "Merge."

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Concerns with PoS systems include the risk of lower security assurances and the potential for centralization of the network.
2.
Users: Users are the stakeholders that hold or transfer Crypto Assets, either by participating directly in the network or by delegating this work to third-party service providers.

Users will typically buy and sell Crypto Assets for fiat currencies through dedicated trading venues. In recent years, a robust ecosystem of trading systems has emerged that cater to these investors.

Once in possession of a Crypto Asset, the interaction between users and the rest of the network can fall between two ends of a spectrum:

On one end, users can opt to be completely sovereign over their asset holdings and transactions. Such users would typically host a local copy of the entire ledger of transactions and validate every single transaction that takes place in the network by running the protocol software in their own machines. They would also own the private keys that guarantee ownership of their Crypto Assets and embrace the responsibility of keeping them safe. This group tends to be technically savvy and/or attribute high value to holding Crypto Assets independently.
On the other end, users can opt to delegate their participation in the network to third-party companies that provide specialized services. Examples of such users include individuals or institutions that delegate the responsibility of keeping their private keys safe to custodians or merchants that use payment processing companies to allow clients to make payments in Crypto Assets. This group tends to use third-party services either due to prioritization of convenience or due to external requirements (regulations, for example).
3.
Developers: Developers are network contributors that build the protocols and software that both users and stakeholders (i.e. Miners and Validators) need to run to participate in the network. Developers are also generally split between two categories depending on the type of software they work in.
Protocol developers are involved directly in building the core software that defines how a network works. Most projects adopt the free and open-source software (FOSS) paradigm, which means that the software is free and openly shared so people can voluntarily contribute to its maintenance and improvement. Protocol developers can exert power over the network as they ultimately define which rules it will abide by. That is why having a high number of developers (i.e. decentralization) is important. Additionally, as the software is open-source, users can opt to run any version of the software they see more fit. This keeps the developers’ power over the network in check. Protocol developers are usually highly specialized experts with deep knowledge not only of software development but also in cryptography, computer networking or other subfields of computer science.
Application developers use the software built by protocol developers to build applications that will ultimately reach end-users. Such projects might or might not be open-source software. Examples of such projects would include digital wallets, which are designed to allow users to hold Crypto Assets without the complexity of interacting with the underlying protocol.

Overview of the Index

The Index is designed to track the performance of the ten largest Crypto Assets, as selected and weighted by free-float market capitalization. These assets collectively account for more than 64% of the total market capitalization of the Crypto Asset market as of December 31, 2022.

The Index uses a variety of rules to screen out assets that the Committee – the governing body for the Index – believes represent undesirable or uncompensated risks in the market. These rules require, among other things, that Crypto Assets included in the Index are available for custody at a third-party custodian regulated as a federally chartered bank or as a state trust company, and subject to additional screens for security practices, insurance requirements and business practice requirements as determined by the Committee; maintain a certain level of liquidity; are listed on multiple established Crypto Asset trading venues; and more. An additional rule excludes assets that are tethered or pegged to the price of other Crypto Assets.

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The Index is reconstituted on a monthly basis at 4:00 pm Eastern Time on the last “business day” of each month. The Index considers a “business day” to be any day that the New York Stock Exchange is scheduled to be open for trading. The Index’s rules are designed and maintained specifically for the Crypto Asset market. For instance, the Index’s rules are designed to capture the value of significant “Hard Forks” of constituent assets, should they occur. A “Hard Fork” occurs when there is a change in the set of rules governing a Blockchain that makes it more restrictive than the previous set of rules in place (conversely, a change that makes the set of rules less restrictive is called a “Soft Fork”). Forks might lead to a split in the network, which would lead to two groups of network participants running different versions of the Blockchain software. The result is two separate Blockchains and two separate and not interchangeable assets. When a fork occurs, the holder of the original Crypto Asset typically ends up with a pro-rata share of the new asset after some period of time. The Index rules govern how the newly forked asset is handled, including whether the asset is retained, liquidated or (if it is of de minimis market value) ignored by the Index.

Summary of the Index Methodology

The following is a materially complete description of the Index methodology (“Index Methodology”). The full Index Methodology is publicly available at https://app.bitwiseinvestments.com/indexes/methodology. 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, and that also results in a corresponding change to the Trust. If not required by applicable law, the Trust may or may not file a Form 8-K with the SEC to disclose changes to the Index Methodology that do not result in a material change. When deciding whether or not to file a Form 8-K to disclose changes to the Index Methodology that do not result in a material change, the Trust will consider whether the particular changes are required to be disclosed by one or more of the specific requirements of Form 8-K, and whether there is an independent legal obligation under the federal securities laws to make such a disclosure even in the absence of a specific requirement in Form 8-K. The Trust may have additional current or periodic reporting obligations under the Exchange Act due to other changes to the Index Methodology, such as to how the Index is calculated.

Purpose of the Index

The purpose of the Index is to track a basket of Crypto Assets that represents the majority of Crypto Assets by market capitalization. At its inception on October 1, 2017, the Crypto Assets in the Index represented about 83% of all Crypto Assets by market capitalization, and now represent approximately 64% as of December 31, 2022. The Index is comprised of the top 10 coins selected and weighted by free-float-adjusted market capitalization. The Index is rebalanced monthly. Additional eligibility criteria are applied to screen coins for investment feasibility (as defined below), to ensure the integrity of the coins selected to comprise the Index, and to appropriately account for one-off events. As a result, the 10 coins in the Index may not always completely match the top 10 coins on popular websites like CoinMarketCap.com that do not include such screening.

Index Methodology

The Index, designed by the Index Provider, an affiliate of the Sponsor, is comprised of the top ten largest Crypto Assets in the world based on free-float-adjusted market capitalizations. The market capitalizations of Crypto Assets are calculated using data sources from multiple publicly available, well-established and reputable Crypto Asset exchanges. The selection of Crypto Asset exchanges used to calculate market capitalization is made by the Committee, as defined below, in its sole discretion. Currently, the list of exchanges used to calculate the value of Crypto Assets in the Index include: BitFlyer, Binance, Bitstamp, Bittrex, Coinbase, itBit, Kraken, Gemini and Poloniex.

The market capitalization of a Crypto Asset is calculated by multiplying its price times its free-float-adjusted or “circulating” supply. The proportion of each Crypto Asset in the Index is based on this adjusted market capitalization. Public exchanges used for calculating the Index are selected using criteria which may include factors such as trading volume, availability, regulatory compliance, security, and reliability of real-time price and trade volume information and absence of abnormal withdrawal restrictions of crypto and fiat currencies. Regulatory

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compliance is defined as the exchange having no public evidence, such as statements by a relevant regulator, that it is not in compliance with the local regulations of the exchange’s domicile, and not being subject to publicly disclosed legal or regulatory action. The Committee monitors company websites, news flow, social media, and API-level data feeds to determine the regulatory compliance, security and reliability of real-time price and trade volume information and the absence of abnormal withdrawal restrictions of crypto and fiat currencies.

The Index is actively researched and evaluated and, therefore, the Index Methodology’s eligibility criteria, constituents and overall strategy may be adjusted over time. The Index is calculated by the Sponsor and its affiliates on a daily basis and published on the Sponsor’s website. Since the Trust’s investment strategy is to invest its assets to track the Index, a change in Index Methodology or composition will not automatically warrant a notice or consent requirement to Shareholders. 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 material change as any change of 10% or more to the composition of the Index.

To screen, select and weight the top 10 coins, the Index uses a free-float-adjusted market capitalization which is calculated as follows:

(composite price) x (free-float-adjusted or circulating supply)

A coin’s composite price is derived from the real-time price data pulled from multiple exchanges. The individual exchange price data is combined using a trade volume weighting technique. The price on the exchange with more trade volume has more influence on the composite price while the exchange with the price that deviates more from the prices of the other exchanges has less influence on the composite price. This normalization produces a more accurate composited price which is then used in the market capitalization calculation.

In calculating the available supply of a coin, the Index looks at circulating supply. Circulating supply is the best approximation of the number of coins available on public markets. Circulating supply is derived by taking the total number of existing Crypto Assets native to a specific Blockchain and subtracting the number of coins verifiably burned, locked, or reserved (for example, by a foundation).

The top 10 Crypto Assets in the Index are selected and held in proportion to their valuation, often referred to as “Market-Capitalization Weighted.”

Composite Price Determination by the Index

Broadly speaking, the intent is to generate a price to reflect the price at which an institutionally oriented investor can trade any given Crypto Asset. This price is called the Index Crypto Asset Price (“Index CAP”). The Index CAP is used solely by the Index and is not used by the Trust or the Sponsor. The default denomination of an Index CAP is the U.S. dollar, and the methodology is as follows:

Calculating Crypto Asset Prices in U.S. Dollars: The Crypto Asset world has two modalities of trading: crypto-to-fiat trading and crypto-to-crypto trading. To create a single unified price for every Crypto Asset, all trading pairs must be standardized to price that asset in a single currency (for the Index, this currency is the U.S. dollar). The steps to do that are listed below in the order that they are followed:

1.
Select Quote Crypto Assets: To avoid circular pricing when standardizing crypto-to-crypto trading pairs, the Committee must select a group of “Quote Crypto Assets.” Quote Crypto Assets are determined on an annual basis at the Committee meeting that precedes the start of a new calendar year.
a.
Quote Crypto Assets are those that:
i.
Have crypto-to-fiat trading on at least two Eligible Crypto Asset trading venues that allow for institutional deposits and withdrawals in a noncapital-controlled fiat currency (an “Eligible Fiat Currency”).
ii.
Are the largest crypto trading pair (measured by trailing 30-day dollar trading volume) for at least one of the top 100 Eligible Crypto Assets in each of the past three months.

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iii.
As of December 31, 2022, Quote Crypto Assets were Bitcoin (BTC) and Ethereum (ETH).
2.
Calculate Quote Crypto Assets Index CAPs: Quote Crypto Assets are unique in that the Index only considers fiat-to-crypto trades when calculating their Index CAPs, as the goal is to calculate the fiat-convertible price of Eligible Crypto Assets that have crypto-to-crypto trading pairs.
a.
The Index CAP for a Quote Crypto Asset is calculated as follows:
i.
Aggregate all crypto-to-fiat trading pairs for Eligible Fiat Currencies that take place on Eligible Crypto Asset trading venues, removing any pairs that face withdrawal issues.
ii.
Transform all non-U.S.-dollar fiat trading pairs into U.S. dollar prices using synchronous data from an established foreign exchange reference data provider.
iii.
Calculate the U.S. dollar volume over the previous hour for each crypto-to-fiat trading pair.
iv.
Assign each trading pair a contribution weight based on its share of total dollar trading volume in a given asset over the previous hour.
v.
Multiply the last traded price (adjusted into U.S. dollars) for each trading venue pair by its contribution weight. In the event that no trading price is pulled for a particular trading pair either due to technical reasons or to a lack of trading volume, the Committee may substitute a fair market value estimate for that price or eliminate that price from consideration.
vi.
Sum to find the Index CAP.
3.
Calculate the Index CAP for Non-Quote Crypto Assets: Many crypto assets trade (sometimes exclusively) in pairs with other crypto assets.
a.
The process for translating these crypto-to-crypto pairs along with crypto-to-fiat pairs into an aggregate Index CAP is as follows:
i.
Consider both crypto-to-fiat trading pairs and crypto-to-crypto trading pairs on Eligible Crypto Asset trading venues, excluding any trading venue pairs that have withdrawal issues.
ii.
Exclude all trading pairs that are not denominated in either Eligible Fiat Currencies or Quote Crypto Assets.
iii.
Transform all non-U.S.-dollar fiat trading pairs into U.S. dollars using synchronous foreign exchange data from an established foreign exchange data supplier.
iv.
For Quote Crypto Assets, use the synchronous Index CAP to translate crypto-to-crypto pairs into a crypto-to-U.S.-dollar equivalent. The synchronous Index CAP is used to establish a conversion rate for non-fiat denominated crypto pairs. Non-quote crypto assets are usually priced relative to a Quote Crypto Asset; therefore, the price can be converted into a U.S. dollar price by multiplying by the U.S. dollar Index CAP of the Quote Crypto Asset. For example, a non-quote crypto asset can be priced in Bitcoin, which is a Quote Crypto Asset. Therefore, you would convert the price of the non-quote crypto asset to its price in Bitcoin, and then convert that price to U.S. dollars. In either scenario, the crypto-to-crypto price is converted or "translated" into a crypto-to-U.S. dollar equivalent. This process is similar to how a foreign exchange rate would be used to convert or “translate” a crypto-to-forex price into a crypto-to-U.S. dollar equivalent.
v.
Calculate the U.S. dollar volume for each trading pair and assign each pair a contribution weight based on its share of total U.S. dollar trading volume in a given Crypto Asset over the past hour.
vi.
Multiply the last traded price (adjusted into U.S. dollars) by its contribution weight. Note: In the event that no trading price is pulled for a particular trading pair either due to

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technical reasons or a lack of trading volume, the Committee may substitute a fair market value estimate for that price or eliminate that price from consideration.
vii.
Sum to find the Index CAP.

