19-Jan-2024
βAn exchange-traded fund (ETF) is a type of pooled investment security that operates much like a mutual fund. Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.β β Investopedia
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According to J.P. Morgan's 2023 ETF Handbook, there are currently more than 11,000 ETFs listed globally, offering a wide range of features and options. ETFs have gained significant traction and popularity in recent years, attracting strong inflows and market interest.
In addition to the characteristics mentioned earlier, ETFs also provide active management strategies, sector-specific and thematic exposure, and various other investment opportunities. These factors have contributed to the growth and diversification of the ETF market.
The liquidity of ETFs is generally high due to their open-ended structure. This means that the supply of ETF shares is not limited and can be adjusted according to market demand through the creation and redemption process.
As long as an ETF is not in the process of liquidation, Authorized Participants (APs) have the ability to create new ETF shares by delivering the underlying assets to the ETF sponsor. In exchange, the ETF sponsor provides the AP with ETF shares of equal value, which the AP can then sell on the exchange to meet investor demand. This creation process occurs in the primary market.
Once the ETF shares are created, they can be bought or sold by investors on the secondary market exchanges without the involvement of the ETF sponsor. This allows for ease of trading and liquidity as investors can transact with other market participants based on prevailing market prices.
It's important to note that while most ETFs have high liquidity, there may be variations in liquidity among different ETFs. Factors such as the underlying assets' liquidity, trading volumes, and market conditions can impact the liquidity of specific ETFs. Investors should always consider the liquidity of an ETF before making investment decisions, especially when dealing with less liquid or niche ETFs.
Bitcoin was initially designed in 2008 by Satoshi Nakamoto as a peer-to-peer cash payment system. The underlying technology used for its decentralized ledger is commonly known as blockchain technology. Over time, as its user base expanded, more individuals started accepting, owning, and investing in Bitcoin. However, the high transaction fees associated with Bitcoin have made it less practical as a widely adopted payment method. As a result, Bitcoin has evolved primarily into an alternative investment vehicle, with some likening it to "digital gold.β
Bitcoin ETFs are funds that can be traded on regulated exchanges like NYSE or NASDAQ. They enable investors to track the price of Bitcoin and benefit from it without the need to directly purchase or hold the bitcoins. Unlike traditional crypto investments, which require using crypto exchanges, Bitcoin ETFs simplify the investment process and eliminate the need for secure storage of bitcoins.
Furthermore, due to compliance issues surrounding crypto exchanges, many institutional investors are unable to invest in digital currencies through this means. The emergence of Bitcoin ETFs addresses these challenges. Bitcoin ETFs are compliant products designed for traditional investors, enabling them to invest in this new asset class while delegating the tasks of purchasing and custodying Bitcoin to professionals, thereby overcoming technical barriers.
There are two types of Bitcoin ETFs in the market: Bitcoin futures ETFs and spot ETFs. Futures ETFs track the price of futures contracts and were introduced earlier. Spot ETFs, on the other hand, hold physical Bitcoin and were recently approved by the SEC on January 10th.
Futures ETFs have higher holding costs compared to spot ETFs. This is because investors holding futures ETFs for the long term need to pay additional expenses for rolling over the contracts when they expire.
Winklevoss brothers' Winklevoss Bitcoin Shares1 became the first fund to formally file a Bitcoin ETF application with the SEC in 2013.1. At that time, Bitcoin's market cap had just exceeded $1 billion, with a price of $87.2 Currently, the market cap exceeds $800 billion, with a price of $42,640.3
Unfortunately, this ETF application was rejected by the SEC in March 2017 after over three years. The SEC cited concerns about fraud risks and lack of compliance in the Bitcoin market.
Interestingly, 10 years ago, the Winklevoss had predicted Bitcoin price would surpass $40,0004.
In the following years, multiple Bitcoin ETF applications were submitted but were all rejected by the SEC. It wasn't until Gary Gensler took over as the SEC Chairman, succeeding Jay Clayton, that the situation began to change.
