Large-scale Bitcoin holders are increasingly looking to convert their directly held assets into shares of exchange-traded funds that track the digital currency. In-kind crypto conversions are relatively novel -- regulators only granted approval last year, but already BlackRock, which operates the largest Bitcoin ETF, has seen billions of dollars in transaction volume.

"The level of demand and interest has sort of been one way -- up," says Robbie Mitchnick, BlackRock's head of digital assets. "The current moment is the highest we've seen at any point."

Mitchnick tells Barron's Advisor that conversions of digital holdings to shares of BlackRock's iShares Bitcoin Trust ETF $(IBIT)$ have been rising steadily, regardless of the fluctuations in Bitcoin's price. Converting appreciated Bitcoin assets into IBIT shares through an in-kind transaction generally isn't seen as a sale that would trigger capital-gains taxes. Investor motivations for converting their Bitcoin holdings vary, but security and simplicity are at the top of the list.

On the security front, holding shares of an ETF managed by a large fund company such as BlackRock is generally seen as less risky than dealing with a crypto exchange or storing assets in a hot wallet, an industry term for crypto storage that is always online.

"Outsourcing the custody to an institutional-grade cold-storage model that the holder doesn't have to worry about is proving to be really reassuring and attractive to these holders," Mitchnick says.

The recent hack of Binance was a fresh reminder of the security risks associated with crypto exchanges, though that event likely didn't surprise seasoned investors with digital asset holdings large enough to qualify for in-kind exchanges with BlackRock.

"It's been a known risk for plenty of time," Mitchnick says. "Most large Bitcoin holders were already acutely aware of the risk of holding on an exchange and in a hot wallet, so for them it's not that novel even though for the broader investor audience it seems more so."

Since regulators approved in-kind crypto transactions last year, BlackRock has seen $3.6 billion of in-kind conversions for IBIT shares, though the actual figure could be much larger, because the asset manager doesn't process the transactions itself and doesn't necessarily see every conversion. BlackRock also offers in-kind conversions for shares of two Ethereum ETFs, iShares Ethereum Trust ETF and iShares Staked Ethereum Trust ETF, but the volume of those transactions is far smaller.

Lower minimums. A big part of the story of rising interest in BlackRock's in-kind exchanges has been declining minimum transaction levels, which have steadily expanded access to smaller investors. The formula for calculating a minimum transaction is complicated, but rates have steadily been declining. When BlackRock first began offering in-kind transactions, the minimum was around $30 million. It now is hovering between $1 and $2 million.

BlackRock oversees the largest Bitcoin ETF, but competitors with smaller funds are also offering in-kind conversions. Fidelity Investments, which oversees the second-largest Bitcoin fund, Fidelity Wise Origin Bitcoin Fund, offers in-kind conversions on Bitcoin, Ethereum, and Solana funds, with a $1 million transaction minimum. The firm declined to comment on transaction volume.

In October, Grayscale announced that it is accepting in-kind contributions through 10 of its ETFs, with transaction minimums that, while they fluctuate, are far lower than the minimums at BlackRock or Fidelity. Grayscale declined to comment on the volume of in-kind crypto conversions that it has seen.

The transaction minimum for in-kind transactions at BlackRock are set by the intermediaries that it uses to facilitate the exchanges -- Galaxy Digital, Talos, and Virtu. The costs those entities bear in navigating the plumbing of the digital-asset ecosystem have been declining. Mitchnick, while he says he would love to see transaction minimums fall to a single share of an ETF, acknowledges that there is a "physics" to the cost structure that won't bring minimums down to zero any time soon.

Still, the effect of bringing down the minimum transaction size has been "very positive," he says. Investors with $1 million to $2 million in Bitcoin are in rare company, but moving down from the $30 million level meant that the in-kind transactions are an option for more than just institutional investors and ultrawealthy individuals.

"That's why we continue to see steady month-over-month growth as the minimums have come down," Mitchnick says.

Beyond security. Apart from the security considerations, exchanging directly held Bitcoin for shares of an ETF can bring those holdings into a managed brokerage account where more of investors' other holdings live. That can greatly simplify the treatment of digital assets in tax and estate planning.

"It's much, much simpler being able to do that within the confines of their private bank or wherever their wealth is managed," Mitchnick says.

Some investors look to in-kind exchanges as a diversification play, just as they might hold assets at multiple private banks. Some investors also want to use IBIT shares as part of an options strategy to hedge against downside risk in Bitcoin prices.

But of all the reasons investors are conducting in-kind exchanges, Mitchnick says, "The single largest one is security and peace of mind."

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