Changes in Index Methodology

The Index Methodology is subject to change, though changes are expected to be infrequent and consistent with the Index’s goal of including the most valuable coins that cover the majority of the Crypto Asset market based on market capitalization, while meeting criteria relating to liquidity, access to markets, available pricing, available custody options, and other criteria included within the Index’s rules, which we collectively refer to as meeting an “investment feasibility” standard. See “—Eligibility of Crypto Assets ” for additional information.

Given the speed at which the Crypto Asset market has been changing over the past few years, some adjustments to the methodology have been made in order for the Index to better reflect its target market. Examples of such changes include the method followed to determine which exchanges or custodians are needed to support a Crypto Asset in order to make it eligible, the method to calculate a Crypto Asset’s free-float-adjusted market capitalization, and the specifics of how to screen out assets for non-compensated regulatory or technical risks.

Since the inception of the Index on October 1, 2017, the Committee approved the following changes to the methodology:

Meeting of September, 30, 2020: Adopted a new rule concerning the risk, given present facts and circumstances, of a Crypto Asset being deemed a security under federal securities laws.
Meeting of December, 29, 2020: Adopted a change to Rule V.B, which defines the calculation methodology of market capitalization to exclude the five-year inflation adjustment that was in place up until that time.
Meeting of January 25, 2021: Adopted an amendment to Rule III.B.3.i.e, the custody rule, to require inclusion of additional factors related to the regulatory standing of approved custodians requiring that such custodians follow industry best practices.
Meeting of June 30, 2021: Adopted an amendment to Rule III.B.i.g to state that Crypto Assets will be screened for undue risk “of being in violation of U.S. federal securities laws” rather than being screened for undue risk “of being deemed a security under U.S. federal securities laws.”
Meeting of October 25, 2021: The committee unanimously voted in favor of adopting a new rule to the Bitwise Crypto Index Methodolgy that requires eliginle assets to sustain a price of over $0.01 for the last 30 consecutive days before the rebalancing date to ensure that all assets included in the index have a robust price discovery mechanism in place. As a result, rule III.B.i.i of the Bitwise Crypto Index Methodology reads as follows: “i. Has maintained a unit price greater than $0.01 for the past 30 consecutive days”.
Meeting of February 22, 2022: The Committee voted unanimously in favor of a proposal to change the wording of Rule V.A.II of the methodology from “All Crypto Assets that are publicly known to be lost, burned, programmatically time-locked, or verifiably illiquid in another way” to “All Crypto Assets that are publicly known to be lost or burned”. The removal of the phrase “programmatically time-locked” is designed to clarify that the rule is not intended to remove from free-float calculations Crypto Assets staked by individual users. The phrase “verifiably illiquid in another way” was removed because it was redundant with Rule V.A.III of the methodology.
Special Meeting of November 29, 2022: Adopted an amendment to Rule III.A.i.h to read as follows: “In the opinion of the Bitwise Crypto Index Committee, the venue has significant real spot trading volume." The goal of this rule is to select venues that the Bitwise Crypto Index Committee believes have economically meaningful trading volume.”

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 in which Crypto Assets it

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should invest. The Trust does not intend for its holdings to deviate from the Crypto Assets as determined by the Index, and the Trust anticipates that such deviation would likely occur only if the Trust was unable to hold a particular Crypto Asset that was included in the Index or if the Trust determined that holding a particular asset would result in significant harm to Shareholders.

Eligibility of Crypto Assets

The Index is comprised of the top 10 coins measured by free-float-adjusted market capitalization. The Index is rebalanced monthly. Additional eligibility criteria are applied to screen coins for investment feasibility (as defined below), to ensure the integrity of the coins selected to comprise the Index, and to appropriately account for one-off events. As a result, the 10 coins that comprise the Index may not always completely correlate with the top 10 coins posted on popular websites like CoinMarketCap.com to the extent that such coins do not also meet the Index’s eligibility criteria. The Index will only consider for eligibility Crypto Assets that satisfy the following conditions as established by the Committee for each coin:

1.
Is a cryptographically secured digital bearer instrument
2.
Has a price that is not pegged to another Crypto Asset, fiat currency, group of those currencies, or hard asset
3.
Is freely traded and can be freely held for the foreseeable future
4.
Trades on two or more Eligible Crypto Asset trading venues, without withdrawal issues specific to that Crypto Asset
5.
Is custodied by a third-party custodian regulated as a federally chartered bank or as a state trust company, and meets additional security practices, insurance requirements and business practice requirements as determined by the Committee. The list of approved custodians is reviewed and updated on an annual basis, or at the discretion of the Committee. As of January 25, 2021, the date that the Committee performed its 2022 annual review of eligible custodians, the list of approved custodians was as follows:
i.
Anchorage
ii.
Bakkt Warehouse
iii.
BitGo
iv.
Coinbase Custody
v.
Fidelity Digital Assets
vi.
Gemini Custody
6.
Has no known security vulnerabilities, including critical bugs, undue exposure to 51% attacks, or other factors, as determined by the Committee.
7.
Does not face undue risk of being in violation of U.S. federal securities laws in the opinion of the Committee, given present knowable facts and circumstances. This is a risk-based assessment that considers whether the Crypto Asset may be deemed a security under U.S. federal securities laws and whether it is subject to regulatory action that may imperil the value of the Crypto Asset. Such assessment does not preclude legal or regulatory action based on the presence of a security. The Committee does not engage in legal analysis of any Crypto Assets or perform any analysis of Crypto Assets based upon any legal standards.

 

The Committee reviews the following information to make this determination: 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

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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, including a review of any websites associated with the Crypto Asset's development.

 

Any legal test utilized to determine whether a Crypto Asset is a security would differ from the analysis performed by the Committee. If the Committee adds a Crypto Asset to the Index, but later becomes aware of new information that causes the Committee to revalue the risk profile of such Crypto Asset, the Committee will review such information and determine whether the Crypto Asset should be removed from the Index.

8.
Has traded more than 10% of its free-float-adjusted market capitalization on Eligible Crypto Asset trading venues over the past 30 days.

The following table sets forth all of the Crypto Assets included in the Index as of December 31, 2022, as well as Crypto Assets that were included in the list of the top 10 coins measured by market capitalization on CoinMarketCap.com as of December 31, 2022, but were deemed by the Committee not to satisfy each of the above- described eligibility requirements and were therefore not included in the Index:

 

Crypto Assets

 

Symbol

 

Included in / Excluded from Index

 

If excluded, reason for exclusion

Bitcoin

 

BTC

 

Included

 

Ethereum

 

ETH

 

Included

 

Tether

 

USDT

 

Excluded

 

Because USDT is a stablecoin designed to reflect the value of the dollar.

Binance Coin

 

BNB

 

Excluded

 

Because BNB does not trade on two or more eligible crypto asset trading venues.

USD Coin

 

USDC

 

Excluded

 

Because USDC is a stablecoin designed to reflect the value of the dollar.

Ripple

 

XRP

 

Excluded

 

Because Ripple may face undue risk of being in violation of U.S. federal securities laws.

Binance USD

 

BUSD

 

Excluded

 

Because BUSD is a stablecoin designed to reflect the value of the dollar.

Cardano

 

ADA

 

Included

 

Dogecoin

 

DOGE

 

Excluded

 

Because Dogecoin has security risks and undue exposure to a 51% attack due to its use of auxilliary proof of work.

Solana

 

SOL

 

Included

 

Polygon

 

MATIC

 

Included

 

Polkadot

 

DOT

 

Included

 

Litecoin

 

LTC

 

Included

 

Uniswap

 

UNI

 

Included

 

Avalanche

 

AVAX

 

Included

 

Chainlink

 

LINK

 

Included

 

To the extent that such coin meets the Index’s eligibility requirements at a future date, it would be considered for inclusion in the Index in connection with a future rebalancing. 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 web site. In either case, if the Sponsor determines that the change is material (which the Sponsor generally considers to be a change of 10% or more to the Trust or the Index holdings, but in any event, is also determined at the Trust’s discretion) the Sponsor will disclose such change by filing a Form 8-K. The Committee relies on the analysis conducted by the Sponsor as described in Overview of Government Regulation.” 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 increased 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 that used by the Committee as set forth above. In certain circumstances, the Sponsor may cause the Trust to differ from the Index in the coins that it holds if the Sponsor causes the Trust to exclude a coin based on these or similar circumstances, and this may lead to tracking differences between the Trust and the Index.

One-Off Events

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The Index has provisions for handling one-off events that occur in a Crypto Asset that is currently part of the Index or in the Crypto Asset market generally, such as trade suspensions and Hard Forks. One-off events are events that are not expected to occur during the normal functioning of a Crypto Asset network and that significantly impact the operation of the network or the ability for market players to trade in or out of the Crypto Asset. Examples of these are Hard Forks, which can lead to a network split and therefore two versions of the same asset circulating in the market, or significant liquidity reductions, such as in the event of trading suspensions or delistings from exchanges. If new types of important one-off events become common, the Index may adopt additional policies to address them as determined in the sole discretion of the Index Committee. With regard to trade suspensions, if an exchange suspends the trading of a given coin for any reason, the Index may remove that individual exchange from consideration. In the event of delisting of such coin from all public exchanges, then the coin will be removed from the Index during the next rebalancing regardless of what the assumed market capitalization might have been. The Committee may convene ad hoc to consider appropriate actions should there be a sudden and extenuating event.

The Index views Hard Forks similarly to how company spinoffs are viewed in U.S. equity markets. A Hard Fork is when a Crypto Asset is split because portions of the consensus nodes adopt different policies. In such an event, often a private key holder ends up with ownership on both chains. Often there is a primary chain that is adopted by the majority. When a Hard Fork occurs, the forked coin will be held in the Index until the next rebalancing. This embodies the idea that the value of the forked coin stems from that of the original coin. Thus, the Index will hold the two Crypto Assets as if they were one until the next opportunity to treat them as separate. The new forked coin will then be removed from the Index upon the next rebalancing unless it meets all the eligibility requirements (except the requirement to have a three-month trade history) and has a free-float adjusted market capitalization of its own to warrant being included in the Index.