BITO, issued by ProShares, was the first BTC fund to receive approval from the SEC. BITO invests in Bitcoin futures instead of actual bitcoins. It made its trading debut on Oct 19, 2021, with an impressive volume of $550m. BITO held the position of the largest digital asset ETF until Grayscale's GBTC made its transition to an ETF.
However, in hindsight, it became evident that the timing of BITO's launch was quite unfortunate.
At the time of BITO's launch, the price of Bitcoin was around $62,000. Within 20 days, it rapidly climbed to nearly $70,000, reaching an all-time high. However, it was followed by a sharp decline. One year after BITO's issuance, the price of Bitcoin dropped to less than $20,000.
After more than 10 years, on January 10, 2024, the SEC approved Bitcoin spot ETFs in the US. This approval was influenced by Grayscale's legal battle1 with the SEC in August 2023, where the SEC couldn't provide sufficient grounds to reject Grayscale's GBTC conversion into a spot ETF.
A total of 11 Bitcoin spot ETFs, including GBTC, received SEC approval. Notably, BlackRock, the largest asset management company by AUM, is among them.
It's worth noting that while Bitcoin spot ETFs have recently been approved in the US market, countries like Canada introduced Bitcoin spot ETFs several years ago.
The largest fund among them is GBTC, issued by Grayscale, with a market value exceeding $25 billion. GBTC transformed from a trust that was previously only tradable on the OTC market.
Since GBTC officially became an ETF, the fund has experienced daily outflows. According to BitMEX Research1, the outflows in the first 4 trading days were $95m, $478m, $590m, and $458m, totaling $1.6 billion. There are two main reasons for the significant outflows of GBTC. Many GBTC investors have found themselves in a profitable position but faced challenges when trying to liquidate their holdings.
Previously, GBTC could only be traded on the OTC market, and it did not offer a way to convert GBTC back into BTC. As a result, GBTC often traded at a significant discount. However, with the official transformation of GBTC into an ETF, investors now have the opportunity to sell their GBTC holdings more easily.
The high management fees of GBTC pose another reason for the outflows. While most ETFs have management fees ranging from 0.2% to 0.3%, with few exceeding 0.5%, GBTC charges a management fee of 1.5%. As a result, investors who seek exposure to Bitcoin may find it more beneficial to sell GBTC and invest in ETFs offered by other institutions.
Regarding trading activity, GBTC has the highest volume, accounting for about half of the total volume of all ETFs. Following GBTC is IBIT, issued by BlackRock, with daily trading volumes of around $1.04b, $585m, and $371m in the first three days of listing, totaling approximately $2b. When considering all Bitcoin spot ETFs, the total trading volume in the past three days has reached nearly $10 billion.
According to Eric Balchunas1, a senior ETF analyst at Bloomberg, there were ~500 new ETFs launched in 2023. These ETFs collectively had a total trading volume of around $450m on January 16, with the highest trading volume reaching $45m. In comparison, a single fund like IBIT seems to rival the trading volume of all funds introduced in the past year.
This data may seem impressive. In traditional finance, there haven't been many new asset classes introduced for a long time. Even when new ETFs are launched, they are often backed by existing assets have been around for a while.
We can draw a parallel to the crypto market, where during less active periods, aside from a few top coins, the trading volume for alts is relatively low. However, when the market becomes more active, the majority of trading activity revolves around top coins and new narratives. Currently, crypto assets represent an emerging asset class in traditional markets and naturally attract significant attention.
It is well-known that prior to the advent of Bitcoin spot ETFs, Bitcoin trading primarily took place on cryptocurrency exchanges, with a significant portion of the trading volume originating from Binance, the leading exchange.
According to LTP Research's exchange liquidity, Binance is currently regarded as the most liquid exchange, with its trading volume accounting for over half of the market.
The most liquid venues are naturally the places where pricing occurs.