 

The Index also has provisions for other Network Distribution Events. Network Distribution Events include Emissions, Airdrops, and staking. To the extent that Network Distribution Events occur that impact the Index and, due to the Trust’s goal of tracking the Index, thereby impact the Trust as well, the Trust will notify Shareholders of such Network Distribution Events by filing a Form 8-K with the SEC.

Emissions: Certain Crypto Assets provide regular awards to holders in the form of Crypto Asset grants, often in the form of “gas” that powers transactions on the network itself, which are referred to as “Emissions.” Such Emissions are a native development for the Crypto Assets that provide them. Currently, there are no assets in the Index that produce Emissions, and historically, there has been just one asset (NEO) that did so. To date, the daily value of distributed Emissions has been de minimis for any given Crypto Asset. Given the small values involved, it would not be practical for investment funds handling regular inflows and outflows to accurately track the Index if it accrued Emissions on a daily basis, regardless of whether the Index collected those Emissions over time or liquidated them daily. As a result, the Index ignores Emissions for Index calculation purposes. It is possible that the Trust may choose to periodically liquidate Emissions and return the proceeds of such liquidation to Shareholders. The Trust will only do so if it has a good faith belief that such liquidation would result in a benefit to Shareholders.
Airdrops: An Airdrop occurs when a new or emergent Crypto Asset is granted to holders of an existing Crypto Asset on a one-off or occasional basis. Airdrops are not native to the internal return drivers of any given Crypto Asset. Importantly, they also require agency on the part of Crypto Asset holders to claim, and the act of claiming an Airdropped Crypto Asset can potentially put holders of a given Crypto Asset at risk. As such, the Index does not incorporate the value of Airdropped Crypto Assets into the Index. It is possible that the Trust may choose to periodically liquidate Airdropped assets and return the proceeds of such liquidation to Shareholders. The Trust will only do so if it has a good faith belief that such liquidation would result in a benefit to Shareholders.

When considering whether or not to accept and/or sell an Airdrop of Crypto Assets, the Trust primarily considers whether or not the Trust’s Custodian will support such activities related to the Airdropped asset. If the Trust’s Custodian does not support the Airdrop, it is unlikely that the Trust will participate in the acceptance and sale of the Airdropped asset. If the Trust’s Custodian does support the Airdropped asset, it is likely, though not necessary, that the Trust will participate in the acceptance and sale of the Airdropped asset. However, as Airdrops may provide opportunities to generate incremental return, the Sponsor retains discretion to pursue receipt of any Airdropped asset, even if not supported

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by the Custodian, which may require putting a related Portfolio Crypto Asset at risk. 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 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 Airdrop, or ever). There were no “Airdrops” or Emissions recognized or not recognized during the fiscal years ended December 31, 2022, 2021 and 2020.

Staking: A staking reward is granted to holders of a Crypto Asset when the holders lock up that Crypto Asset as collateral to secure fairness when validating transactions or other network actions. Staking rewards require agency on the part of Crypto Asset holders and can also introduce liquidity restrictions, since the act of staking “locks up” Crypto Assets for a period of time. As such, the Index does not incorporate the value of staking rewards into the Index. It is possible that the Trust may choose to periodically liquidate staking rewards and return the proceeds of such liquidation to Shareholders. The Trust will only do so if it has a good faith belief that such liquidation would result in a benefit to Shareholders.

 

When considering whether or not to participate in staking activities, the Trust considers whether the staking activities present possible and prudent opportunities to generate additional returns for Shareholders in excess of the Index, the risks associated with the staking activities, potential for the loss of all or part of the staked amounts, and whether or. While the Trust has only participated in a limited and immaterial manner in staking activities to date, it retains the discretion to develop additional policies related to staking of assets, and may consider pursuit of additional staking activity or policies in the future. If the Trust makes material changes to its staking policy in the future, it will disclose such changes by filing a Form 8-K. The Trust has not participated in any staking or reward generation activity other than with respect to Tezos in 2020. The Trust received $2,139 in total staking rewards in 2020 from its Tezos staking activities. These rewards were treated as investment income in the Trust’s audited financial statements for the fiscal year ended December 31, 2020. 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. If the Trust makes material changes to its staking policy in the future, it will disclose such changes on Form 8-K.

The Trust does not maintain policies or procedures related to the abandonment of Crypto Assets acquired in a Network Distribution Event, but will evaluate the situation and determine, within the framework of the Trust’s investment objective and in its sole discretion, what action, if any, should be taken in response to a Network Distribution Event.

Bitwise Crypto Index Committee

The Committee, which was convened by the Index Provider, an affiliate of the Trust that is controlled by the parent of the Sponsor, has total responsibility for developing, maintaining, and adjusting the Index Methodology. The components of the Index Methodology are subject to change in the sole discretion of the Committee. The Bitwise Crypto Index Advisory Board is a consultative board composed of leading external experts in indexing and Crypto Asset research that the Committee can rely upon for opinions on critical issues that the Committee might face.

The Committee currently has three members, who meet once a month to review data sources, evaluate potential methodological changes, or make other decisions that require judgment. Any Committee member can also call emergency meetings on an as-needed basis. Special meetings may be called ad hoc when unexpected market conditions arise such as Hard Forks, extreme price movements, serious issues in data availability or sudden events with severe impact on the Crypto Asset market. Currently, the Committee is composed of Matthew Hougan (Bitwise’s Chief Investment Officer) as Chairman, Hunter Horsley (Bitwise’s Chief Executive Officer) as a member, and Hong Kim (Bitwise’s Chief Technology Officer) as a member. All of the members of the Committee are employees of Bitwise, the parent company of the Sponsor. Decisions are voted on by simple majority with a minimum quorum of two members. When only two members are present, votes must be unanimous in order to pass.

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The objective of methodological changes introduced by the Committee is to keep up with the evolution of the Crypto Asset market. More broadly, the aim is to make sure that the selection of the top 10 assets continues to reflect as much as possible investors’ preferences by removing market distortions and screening out uncompensated risks of an either technical or regulatory nature for U.S. investors.

The Committee members owe no duty to the Trust and may make decisions or take actions with respect to the Index that may be adverse to the Trust. The Committee has no decision-making authority or control over the Trust. No member of the Committee in his or her capacity as a committee member has a right to participate in the management of the Trust, to act for or bind the Trust, or to vote on Trust matters except as specifically provided under applicable law or in the Trust Agreement.

The Index is evaluated and studied on an ongoing basis by the Committee. Variables such as eligibility and liquidity are benchmarked against new market conditions and new data sources are considered for inclusion while old ones are considered for exclusion.

Departures from the Index

Performance of the Trust may differ from the Index. For example, tracking errors may emerge as a result of trading fees, bank fees, and the management fee, which pays for custody, audit, administration, portfolio management, Index use, and other necessary services. The Trust will attempt to pay expenses in the most tax and cost-efficient manner possible. It is possible that a Network Distribution Event could occur that may result in an opportunity for the Trust to generate additional returns. If such a Network Distribution Event were to occur, the Trust may seek to utilize the Network Distribution Event in such a way as to benefit the Shareholders of the Trust. 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 due to monthly rebalancing of the Index, which could cause deviations between the Trust and the Index, and 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. If required by applicable law, the Trust would also disclose such information by filing a current or periodic report with the SEC.
 

In addition, the Trust may differ from the Index in the Crypto Assets it holds. Such differences may arise from situations in which the Trust is not technologically able to hold a Crypto Asset held by the Index, such as if a coin held by the Index is not able to be accepted by the Trust’s Custodian. In such a case, the Sponsor in its sole discretion may create an exception and such exception may not always be communicated in advance to Shareholders. To the extent any exception resulted in a material change to the Index and a subsequent material change to the composition of the Trust, the exception would be disclosed to Shareholders by the Trust filing a Form 8-K with the SEC. In addition, if a particular situation results in the Trust differing from the Index, the Sponsor may permit the Trust to invest in other assets on a limited basis in the sole discretion of the Sponsor. Although the Trust rarely holds “other assets” outside of negligible amounts of U.S. dollars, the Trust may receive assets that are not in the Index as a result of Airdrops, Emissions, Hard Forks, trading errors and/or accidental delivery of Crypto Assets to the Trust’s custodian, among other reasons. The Trust may also be unable to sell or liquidate assets that are removed from the Index. The Trust may receive assets as a part of an in-kind subscription that are not components of the Index. The Sponsor notes that portfolio management of an index fund is a dynamic and complex activity, and the Sponsor expects that these situations may arise as a result of normal and ongoing fund management and rebalancing activity. While there is no limitation to what other assets the Trust may hold as a result of these dynamics, the Trust’s investment objective is to manage a portfolio that tracks as closely as possible with the Index, and as a result, will typically hold Index components. Upon the resolution of such a situation that resulted in there being a difference between the composition of the Trust and the Index, the Trust would intend to rebalance to conform to the Index.

The Trust and Index have differed in their holdings on two occasions. The Trust temporarily held Bitcoin SV (BSV) following the Bitcoin Cash Hard Fork. The Trust sold the BSV as soon as practicable once access to a custodian was provided. The Index held Cardano (ADA) and the Trust did not, because while ADA met the eligibility requirements

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for the Index, the Trust requires that all the Crypto Assets it holds be custodied by a specific custodian, and the Trust's custodian at that time was not technologically enabled to accept and hold ADA.

The Trust does not hold any form of asset other than Crypto Assets, outside of negligible amounts of U.S. dollars.

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.

Additional Trust Investment Restrictions

The Sponsor does not currently intend to cause the Trust to incur leverage, employ derivatives, or enter into short sales. The Sponsor, however, retains the right to remove any of these investment restrictions at any time in its sole discretion. The Sponsor will notify the Shareholders in the Trust prior to modifying any of the investment restrictions described in this section.

 

Rebalancing of the Index

The Index is reconstituted on a monthly basis. The Committee meets once a month (typically on the fifth-to-last business day of the month) to review data sources, evaluate potential methodological changes, or make other decisions that require judgment. On the third last business day of the month, the Eligible Crypto Assets are ranked by free-float adjusted market capitalization and the top ten assets are selected. On the last business day of the month, at 4:00 pm ET, the Index is reconstituted. This version of the Index will remain in place until the next Index reconstitution (barring an emergency meeting of the Committee that leads to the exclusion of an asset). The Trust rebalances its portfolio at approximately 4:00 pm ET to reflect the new composition of the Index. There may be small delays between when the Index rebalances and when such rebalance is reflected in the Trust’s financial statements. For example on December 31, 2021, as part of the Index’s December rebalance, the Index removed Uniswap and added Avalanche. The Trust then rebalanced its portfolio to reflect the rebalanced Index; however, due to the timing of when the Trust’s books and records were finalized, the complete removal of Uniswap and addition of Avalanche appeared in the Trust’s financial statements beginning on January 3, 2022.

 

Overview of Index Constituents

As of December 31, 2022, the constituents in the Index and their weights were as follows:

 

Bitcoin:

 

 

63.53

%

Ethereum:

 

 

28.75

%

Cardano:

 

 

1.71

%

Polygon:

 

 

1.32

%

Polkadot:

 

 

1.02

%

Litecoin:

 

 

0.98

%

Uniswap:

 

 

0.76

%

Solana:

 

 

0.72

%

Avalanche:

 

 

0.68

%

Chainlink:

 

 

0.53

%

 

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As of December 31, 2021, the constituents in the Index and their weights were as follows:

 

Bitcoin:

 

 

58.69

%

Ethereum:

 

 

29.33

%

Solana:

 

 

3.52

%

Cardano:

 

 

2.98

%

Avalanche:

 

 

1.76

%

Polygon:

 

 

1.19

%

Algorand:

 

 

0.71

%

Litecoin:

 

 

0.68

%

Chainlink:

 

 

0.60

%

Bitcoin Cash:

 

 

0.54

%

 

As of December 31, 2020, the constituents in the Index and their weights were as follows:

 

Bitcoin:

 

 

82.20

%

Ethereum:

 

 

12.90

%

Litecoin:

 

 

1.20

%

Bitcoin Cash:

 

 

1.00

%

Cardano:

 

 

0.90

%

Chainlink:

 

 

0.70

%

Stellar Lumens:

 

 

0.40

%

EOS:

 

 

0.40

%

Tezos:

 

 

0.20

%

Cosmos:

 

 

0.20

%

 

The following is an overview of the constituents in the Index as of December 31, 2022:

 

Bitcoin (BTC)

Bitcoin is the most well-recognized Crypto Asset in the world. As of December 31, 2022, Bitcoin is the largest Crypto Asset in the world by market capitalization. It is commonly referred to by its ticker symbol BTC.

Bitcoin was invented in 2008 by a pseudonymous software developer, or a group of software developers, under the name Satoshi Nakamoto. Nakamoto published a white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” on October 31, 2008, which provided the technical outline for launching the Bitcoin network. The network went live on January 3, 2009, when Nakamoto mined the first block of transactions, known as the “Genesis Block.”

The software underlying the Bitcoin Blockchain determines a number of key and independent parameters. At the heart of the system lies the algorithm that enforces that all ledgers converge over time (commonly known as the “Consensus Algorithm”). Other important portions of the system include the rules that deem a transaction valid, a programming language that allows for different types of transactions to be executed, and the process through which new Crypto Assets are minted (commonly known as “Mining”), and others.

 

One important property of Bitcoin is that the network strictly enforces the total amount of units issued to converge towards 21 million by the year 2140 through a predetermined schedule. The total number of Bitcoin created as of December 31, 2022, was approximately 19.25 million. It is believed that some portion of the Bitcoin created to-date is irretrievable because the private keys that would allow users to access that Bitcoin have been lost, although the exact amount that has been lost is unknown.

 

New Bitcoin iscreated when Miners process blocks of transactions. In the Bitcoin network, this occurs roughly every ten minutes. The Blockchain periodically adjusts the difficulty of settling transactions to ensure that cadence remains approximately accurate.

 

The amount of new Bitcoin created each time a block of Bitcoin transactions is processed is predetermined by the software underlying the Bitcoin Blockchain. Initially, the Miner that settled a block of transactions on the Bitcoin

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Blockchain received 50 Bitcoin. That reward was and is programmed to be cut in half roughly every four years; currently, Miners receive 6.25 Bitcoin for each block of settled transactions.

 

Although there are a few interoperable versions of the Bitcoin software, most network participants run a version called “Bitcoin Core,” which is maintained by a group of independent developers. The Bitcoin core developers are able to propose changes to this version of the software that powers the network. However, as a decentralized network, any changes must be downloaded and accepted by the users of the network in order for these changes to be implemented. If not all users accept a proposed change, the network can be split, as detailed in the section entitled

“Item 1. BusinessChanges in Index MethodologyOne-Off Events.”

 

The Bitcoin network is known for being extremely decentralized, as it is maintained by a network of computers that, joined together, represents the largest supercomputer in the world. Some believe that this makes Bitcoin more secure and resistant to attacks compared to other Blockchain networks.

 

One of the key limitations of the Bitcoin network is the limited number of transactions that can be processed per second, a statistic commonly referred to as throughput. The trade-off between decentralization and scalability is present in any Crypto Asset Network, and Bitcoin is optimized for the former. There are, however, a number of efforts in relatively advanced stages underway to expand the network’s throughput, including efforts to build networks that can be layered over Bitcoin.

 

Other concerns and limitations raised by market participants about Bitcoin include worries that its PoW scheme consumes a large amount of electricity, which could entail significant economic and environmental costs, and that Bitcoin could be used for criminal activity due to its pseudonymous nature.

 

Ethereum (ETH)

Ether is the native Crypto Asset of Ethereum, the second largest Blockchain network ranked by market capitalization as of December 30, 2022. Ethereum was described in a white paper in late 2013, and an online crowdsale to fund development took place between July and August 2014. The network went live in July 2015.

Ethereum was specifically designed to power smart contracts, which are computer programs intended to enforce the performance of a contract that parties can codify and agree upon with minimal or no need of trusted intermediaries. Crypto Asset pioneer Nick Szabo, who coined the term smart contract in the early 1990s, mentioned a vending machine as a rudimentary example of a smart contract.

 

In order to achieve this functionality, the designers of Ethereum opted for a different set of trade-offs compared to Bitcoin. One important difference is that Ethereum’s script language, the programming language that developers use for creating Blockchain applications, is significantly more flexible than Bitcoin’s. This allows the creation of programs that do general computation instead of only the relatively simple conditional payments that are possible with Bitcoin. As such, a whole ecosystem of different applications including asset issuance, decentralized financial applications, identity management, and others are able to and have been developed on top of the Ethereum network.

Ethereum currently supports the majority of the stablecoin (e.g., Crypto Assets pegged to a fiat currency, typically the U.S. Dollar) market capitalization and it also boasts the largest number of developers building applications on top of it. Ethereum is also the Blockchain used as the base layer for many DeFi applications, which aim to replace traditional financial services with software-enabled processes, including lending, market making, insurance, and more.

 

Ethereum’s richer feature set compared to Bitcoin comes at a cost. The more permissive programming language makes the network inherently less secure because it can increase the odds that a catastrophic bug in one smart contract could affect the whole network. In late 2017, for instance, a prominent digital wallet provider called Parity identified a vulnerability that froze more than $150 million in Ether.

 

Another subjective but important difference between the Ethereum and Bitcoin ecosystems is that while the former is usually more driven towards innovation, the latter is more focused on stability and security. As such, events like Hard Forks are significantly more common in Ethereum than in Bitcoin. For example, on September 15, 2022, Ethereum transitioned for a PoW network to a PoS network. This infrastructure upgrade is known as "The Merge." Itis one of several Hard Forks the Ethereum Blockchain has undergone since inception. Some consider Ethereum’s

24


 

stance as an advantage, while others perceive it as a risk, especially as the project grows larger and the cost of potential mistakes rises.

 

The differences between Bitcoin and Ethereum are likely to increase significantly over the next few years as Ethereum is scheduled to go through a series of major upgrades to make the network more scalable, more decentralized, more private, more secure and more efficient. For example, "The Merge" resulted in a reduction of the Ethereum network's energy consumption of over 95% overnight.

 

Cardano (ADA)

Cardano (ADA): Cardano is a proof-of-stake (PoS) blockchain and smart contract platform that facilitates secure payments and enables developers to build decentralized applications (dApps). Grounded in research and academia, the protocol and it's token were named after 16th and 19th century polymaths, and its programming language, Haskell, is commonly used in the traditional finance and security sectors.

 

Polygon (MATIC)

Polygon is one of Ethereum’s leading scaling solutions that provides a suite of tools to improve the speed and reduce the cost of transactions on the Ethereum network. MATIC is the Crypto Asset that powers the Polygon network, a cutting-edge technology that makes Ethereum transactions up to 10,000x cheaper. Compared to Ethereum’s 15 to 45 transactions per second, Polygon is able to process up to 65,000 transactions per second at a fraction of the cost. With scalability being the most significant bottleneck to Ethereum’s growth, solutions like Polygon have risen to prominence.

 

Polygon is a user-friendly gateway to the Ethereum network that has become home to a rich application ecosystem as users and developers seek to reap the benefits of the Ethereum ecosystem without suffering from its higher transaction fees and slower transaction processing time. Polygon can help blockchain applications like Decentralized Finance (DeFi), Non-Fungible Tokens (NFTs), and gaming reach their full potential. Additionally, a number of non-crypto companies across various industries have chosen to enter Web3 through the Polygon network. These include, but are not limited to, Starbucks, Reddit, Meta, and Robinhood.

 

Holders can also “stake” MATIC, which helps to secure the network by participating in the validation of transactions, thereby earning staking rewards for the holder. Polygon’s infrastructure also allows applications to interact with each other seamlessly, fostering interoperability.

 

Solana (SOL)

Solana is a decentralized blockchain network with a focus on secure, low-fee, high-speed transactions that are paid for using the SOL, or the Solana blockchain’s native Crypto Asset. By leveraging Proof-of-History (PoH) and other breakthrough innovations, Solana allows for greater throughput than many other blockchains, with the ability to scale at the rate of Moore's Law. Solana, like Ethereum, is home to several use cases including gaming, decentralized finance (DeFi), and non-fungible token (NFT) marketplaces.

 

Among the risks that attend Solana is that its development was initially backed by a comparatively small number of entities, which have comparatively larger stakes in Solana than single entities do in, for instance, Ethereum. In 2022, for instance, one of the entities that was an early supporter of Solana - FTX Limited -- went bankrupt, which had significant negative ramifications for the Solana network.

 

Polkadot (DOT)

Polkadot is a proof-of-stake blockchain that leverages a newer infrastructure design to that of Solana’s and Ethereum’s. For purposes of enhanced performance, Polkadot splits up the workload by hosting various independent blockchains on top of one central blockchain, known as the Relay Chain. The purpose of the Relay Chain is to provide ecosystem support, notably in terms of security and interoperability.

 

Litecoin (LTC)

Litecoin was launched in October 2011. Derived from Bitcoin’s original code, the main modifications to the Litecoin Blockchain were a shorter time between blocks, (2.5 minutes versus 10 minutes for Bitcoin), a larger total supply of Crypto Assets (84 million versus 21 million for Bitcoin), and a different Mining hashing algorithm (scrypt versus Bitcoin’s SHA-256), which was developed to discourage large-scale Mining. In general, Litecoin was

25


 

designed to facilitate small payments in a faster and cheaper fashion compared to Bitcoin. As one of the first Blockchains developed after Bitcoin, Litecoin has strong brand recognition in the crypto community.

 

Avalanche (AVAX)

Avalanche is a blockchain ecosystem that is home to several applications across a variety of use cases including, but not limited to, gaming and decentralized finance. Avalanche’s design makes it relatively easy for developers to deploy applications to and from Ethereum. Avalanche was designed to be a faster and cheaper alternative to other blockchains for purposes of a better user and developer experience. For example, the network leverages its different built-in blockchains for enhanced transaction speeds at economically feasible costs. To that end, some of its built-in blockchains are dedicated to specific use cases and/or applications to avoid network congestion the popularity of other applications can cause.

 

Uniswap (UNI)

Uniswap is a leading decentralized exchange (DEX) for Crypto Assets that is built on the Ethereum network. Uniswap’s automated platform lets traders exchange Crypto Assets in the same way they do on centralized exchanges, like Coinbase, but without the involvement of a centralized third party. Additionally, Uniswap’s decentralized structure allows any individual to act as a market maker and provide liquidity on the platform, earning passive income. To make a transaction, users simply send Crypto Assets from their crypto accounts and receive their desired Crypto Assets in return — all while paying a fee that is typically lower than that of a centralized exchange, like Coinbase. Uniswap issued its own Crypto Asset, called UNI, in September 2020. Holding UNI gives the holder a vote in Uniswap’s governance decisions, such as fee structures and how to deploy the exchange’s treasury. UNI can also be traded as an asset in its own right.