As mentioned earlier, after three trading days since the launch of Bitcoin spot ETF, the trading volume reached nearly $1 billion, with an average of $330 million per day. In contrast, the average daily trading volume for Bitcoin from June of last year to January 18th of this year was $15 billion, which is 45 times higher than that of the spot ETF.
However, it is important to note that the $15 billion trading volume includes all exchanges in the crypto market, including some trades with zero costs or fake volumes.
If we only consider the most active Bitcoin trading pair, BTCUSDT, on Binance, the average daily trading volume from June to now is around $1.21 billion1, which is about 4 times the volume of the spot ETF.
From a purely trading volume perspective, it is difficult to determine where the pricing power lies and can only serve as a reference. To further validate this hypothesis, I used Binance's API to retrieve Bitcoin (BTCUSDT) trading data from January 7th to 18th, with a time interval of 15 minutes.
Next, the data was divided into three groups:
The statistical results are as follows.
Through the data comparison above, it seems that Bitcoin trading on Binance was indeed influenced by the listing of the Bitcoin spot ETF. There was a noticeable increase in price volatility during trading hours after the ETF listing. The standard deviation of price fluctuations before the listing was 1080, which increased to 1350 during non-trading hours after the listing, and further increased to 1732 during trading hours.
The average trading volume during U.S. trading hours also showed a significant increase. It is important to note that the above data analysis is not a rigorous academic study. For more robust conclusions, it would require more rigorous methods and additional supporting data.
The approval of a Bitcoin spot ETF by the U.S. SEC has been long-awaited by the entire crypto community. The reason behind this anticipation is primarily the desire for a regulated traditional financial channel to allocate Bitcoin.
In the last bull run, it was evident that GBTC had a significant impact on driving the price of Bitcoin. It seemed that traditional finance was recognizing Bitcoin as an emerging asset. A Bitcoin spot ETF signifies a compliant traditional financial channel that allows the world's largest financial market to easily access Bitcoin.
Bitcoin is often touted as digital gold and holds significant value for portfolio diversification. When the GLD ETF launched on the NYSE in November 2004, the price of gold was around $440, but it has since skyrocketed to $2000. Given this performance of physical gold, it is natural to speculate about a similar scenario for Bitcoin as digital gold.
Numerous institutions have expressed their belief that once an ETF is approved, a substantial amount of capital will flow in, making Bitcoin a crucial asset allocation choice. Whether we base it on the scale of U.S. asset management or assume a proportion allocated to a Bitcoin ETF similar to the Canadian Bitcoin spot ETF, we can expect impressive figures.
Although Bitcoin is often referred to as digital gold, it is worth questioning whether Bitcoin possesses the same qualities as physical gold.
The primary investment value of gold lies in its ability to serve as a hedge against risks, making it a crucial safe-haven asset.
The chart below showcases the price reactions of Bitcoin and gold when news of the Russia-Ukraine war emerged.
On February 24, 2022, in response to the war, the price of gold surged from an opening of $1911 to a peak of $1976. In contrast, Bitcoin initially experienced a decline, dropping from $37,278 to a low of $34,459 on the same day before eventually recovering.
The initial response from investors did not position Bitcoin as a safe-haven asset, casting doubt on the notion of Bitcoin as digital gold.
Bitcoin's performance does not seem to align with the characteristics of "digital gold." As a highly liquid asset, Bitcoin appears to be the first one to be abandoned in times of unfavorable macroeconomic conditions or liquidity stress.
If things do not unfold as expected, Bitcoin may not serve as digital gold but rather remain a highly liquid speculative product. What will be the next step for Bitcoin ETFs?
Following the launch of the first Bitcoin futures ETF in the U.S. market, the price of Bitcoin experienced a significant decline. It is hoped that the introduction of a Bitcoin spot ETF will yield different results.
https://drive.google.com/file/d/1ilt2_rbI1Ck-2eooiPl75WdDyMQ2rJfU/view?usp=drive_linkERC20BTC
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