 

Chainlink (LINK)

Chainlink is a network that connects smart contracts with real world data. Blockchain networks are unaware of what happens outside of those networks, and therefore whenever a Blockchain application needs to interact with external data, it needs a reliable data source to do so. These data sources are known in the industry as Oracles. Relying on one Oracle creates a single point of failure, and Chainlink aims to solve this issue by providing a decentralized network of multiple Oracles that can evaluate the same data. The accuracy of this data can be important if this data is used to trigger activity on a smart contract or other Blockchain application. Chainlink provides price reference data feeds for DeFi, and also allows users to create their own Oracle networks. Larger enterprises can also use Chainlink to sell their data to smart contracts that need them to trigger a certain condition. Current use cases for Chainlink include stableCrypto Assets, decentralized lending and borrowing, and asset management.

Overview of Government Regulation

Securities Act of 1933

The Shares have not been registered under the Securities Act or the securities laws of any U.S. state or the securities laws of any other jurisdiction, and, therefore, cannot be resold unless they are subsequently registered under the Securities Act and other applicable securities laws or unless an exemption from registration is available. It is not contemplated that registration of the offer of the Shares under the Securities Act will ever be effected. Shares in the Trust are sold by the Trust only to investors who, under U.S. securities laws, are “accredited investors.” As a result, we expect that (i) any Shares issued to investors in such offerings will be “restricted securities” under Rule 144, and (ii) the Shares issued to such an investor will be “unrestricted” under Rule 144 one year and a day subsequent to the date that the investor acquired the Shares. Shares held by affiliates and insiders will be subject to additional restrictions on resales, including restrictions on the number of Shares that may be resold within any three-month period.

In addition, certain regulatory considerations may exist under the Securities Act with respect to the Portfolio Crypto Assets, and it is possible that the SEC may determine that the Trust has invested in assets that are deemed to be securities. In the event the Trust is invested in assets that are deemed securities, the Sponsor may also be subject to additional regulatory requirements, including under the Securities Act. See “Item 1A. Risk Factors—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” and below for additional information. For example,

26


 

typically, offerings of securities in the United States are required to register under the Securities Act with the SEC and, in compliance with state law, with applicable state regulators, and to the extent any Portfolio Crypto Asset was originally distributed in connection with an illegal securities offering, our Portfolio Crypto Assets may lose value. In addition, our plans to make purchases and sales of Portfolio Crypto Assets in connection with the monthly rebalancing of the Index may be substantially constrained or prohibited with respect to transactions in any Portfolio Crypto Asset determined to be a security. We may need to find a suitable exemption from registration for these sales. As a result, the Trust may not be permitted to operate its business in the manner in which we currently operate our businesses.

Securities Exchange Act of 1934

As described above, it is possible that the Portfolio Crypto Assets could be deemed to be “securities” under the federal or state securities laws. See “Item 1A. Risk Factors—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. In the event the Trust does invest in assets that are deemed securities, the Sponsor may also be subject to additional regulatory requirements, including under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). For example, the Trust may be required to make certain filings with the SEC in connection with any acquisition or beneficial ownership of more than 5% of any class of the equity securities of a company registered under the Exchange Act. Generally, these filings require disclosure of the identity and background of the purchaser, the source and amount of funds used to acquire the securities, the purpose of the transaction, the purchaser’s interest in the securities, and any contracts, arrangements or undertakings regarding the securities. In certain circumstances, the Trust may be required to aggregate its investment position in a given company with the beneficial ownership of that company’s securities by or on behalf of the Sponsor or its affiliates, which could require the Trust, together with such other parties, to make certain disclosure filings or otherwise restrict the Trust’s activities with respect to such securities.

In addition, if the Trust becomes the beneficial owner of more than 10% of any class of the equity securities of a company registered under the Exchange Act, the Trust may be subject to certain additional reporting requirements and to liability for short-swing profits under Section 16 of the Exchange Act.

Investment Company Act of 1940

The Investment Company Act regulates certain companies that invest in, hold or trade securities. In general, a company with more than 40% of the value of its non-cash assets held in investment securities is an “investment company.” It is possible that the Trust could be subject to the provisions of the Investment Company Act if its assets were deemed to constitute securities under the U.S. securities laws. See “Item 1A. Risk Factors—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” for additional information. Currently, because the Trust has determined that it does not invest in, hold or trade securities, Shareholders are not afforded the protections of the Investment Company Act.

In the event the Trust does invest in assets that are deemed securities, the Trust may be subject to additional regulatory requirements, including under the Investment Company Act. For example, the Trust may be required to register as an investment company. Registered investment companies are subject to extensive, restrictive and potentially adverse regulations relating to, among other things, operating methods, leverage, management, capital structure, dividends and transactions with affiliates. Registered investment companies may not be permitted to operate their business in the manner in which we operate our businesses, nor are registered investment companies permitted to have many of the relationships that we have with our affiliated companies.

Investment Advisers Act of 1940

The Investment Advisers Act of 1940, as amended (the “Advisers Act”) regulates persons who for compensation are engaged in the business of providing advice, making recommendations, issuing reports, or furnishing analyses on securities, either directly or through publications, to others. We believe that, because the assets of the Trust do

27


 

not constitute securities under the U.S. securities laws, the Sponsor is not subject to investment adviser regulation under the Advisers Act. See “Item 1A. Risk Factors—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” for additional information.

In the event the Trust does invest in assets that are deemed securities, however, the Trust may be subject to additional regulatory requirements, including under the Advisers Act. For example, the Sponsor may be required to register as an investment adviser. Registered investment advisers are subject to extensive, restrictive and potentially adverse regulations relating to, among other things, operating methods, disclosure, advertising, and fees. Registered investment advisers may not be permitted to operate their business in the manner in which the Sponsor operates its businesses. However, the Sponsor seeks to operate in a manner that would be expected of an investment adviser, including the administration of a rigorous internal compliance policy.

Anti-Money Laundering and Economic Sanctions Requirements

In order to comply with applicable anti-money laundering requirements, each investor must represent, among other things, in its Subscription Agreement with the Trust, that neither the investor, nor any person having a direct or indirect beneficial interest in the Shares being acquired by the investor, appears on the Specifically Designated Nationals and Blocked Persons List of the Office of Foreign Assets Control in the United States Department of the Treasury (“OFAC”), is otherwise a party with which the Trust is prohibited to deal under the laws of the United States or is otherwise the subject or target of sanctions administered or enforced by OFAC, and that the investor does not know or have any reason to suspect that (i) the monies used to fund the investor’s investment in the Trust have been or will be derived from or related to any illegal activities or (ii) the proceeds from the investor’s investment in the Trust will be used to finance any illegal activities. Each investor must also agree to provide any information to the Trust and its agents as the Trust may require in order to determine the investor’s and any of its beneficial owners’ identity and source and use of funds and to comply with any anti-money laundering laws and regulations applicable to the Trust.

The Trust may decline to accept a subscription on the basis of the information that is provided or if certain information is not provided. 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 the Shareholders that the information has been provided. Each of the Sponsor and the Trust will take such steps as it determines in its sole discretion are necessary to comply with applicable laws, regulations, orders, directives or special measures. These steps may include prohibiting a Shareholder from making further contributions of capital to the Trust, depositing distributions or other funds or assets to which a Shareholder would otherwise be entitled to in an escrow account or causing the exclusion of a Shareholder from the Trust. The Trust will not admit an investor without obtaining all know-your-client information that the Trust determines is required. By subscribing for the Shares, investors consent to the disclosure by the Trust and the Sponsor of any information about them to regulators and others upon request in connection with money laundering and similar matters in relevant jurisdictions.

Commodity Exchange Act

The Trust will not hold or trade in commodity futures contracts or other derivative contracts regulated by the CEA, as administered by the CFTC. The Sponsor believes that the Trust is not a commodity pool for purposes of the CEA, and that neither the Sponsor nor the Trustee is subject to regulation as a commodity pool operator or a commodity trading adviser in connection with the operation of the Trust.

Foreign Considerations

Our primary place of business and market of operation is the United States. We may, however, 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 and regulations of jurisdictions in which we operate, foreign laws and

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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 coin 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. Please refer to “Item 1A. Risk Factors—Risk Related to Regulatory and Compliance” for additional discussion of the effect of existing or probable governmental regulations on the Trust’s operations.

Certain U.S. Federal Income Tax Considerations

Introduction

The following discussion is a general summary of certain U.S. federal income tax considerations relating to an investment in the Trust. This summary does not address all income tax consequences of an investment in the Trust, many of which may depend on individual circumstances, such as the residence or domicile of a Shareholder. It is based on the Code, the Treasury regulations thereunder (“Regulations”) and judicial and administrative interpretations thereof, all as of the date of this Annual Report on Form 10-K. No assurance can be given that future legislation, Regulations, administrative pronouncements and/or court decisions will not significantly change applicable law and materially affect the conclusions expressed in this Annual Report on Form 10-K. Any such change, even though made after a Shareholder has invested in the Trust, could be applied retroactively. Moreover, the effects of any state, local or foreign tax law, or of federal tax law other than income tax law, are not addressed in these discussions and, therefore, must be evaluated independently by each prospective investor. In addition, prospective investors should discuss the impact, if any, of recently enacted U.S. tax legislation on their individual tax circumstances with their own tax advisors.

 

Except to the extent set forth below under the heading “—U.S. Taxation of Non-U.S. Persons,” this discussion does not address the U.S. federal income tax considerations that may be relevant to Non-U.S. Persons (as defined below). In addition, this summary assumes that the Trust’s Shareholders will generally be U.S. Persons (as defined below).

For purposes of this discussion, a “U.S. Person” is a beneficial owner of Shares in the Trust that is (i) an individual who is a citizen of the United States or is treated as a resident of the United States for U.S. federal income tax purposes, (ii) a corporation or other entity treated as a corporation for U.S. federal income tax purposes that is created or organized in or under the laws of the United States, any State thereof or the District of Columbia, (iii) an estate, the income of which is subject to U.S. federal income taxation regardless of its source, or (iv) a trust that (a) is subject to the supervision of a court within the United States and the control of one or more U.S. Persons or (b) has a valid election in effect under applicable Treasury regulations to be treated as a U.S. Person. A “Non-U.S. Person” is a beneficial owner of Shares in the Trust that is an individual, corporation, estate or trust for U.S. federal income tax purposes and is not a U.S. Person.

No ruling has been requested from the Service or any other federal, state or local agency with respect to the U.S. tax matters discussed below; nor has the Trust or the Sponsor asked counsel to render any legal opinions regarding any of the matters discussed below. This summary does not in any way either bind the Service or the courts or constitute an assurance that the income tax consequences discussed in this Annual Report on Form 10-K will be accepted by the Service, any other federal, state or local agency or the courts.

The tax aspects of an investment in the Trust are complicated. Nothing in this Annual Report on Form 10-K is or should be construed as legal or tax advice to any prospective investor. It is recommended that prior to any decision to invest in the Trust, each investor consult with professional advisors familiar with the tax laws and regulations applicable to investment in a trust that is treated as a partnership for U.S. federal income tax purposes.

Entity Classification and Partnership Taxation

Classification of the Trust. The Trust is a statutory trust organized under Delaware law and it is anticipated that at all relevant times it will have at least two Shareholders and thus, subject to the discussion below under “—Publicly Traded Partnership Status,” will be classified as a partnership for U.S. federal income tax purposes. It is anticipated

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that the Trust will not be classified as a grantor trust for U.S. federal income tax purposes because it will not hold a fixed pool of assets. As a partnership, the Trust generally will not be subject to federal income tax. Instead, each Shareholder will be required to report separately on its income tax return for each year its distributive share of the Trust’s items of income, gain, loss and deduction and will be taxed currently on that distributive share, regardless of whether the Shareholder has received or will receive a distribution of cash or other assets from the Trust.

If the Trust were treated as a corporation for U.S. federal income tax purposes, then (i) its taxable income would be subject to corporate income tax, (ii) distributions of that income, other than on certain redemptions, would be treated as dividend income by the Shareholders (to the extent of the Trust’s current or accumulated earnings and profits) and (iii) the Shareholders would not take into account their distributive shares of the Trust’s income, gains, losses and deductions. Accordingly, if the Trust were treated as a corporation for federal tax purposes, the total return to the Shareholders would be significantly reduced.

Publicly Traded Partnership Status. Under the Code, a “publicly traded partnership” generally is treated as a corporation. A partnership is a “publicly traded partnership” if interests therein (i) are traded on an established securities market (as defined under the applicable Regulations (“PTP Regulations”)) or (ii) are readily tradable on a secondary market (or the substantial equivalent thereof) (“Readily Tradable”). Even if interests of a partnership are treated as Readily Tradable such that the partnership is classified as a publicly traded partnership, it would not be treated as a corporation for federal income tax purposes for any taxable year in which (i) it was not registered under the Investment Company Act and (ii) at least 90% of its gross income for that year (and each preceding year from the first year in which it was a publicly traded partnership) consisted of “qualifying income.” “Qualifying income” is defined to include interest (except interest “derived in the conduct of a financial business,” which exception, for example, does not include interest from commercial mortgages held as investments) and dividends and gain from the sale or disposition of a capital asset. Qualifying income also includes any income that would qualify for (i) a regulated investment company (mutual fund), and (ii) a real estate investment trust. Qualifying income generally does not, however, include compensation for the performance of services or income from other trade or business activities. As long as the Trust limits its gross income from “non-qualifying income” to no more than 10% of its gross income and is not required to be registered under the Investment Company Act on a continuing basis, and assuming there is no change in law or relevant change in our structure, it should not be treated as a corporation for U.S. federal income tax purposes. Thus, it is anticipated that the Trust will be taxed as a partnership for U.S. federal income tax purposes.

The remainder of this discussion assumes that the Trust will be classified as a partnership that is not an association or publicly traded partnership taxable as a corporation.

General Principles of Partnership Taxation. A partnership generally is not subject to federal income tax; however, a partnership must file a federal information return in which it reports its items of income, gain, loss and deduction for each taxable year. Each partner in a partnership includes its allocable share of the partnership’s items in determining its taxable income. Thus, each Shareholder must take into account its allocable share of the Trust’s partnership items. A Shareholder will be subject to tax on its distributive share of the Trust’s taxable income regardless of whether any distribution of cash or property is made to it.

Distributions. A distribution by a partnership to a partner generally is not taxable to the partner except to the extent the distribution consists of cash (and, in certain circumstances, marketable securities) and the amount distributed exceeds the partner’s adjusted basis of its Shares immediately before the distribution. See “—Taxation of Operations—Basis” below. Ordinarily, any such excess will be treated as gain from a sale or exchange of the partner’s interest. The Trust may, but it is not required to, make distributions to its Shareholders.

Allocations of Income and Loss. A capital account will be established and maintained on the Trust’s books separately for each Share. These accounts will be maintained in accordance with Code Section 704(b) and Regulation Section 1.704-1(b)(2)(iv).

A partner’s distributive share of a partnership’s items of income, gain, loss or deduction for federal income tax purposes generally is determined in accordance with the provisions of its partnership agreement. An allocation under a partnership agreement may be disregarded, however, if the allocation does not have “substantial economic effect.” An allocation to a partner that does not cause or increase a deficit balance in the partner’s capital account has

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economic effect if (i) the partners’ capital accounts are determined and maintained in accordance with the Regulations, (ii) distributions on liquidation of the partnership are to be made in accordance with the partners’ positive capital account balances and (iii) the partnership agreement includes certain protective allocation provisions. Subject to special rules regarding certain shifting or transitory allocations, the Regulations provide that the economic effect of an allocation will be substantial if there is a reasonable possibility that the allocation will substantially affect the dollar amount to be received by the partners, independent of tax consequences. It is believed that the Trust Agreement contains provisions designed to comply with the requirements of the Regulations so that allocations of taxable income and loss thereunder should have substantial economic effect.

Under the Trust Agreement, the Sponsor has the discretion to follow an industry accounting convention of specially allocating the Trust’s realized gains and losses, for federal income tax purposes, with respect to Shares that are redeemed or transferred to the extent the capital account balance associated with such Shares is more or less, respectively, than the tax basis for such Shares. There can be no assurance that the Service will accept any such special allocation. If the Service successfully challenged such an allocation, the Trust’s gains and losses allocable to the remaining Shares could change.

Allocations Between Transferors and Transferees. In general, our taxable income and losses will be determined on a weekly basis and will be subsequently apportioned among the Shares. As a result, a Shareholder transferring Shares may be allocated income, gain, loss and deduction realized after the date of transfer.

 

Although simplifying conventions are contemplated by the Code and most publicly traded partnerships use similar simplifying conventions, the use of this method may not be permitted under existing Regulations as there is no direct or indirect controlling authority on this issue. Regulations under Section 706 of the Code provide a safe harbor pursuant to which a publicly traded partnership may use a semi-monthly or monthly simplifying convention to allocate tax items among transferors and transferees, although such tax items must be prorated on a daily basis. The Regulations do not specifically authorize the use of the proration method we have adopted. If this method is not allowed under the Regulations, or only applies to transfers of less than all of a Shareholder’s interest in the Trust, our taxable income or losses might be reallocated among the Shareholders. We are authorized to revise our method of allocation between transferors and transferees to conform to a method permitted under existing or future Treasury Regulations.

Taxation of Operations

Gains and Losses from Crypto Asset Transactions. The Trust expects to deal with its Crypto Assets as a trader or investor (generally, a person that buys and sells property for its own account for purposes of investment) and not as a dealer (generally, a person that buys from and sells property to customers with a view to the gains from those transactions). Accordingly, except as discussed below, the Trust generally expects that gains and losses recognized on the sale of its Crypto Assets will be capital gains and losses, which will be long-term or short-term depending, in general, on the length of time it held the Crypto Assets and, in some cases, the nature of the transactions. Without limiting the foregoing, each delivery or sale of Portfolio Crypto Assets for purposes of rebalancing the Trust’s Portfolio Crypto Assets to track the Index will be a taxable event for Shareholders. In addition, each sale of Portfolio Crypto Assets by the Trust to pay the Management Fee and/or any Organizational Expenses will be a taxable event for Shareholders.

Gains recognized by noncorporate taxpayers from property held for more than one year generally will be eligible for favorable tax treatment. The maximum federal income tax rate applicable to a noncorporate taxpayer’s net capital gain (the excess of net long-term capital gain over net short-term capital loss) recognized on the sale or exchange of capital assets held for more than one year is 20%. In addition, certain non-corporate taxpayers are subject to an increased rate of federal tax on some or all of their “net investment income,” which generally will include all or a portion of the income allocated to noncorporate Shareholders by the Trust, and any net gain recognized upon a disposition of Shares. Prospective investors should consult their tax advisor regarding the applicability of this federal tax in respect of an investment in the Trust.

Other Income. The Trust may realize ordinary income from interest and dividends on any securities held by it. The Trust also may realize ordinary income or loss with respect to certain of its other investments.

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Treatment of Management Fees and Expenses. A partnership may deduct a trade or business expense that is ordinary, necessary and reasonable in amount. The Service could challenge any expense deducted by the Trust, including the Management Fee, on the ground that the expense is a capital expenditure, which must either be amortized over an extended period or indefinitely deferred. The Service could also challenge the treatment of the Trust’s expenses, including the Management Fee, on the grounds that the amount of the expense is unreasonable in relation to the value of the services performed, the goods acquired or the other benefits to the Trust.

The Trust pays out of its assets certain legal, accounting and other expenses of its organization. Expenses directly related to the Trust’s organization, such as the costs of preparing the Trust Agreement, may generally be capitalized and amortized over a period of 180 months for tax purposes. Those expenses, if any, related to the sale of Shares must be capitalized and cannot be amortized.

If the Trust were considered an investor rather than a trader in securities (an annual determination which is generally based on facts and circumstances), expenses incurred by the Trust, including the Management Fee, would generally constitute “miscellaneous itemized deductions.” A non-corporate taxpayer’s “miscellaneous itemized deductions,” which include certain investment expenses, are allowable only to the extent they exceed, in the aggregate, 2% of the non-corporate taxpayer’s adjusted gross income and are not allowed for purposes of the alternative minimum tax and are not allowed at all for taxable years beginning after December 31, 2017 and before January 1, 2026. In determining his, her or its miscellaneous itemized deductions, a non-corporate partner in a partnership, such as the Trust, must take into account his, her or its distributive share of the partnership’s deductions. The Sponsor will receive Management Fees. If the Management Fees and/or such other expenses are characterized as “miscellaneous itemized deductions,” each non-corporate Shareholder would be required to include his, her or its allocable share thereof in calculating deductible miscellaneous itemized deductions, if any.

The Code may also require a non-corporate taxpayer whose adjusted gross income exceeds a specified threshold amount which is adjusted annually for inflation to reduce the amount allowable for itemized deductions if available (including such amount of miscellaneous itemized deductions as remain deductible after applying the 2% “floor” described above) by the lesser of (i) 3% of the excess of adjusted gross income over the threshold amount or (ii) 80% of the total amount of otherwise allowable deductions. When taken together with the limitations on miscellaneous itemized deductions, this limitation (sometimes referred to as the “overall limitation on itemized deductions”) could cause the amount of taxable income from the Trust with respect to a Shareholder to be significantly higher than his, her or its share of the Trust’s net profits. Prospective non-corporate Shareholders thus should consider, in the context of their own personal circumstances, the extent to which these limitations may reduce or even eliminate the deductibility of the Trust’s expenses.

Basis. A Shareholder’s basis of its Shares is important in determining (i) the amount of gain or loss it will realize on the sale or other disposition of the Shares, (ii) the amount of non-taxable distributions (including any decrease in the Shareholder’s share of the Trust’s liabilities) that it may receive from the Trust and (iii) its ability to utilize its distributive share of any tax loss of the Trust. A Shareholder’s initial tax basis of its Shares will equal its cost for the Shares (which, to the extent that the Shareholder contributes property other than cash, will be limited to the Shareholder’s basis in the contributed property) plus its share of the Trust’s liabilities at the time of purchase. In general, a Shareholder’s “share” of those liabilities will equal the sum of (i) the entire amount of any otherwise nonrecourse liability of the Trust as to which the Shareholder or an affiliate is the creditor (a “Partner Nonrecourse Liability”) and (ii) a share, based in part on profit-sharing ratios, of any nonrecourse liabilities of the Trust that are not Partner Nonrecourse Liabilities as to any partner.

A Shareholder’s tax basis in each of its Shares will be equal to the Shareholder’s initial purchase price for such Share (i) increased by (a) such Share’s allocable share of the Trust’s taxable income and gain and (b) any amounts treated as additional contributions by the Shareholder to the Trust with respect to such Share and (ii) decreased (but not below zero) by (a) such Share’s allocable share of the Trust’s tax deductions and losses and (b) any distributions by the Trust to the Shareholder with respect to such Share. For this purpose, an increase in a share of the Trust’s liabilities allocated to a Share will be treated as a contribution by the Shareholder to the Trust with respect to such Share and a decrease in a share of the Trust’s liabilities allocated to a Share will be treated as a distribution by the Trust to the Shareholder with respect to such Share.

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At Risk” Limitations. The “at risk” rules of Section 465 of the Code generally limit a taxpayer’s loss to the amount the taxpayer has at risk (i.e., the amount the taxpayer could actually lose from an activity). In the context of a partnership such as the Trust, the “at risk” rules, which apply to individuals, estates, S corporation shareholders and certain closely-held “C” corporations, can operate to limit the amount of losses that such persons can deduct from their participation in a partnership in much the same way that the rules discussed above under “Basis” limit a partner’s ability to deduct currently its distributive share of partnership losses to such partner’s adjusted basis in its partnership interest. In general, a partner’s “at risk” basis will be equal to the sum of (i) the amount of money and adjusted basis of property contributed by such partner to the activity and (ii) any amounts borrowed for use in the activity where the partner is personally liable for the repayment of the loan or has pledged property other than that used in the activity as security (but only to the extent of the net fair market value of the partner’s interest in the property). Such “at risk” basis will be further increased by a partner’s share of partnership income retained in the partnership but reduced by such items as cash distributed by the partnership to such partner, the commencement of a guarantee or similar device that eliminates the partner’s personal liability for borrowed amounts, and losses previously allocated to a partner. If and to the extent that a loss allocated to a partner exceeds the amount that such partner has “at risk,” such loss is not permanently disallowed but can be carried over indefinitely and deducted in a subsequent taxable year to the extent the partner’s “at risk” basis increases and is sufficient to absorb such loss in such later year. Rules requiring the recapture of previously deducted losses can be triggered when a taxpayer’s “at risk” basis in an activity falls below zero.

Limitation on Deductibility of Passive Activity Losses. Section 469 of the Code restricts individual, certain other non-corporate and certain closely-held corporate taxpayers from using trade or business losses incurred by partnerships and other businesses in which the taxpayer does not materially participate to offset income from other sources. Therefore, such losses cannot be used to offset salary or other earned income, active business income or “portfolio” income (i.e., dividends, interest, royalties and non-business capital gains) of the taxpayer. However, losses and credits suspended under Section 469 of the Code may be carried forward indefinitely and may be used in later years to offset income from passive activities. Moreover, a fully taxable disposition by a taxpayer of its entire interest in a passive activity will allow the deduction of any suspended losses attributable to that activity. These so-called “passive activity loss” limitations should not apply to limit the deductibility by Shareholders of their distributive share of any losses of the Trust because the activities of the Trust should be treated as giving rise only to “portfolio” income and deductions allocable to “portfolio” income. However, passive losses from other sources generally will not be deductible against a Shareholder’s share of portfolio income and gain from the Trust. Shareholders should consult with their own tax advisors regarding additional limitations on interest deductions.

Alternative Minimum Tax. The extent, if any, to which the federal alternative minimum tax will be imposed on any Shareholder will depend on the Shareholder’s overall tax situation for the taxable year. Prospective investors should consult with their tax advisors regarding the alternative minimum tax consequences of an investment in the Trust.

Dissolution and Liquidation of the Trust. On dissolution of the Trust, its assets may be sold, which may result in the realization of taxable gain or loss to the Shareholders. Distributions of cash in complete liquidation of the Trust generally will cause recognition of gain or loss – which will be capital gain or loss to a Shareholder if it holds its Shares as capital assets – to the extent, if any, that the Shareholder’s adjusted basis of its Shares is less or greater than the amount of cash received. Any capital gain or loss will be treated as long-term if the Shares are held for more than one year.

If liquidating distributions consist wholly or partly of assets other than cash, the Trust will not recognize any gain or loss on the distributions and a Shareholder that receives such a distribution generally will not recognize any loss on the distribution and will have a basis in the non-cash assets equal to the adjusted basis of its Shares immediately before the liquidating distribution, reduced by the amount of cash the Shareholder receives in the distribution.

Redemption or Transfer of Shares

If a Shareholder’s Shares are redeemed or a Shareholder, with the Sponsor’s consent, sells or exchanges its Shares, the Shareholder will realize gain or loss equal to the difference between the amount realized from the redemption, sale or exchange (including any reduction in its share of the Trust’s liabilities) and its adjusted basis of its Shares. That gain or loss will be treated as capital gain or loss (taxed as described above). In addition, as noted above under “—Entity Classification and Partnership Taxation—Allocations of Income and Loss,” the Sponsor has the discretion

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to specially allocate the Trust’s realized gains and losses, for federal income tax purposes, with respect to Shares that are redeemed or transferred to the extent the capital account balance associated with such Shares is more or less, respectively, than the tax basis in such Shares.

Tax Elections and Returns

The Trust may make various elections for federal income tax purposes that could result in certain items of income, gain, loss and deduction being treated differently for tax and accounting purposes. Elections permitted under the Code that may affect the determination of the Trust’s income, the deductibility of expenses, accounting methods and the like must be made by the Trust and not by the Shareholders, and these elections will be binding in most cases on all Shareholders.

Section 754 of the Code permits a partnership to elect to adjust the basis of partnership property on the sale or exchange of an interest in the partnership or on a partner’s death and on certain distributions of cash or property by the partnership to a partner. These adjustments are mandatory if the aggregate bases of partnership assets exceed their fair market value by more than $250,000 at the time of the sale or exchange, or if a distribution of partnership property would result in a reduction in the basis of the partnership’s assets of more than $250,000 if a Section 754 election were in effect. If such a basis adjustment were made by the Trust, a transferee of Shares would be treated, for purposes of computing gain, as though it had acquired a direct interest in the Trust’s assets, and the Trust would be treated, on certain distributions to Shareholders, as though it had obtained a new cost basis of its assets. The Trust Agreement authorizes the Sponsor, in its discretion, to make a Section 754 election. If the Sponsor determines not to do so, and the Trust is not otherwise required to adjust the bases of its assets, a transferee of Shares may be subject to tax on a portion of the income from the disposition of Trust assets that, as to it, constitutes a return of capital if the purchase price of its Shares exceeds its share of the Trust’s adjusted basis of its investments.

The Trust will file an annual partnership information return with the Service reporting the results of its operations. After the end of each calendar year, the Trust or the Administrator will distribute to the Shareholders or custodians of Shares, as applicable, federal income tax information reasonably necessary to enable each Shareholder to report its distributive share of the Trust’s partnership items. Each Shareholder must treat partnership items reported on the Trust’s returns consistently on the Shareholder’s own returns, unless the Shareholder files a statement with the Service disclosing the inconsistency.

Audits

The Trust, like all partnerships, is subject to a risk of audit by the Service. Prior to January 1, 2018, any adjustments made to the Trust’s information return pursuant to such an audit will require each Shareholder to file an amended federal income tax return for each year involved and might result in audits of and adjustments to the Shareholder’s returns relating to non-Trust-related as well as Trust-related items. In addition, the Trust and the Shareholders could incur substantial legal and accounting costs in contesting and litigating any Service challenge, regardless of the outcome.

The Code contains special provisions for audits of partnerships by the Service. Pursuant to these provisions, for tax periods beginning on or after January 1, 2018, the tax treatment of a partnership’s income and deductions generally will be determined at the partnership level in a single proceeding, rather than by individual audits of the partners, and no deficiency resulting from such an audit may be assessed against a partner until the correctness of any challenge by the Service to any of the partnership’s federal returns is determined at the administrative or judicial level.

Under the Trust Agreement, to the extent permitted by applicable law, the Sponsor serves as the Trust’s “partnership representative.” The Trust will be subject to new partnership audit procedures that may result in partnership adjustments at the Trust level. The Sponsor may require that the Shareholders affected by such partnership adjustments file amended returns that take into account such partnership adjustments and pay any additional tax due or the Sponsor may elect to issue amended statements to the Shareholders and the Shareholders will be responsible for any increase in tax and associated penalties and interest.

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The Trust’s partnership representative will have considerable authority to make decisions affecting the tax treatment of partnership items and procedural rights of the Shareholders. For example, the partnership representative will have the right on behalf of all Shareholders to extend the statute of limitations with respect to the Trust’s tax items and to select the forum for litigating any tax disputes, including a forum that might require the Shareholders to pay an assessed tax deficiency before the litigation is resolved. In certain circumstances, Shareholders may be bound by the outcome of final administrative adjustments agreed to by the partnership representative resulting from an audit by the Service of the Trust, as well as by the outcome of judicial review of disputed adjustments.

Tax Shelter Disclosure

Certain rules require taxpayers to disclose—on their federal income tax returns and, under certain circumstances, separately to the Office of Tax Shelter Analysis—their participation in “reportable transactions” and require “material advisors” to maintain investor lists with respect thereto. These rules apply to a broad range of transactions, including transactions that would not ordinarily be viewed as tax shelters, and to indirect participation in a reportable transaction (such as through a partnership). For example, reportable transactions include “loss transactions,” defined as any losses incurred by a taxpayer, either directly or through a partnership, that exceed certain thresholds.

An excise tax and additional disclosure requirements may apply to certain tax-exempt entities that are “parties” to certain types of reportable transactions (referred to as “Prohibited Tax Shelter Transactions”). A notice issued by the Service in February 2007 and confirmed by Regulations finalized in 2010 provides that a tax-exempt investor in a partnership will generally not be treated as a “party” to a prohibited tax shelter transaction, even if the partnership engages in such a transaction, if the tax-exempt investor does not facilitate the transaction by reason of its tax-exempt, tax indifferent or tax-favored status. There can be no assurance, however, that the Service or Treasury Department will not provide guidance in the future, either generally or with respect to particular types of investors, that reaches a conclusion different than the conclusion in the notice.

Failure to comply with the disclosure requirements for reportable transactions or Prohibited Tax Shelter Transactions can result in the imposition of penalties. Prospective investors are urged to consult with their own tax advisors with respect to the effect of these rules on an investment in the Trust.

U.S. Taxation of Non-U.S. Persons

In general, the tax treatment of a Non-U.S. Person will depend on whether the Trust is deemed to be engaged in a U.S. trade or business and whether the Trust earns effectively connected income (“ECI”).

To the extent the Trust is not engaged in a U.S. trade or business (or such income is not effectively connected to a U.S. trade or business), non-U.S. source dividends and interest paid to the Trust and, except as discussed below, gains from the sale or other disposition of securities by the Trust, that are allocable to a Non-U.S. Person generally will not be subject to U.S. federal income tax. However, a non-resident individual present in the United States for 183 or more days in the taxable year of a sale generally will be subject to a 30% U.S. federal income tax (or applicable lower treaty rate) on any gain resulting from such sale if either (i) such individual’s tax home for U.S. federal income tax purposes is in the United States or (ii) the gain is attributable to an office or other fixed place of business maintained in the United States by such individual.

To the extent the Trust is not engaged in a U.S. trade or business (or such income is not effectively connected to a U.S. trade or business), U.S. source dividends paid to the Trust that are allocable to a Non-U.S. Person generally will be subject to withholding tax at a 30% rate. U.S. source interest paid to the Trust that is allocable to a Non-U.S. Person will also be subject to 30% withholding unless such interest qualifies as portfolio interest. Portfolio interest generally includes (with certain exceptions) interest paid on registered obligations with respect to which the beneficial owner provides a statement that it is not a U.S. Person. The portfolio interest exemption is not available with respect to interest paid to a 10% shareholder of the issuer of the indebtedness and is subject to certain other limitations. A Non-U.S. Person who is resident for tax purposes in a country with respect to which the United States has an income tax treaty may be eligible for a reduced rate of withholding on such Person’s distributive share of U.S. source interest and dividends.

 

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Notwithstanding the foregoing, if the Trust were to acquire stock in a “U.S. real property holding corporation” and either (i) such stock was not regularly traded on an established securities market within the meaning of the Code or (ii) the stock was treated as owned by a holder of more than 5% (by value) of such stock, then gain on the sale of such stock would be treated as income effectively connected with the conduct of a U.S. trade or business and would be subject to regular U.S. federal income tax. A “U.S. real property holding corporation” is generally a corporation 50% or more of whose assets consist of U.S. real property interests within the meaning of Section 897(c) of the Code (“USRPIs”).

If the Trust were engaged in a U.S. trade or business or otherwise realizes ECI, it generally will be required to withhold and pay over to the U.S. tax authorities a percentage equal to the highest applicable U.S. tax rate of each Non-U.S. Person’s share of the Trust’s net ECI (thus, the Trust would be liable for taxes attributable to a Non-U.S. Person’s investment), and each Non-U.S. Person would be required to file U.S. tax returns and pay U.S. tax on its share of the Trust’s net ECI. In addition, all or a portion of the gain realized on the disposition (including by redemption) by a Non-U.S. Person of its Shares will be treated as ECI to the extent such gain is attributable to assets of the Trust that generate ECI, including for this purpose gain that is attributable to stock of a U.S. real property holding corporation, and may be subject to U.S. withholding tax under certain circumstances. ECI realized by a Non-U.S. Person generally will be subject to U.S. income tax on a net basis at graduated rates. A Non-U.S. Person that is a non-U.S. corporation that is (or is deemed to be) engaged in a trade or business also may be subject to an additional branch profits tax of 30% on its effectively connected earnings and profits (which generally will include any ECI realized with respect to its investment in the Trust), adjusted as provided by law (subject to reduction by any applicable tax treaty).

In addition, if the Trust were regarded as engaged in a U.S. trade or business for U.S. federal income tax purposes, Non-U.S. Persons would be viewed as being engaged in a trade or business in the United States and as maintaining an office or other fixed place of business in the United States. Certain other income of a Non-U.S. Person could thus be treated as ECI as a result of such Non-U.S. Person’s investment in the Trust. For example, a Non-U.S. Person who, pursuant to an applicable tax treaty, is currently not subject to tax with respect to a trade or business in the United States because such Non-U.S. Person does not have a permanent establishment in the United States could lose the benefits of the tax treaty as a result of its investment in the Trust.

Special rules may apply in the case of Non-U.S. Persons (i) that have an office or fixed place of business in the United States or (ii) that are former citizens of the United States, controlled foreign corporations as to the United States, foreign insurance companies that hold interests in the Trust in connection with their U.S. business, passive foreign investment companies, and corporations which accumulate earnings to avoid U.S. federal income tax. Such persons are urged to consult their U.S. tax advisors before investing in the Trust.

Possible Legislative or Other Changes

The Code, with respect to all of the foregoing matters and other matters that may affect the Trust or the Shareholders, is constantly subject to change by Congress. Congress, in 2017, enacted a major overhaul of the Code. In recent years there have been significant changes in the Code, many of which are being reconsidered by Congress and interpretations of which are being considered by the Service and the courts. It is not possible at this time to predict whether or to what extent any changes in the Code or interpretations thereof will occur. Prospective investors should note that the Trust will not undertake to advise Shareholders of any legislative or other developments. Such Shareholders should consult their own tax advisors regarding pending and proposed legislation or other changes.

State and Local Taxation

In addition to the federal income tax considerations summarized above, prospective investors should consider potential state and local tax consequences of an investment in the Trust. A Shareholder’s distributive share of the Trust’s taxable income or loss generally will be required to be included in determining the Shareholder’s taxable income for state and local tax purposes in the jurisdiction in which it is resident. However, state and local laws may differ from the federal income tax law with respect to the treatment of specific items of income, gain, loss and deduction from a partnership.

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Prospective Investors are urged to consult with their own tax advisors with respect to state and local income tax consequences of an investment in the Trust.

Other Jurisdictions

Interest, dividend and other income received by the Trust from sources outside the United States may give rise to withholding or other taxes imposed by other jurisdictions. The Trust may also be subject to taxes on net income in certain other jurisdictions with respect to its investments.

Electronic Delivery of Information and Reports

Each Shareholder of the Trust consents to the electronic delivery (including via email and through PDF file format) of information, including, without limitation, any information required to be delivered pursuant to applicable securities laws. In addition, each Shareholder will (i) consent to the electronic delivery of reports, including without limitation, any applicable tax reports (e.g., Schedules K-1), (ii) agree that such reports may be delivered by the Trust making them available for viewing, downloading and/or saving on the Internet website www.bitwiseinvestments.com under “under “Sign In,” and (iii) agree to monitor that website on a regular basis in order to ensure timely receipt of such information.

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 “Item 1A. Risk Factors.” These risks include the following:

investing in Crypto Assets generally is speculative, and the Portfolio Crypto Assets of the Trust are subject to volatile price fluctuations which can negatively impact Shares of the Trust;
because the Portfolio Crypto Assets of the Trust are dependent, in part, on the continued market acceptance and development of Crypto Assets and Blockchain technology by consumers, any declines or negative trends affecting Crypto Assets or Blockchain technology will adversely affect the value of Shares of the Trust;
our relatively limited operating history makes it difficult to evaluate the Index, which is relatively new, and the Index Methodology, which is also relatively new, and may increase the risk that we will not be successful;
our business depends on the development and commercialization of the Index, which is a highly competitive industry, and the Trust may not be commercially successful;
any actual or perceived failure of the Portfolio Crypto Assets of the Trust to block malware or prevent failures or cyber security breaches or incidents could harm the reputation of the assets, and cause the assets to be perceived as insecure, exploitable, or unreliable, and otherwise negatively impact the value of the Shares of the Trust;

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our risk management efforts may not be effective to prevent fraudulent or malicious activities by third-party providers or other parties, which could expose us to material financial losses and liability and lead to theft or loss of the Portfolio Crypto Assets;
our holdings of Portfolio Crypto Assets expose us to potential risks, including exchange, security and liquidity risks, which could negatively affect the value of the Shares of the Trust;
the value of the Trust’s Crypto Assets are dependent, directly or indirectly, on prices established by exchanges and other trading venues, which are new and, in most cases, largely unregulated;
there are uncertainties related to the regulatory regimes governing Blockchain technologies, Crypto Assets and new regulations, and interpretations or policies may materially adversely affect the value of Portfolio Crypto Assets and the Shares;
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 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 which could lead to loss or loss of the value of the Portfolio Crypto Assets;
for a variety of factors, the long-term viability of Crypto Assets is unknown, and this could negatively impact the value of the Portfolio Crypto Assets and the commercial success of the Trust;
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; and
the Trust is a passive investment vehicle and 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 current or projected performance of the Index or of the actual Portfolio Crypto Assets held.

Risks Related to Crypto Assets

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 powereither individually or as part of a “Mining pool” or group of validatorsmay 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 ont he Blockchain by creating multiple identities (or Sybil identities) that appear to be unqiue. 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

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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.

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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 a 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

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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.

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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;
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, 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.

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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 Blockcahins 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

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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 Crypot 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. 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;
Investors’ expectations with respect to the rate of inflation of fiat currencies;

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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;
Monetary policies of governments, trade restrictions, currency devaluations and revaluations;
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; and
Decreased confidence in Crypto Asset exchanges due to the unregulated nature and lack of transparency surrounding the operations of Crypto Asset exchanges.
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 decline. 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

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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 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 of 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.

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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 more volatile the price of such Crypto Assets. 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 who 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.

Competition from the emergence or growth of other Crypto Assets or 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 other potential financial vehicles, possibly including securities backed by or linked to one or more Crypto Assets and Crypto Asset financial vehicles 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 such Crypto Asset directly, which could limit the market for, and reduce the liquidity of, the Shares. In addition, to the extent Crypto Asset financial vehicles other than the Trust tracking the price of one or more Crypto Assets are formed and represent a significant proportion of the demand for any particular Crypto Asset, large purchases or redemptions of the securities of these Crypto Asset financial vehicles, or private funds holding such Crypto Asset, could negatively affect the any of the Crypto Asset reference rates, the Crypto Asset holdings, the price of the Shares, the NAV and the NAV Per Share.

Failure of funds that hold Crypto Assets or that have exposure to Crypto Assets through derivatives to receive SEC approval to list their shares on exchanges could adversely affect the value of the Shares.

There have been a growing a number of attempts to list on national securities exchanges the shares of funds that hold Crypto Assets or that have exposures to Crypto Assets through derivatives. These investment vehicles attempt to provide institutional and retail investors exposure to markets for Crypto Assets and related products. While the SEC gave approval to the first set of funds linked to Crypto Asset derivatives with the launches of the ProShares Bitcoin Strategy ETF (BITO), Valkyrie Bitcoin Strategy ETF (BTF), and VanEck Bitcoin Strategy ETF (XBTF) in the fourth quarter of 2021, the SEC previously denied repeated requests for funds that hold Crypto Assets or that have exposures to Crypto Assets through derivatives, including a request submitted in connection with a fund operated by the Sponsor. The exchange listing of shares of Crypto Asset funds would create more opportunities for institutional and retail investors to invest in the Crypto Asset market. If exchange-listing requests are not ultimately approved by the SEC, increased investment interest by institutional or retail investors could fail to materialize, which could reduce the demand for Crypto Assets generally and therefore adversely affect the value of the Shares.

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The value of the Trust’s Crypto Assets is dependent, directly or indirectly, on prices established by Crypto Assets exchanges and other Crypto Assets 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.

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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.

Crypto Assets have vulnerabilities which may adversely affect their value.

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 not provide banking services, or may cut off banking services, to businesses that provide Crypto Asset-related services or that accept Crypto Assets as payment.

The inability or difficulty of securing banking services could damage the public perception of Crypto Assets and the utility of Crypto Assets as a payment system. It could also decrease the price of Crypto Assets and adversely affect an investment in the Trust.

A number of companies that provide Crypto Asset-related services have been unable 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

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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;
Changes in consumer demographics and public tastes and preferences;
The maintenance and development of the open-source software protocol of Crypto Asset exchanges;
The availability and popularity of other forms or methods of buying and selling goods and services, including new means of using fiat currencies;
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.

Shareholders may not receive the benefits of any forks or Airdrops.

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

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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.

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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.

Banks and financial institutions may not provide banking services, or may cut off services, to businesses that engage in cryptocurrency-related activities.

A number of companies that engage in Crypto Asset-related activities have been unable to find banks or financial institutions that are willing to provide them with bank accounts and other services. Similarly, a number of companies and individuals or businesses associated with cryptocurrencies may have had and may continue to have their existing bank accounts closed or services discontinued with financial institutions. To the extent that such events may happen to us, they 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.

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

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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 creates 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.

 

The Ethereum Network is in the process of implementing a series of software upgrades and other significant changes to the protocol, including the September 2022 transition from its PoW to PoS consensus mechanism. 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.

 

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.

 

 

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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 to 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.

 

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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.

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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

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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 heading 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 Trusts’s ether and the value of an investment in the Trusts.

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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 values of the Shares in the Trust are directly related to the value of the amount of bitcoin and ether held by the Trust. The prices of bitcoin and ether has 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 are 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

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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 du