The cryptocurrency space experienced a major milestone last week as the SEC gave the go-ahead for Spot Bitcoin ETFs. This pushed Bitcoin price up 63% in 3 months since October last year. As of the point of writing, Bitcoin's price had fallen more than 10% from a high of more than 49,000. Not an uncommon sight, particularly after a spectacular run-up to the much anticipated SEC approval.
Now, this is not the first exchange-traded product related to Bitcoin. Before this, we already have the Grayscale Bitcoin Trust (Ticker: GBTC) and Bitcoin futures-based ETFs such as the Proshares Bitcoin Strategy ETF (Ticker: BITO) and VanEck Bitcoin Strategy ETF (Ticker: XBTF).
If that is the case, then why has this regulatory nod sparked such excitement within the community?
What is all this excitement about Bitcoin ETFs?
Beyond the usual push and hype from vested businesses, opportunists, and ardent crypto investors, the more practical reasons are these.
1. ETFs are open-ended structures
Before being converted to an ETF, GBTC was the only exchange-traded product that held spot Bitcoins. However, it is a closed-end fund that did not allow for the creation and redemption of shares. ETFs, on the other hand, are structured as open-ended funds and can do so. And why does that matter?
Theoretically, the market value of an ETF should be the same as its underlying assets' NAV. For example, if a Bitcoin ETF holds $1 billion worth of Bitcoin, then the total value of this ETF should also be worth $1 billion. But because the ETF is itself subject to the supply and demand from market participants on its listed exchange, its price and hence value can deviate from the underlying assets at any point in time. If a lot of people want to buy the ETF, this can push the ETF price up above the value of its underlying asset and vice versa.
But if an ETF can create and redeem shares (done through authorized participants), then it can stabilize its market price so that it tracks its underlying assets' NAV more closely. The idea is fairly straightforward without delving into the complexities of the mechanics and process. If the ETF is overpriced relative to the asset, then create more shares to increase the supply. Conversely, if the ETF is underpriced, then redeem the shares to reduce the supply.
2. Spot Bitcoin ETFs invest and hold Bitcoin directly
But, GBTC aside, don’t we already have Bitcoin-based ETFs? Strictly speaking, not before last week. ETFs such as BITO and XBTF were based on Bitcoin futures and not Bitcoin itself. That means these ETFs invest and hold Bitcoin futures and not Bitcoin. So, there is no guarantee that they can track Bitcoin prices closely. In addition, there is also the added cost of rolling over the futures contract when they are about to expire. In terms of size, the Bitcoin futures market size is also a mere fraction of the spot Bitcoin market. The notional open interest (the value of the open contracts on Bitcoin) for the Bitcoin futures market now ranges between $17-$18 billion while the spot Bitcoin market size is more than $800 billion. So, there is no question about which is more liquid.
3. Convenient mainstream access to Bitcoin
Retail investors can now invest in Bitcoin without going through crypto exchanges of which regulation, trust and security are still a major concern. There has been no lack of news regarding crypto exchanges being hacked, founders stealing assets, involved in fraud or shady businesses such as money laundering.
Neither do you need to go through the hassle of setting up crypto wallets and remembering complicated private keys. You also no longer need to switch to Stablecoins between trades when these coins haven't been put through an extreme test to see if they can hold up.
Now, with ETFs, everything can be done through your traditional regulated brokerages just like any other listed securities. And you can park your sales proceeds in the real USD instead of subjecting yourself to the risk behind stablecoins should they be unable to maintain the peg.
4. Stronger perception of Bitcoin's legitimacy
While this is not the first point I made, this is perhaps the strongest reason for all this buzz. For the crypto community, the green light on Spot Bitcoin ETF from the SEC is a watershed moment. Because regulatory recognition represents an elevation of the overall crypto's status, moving it another step closer to mainstream products. And with it are expectations of greater interests, fund flows, and business opportunities.
5. 11 ETFs are launched at one go
As a show of business potential, 11 Spot Bitcoin ETFs were launched in one go. Issuers include familiar names such as Grayscale, BlackRock, Fidelity, Franklin Templeton, and Ark Investments. Competition is intense. Other than Grayscale which is converting its Bitcoin Trust (which already holds $27 billion in assets) into ETF and charges a fee of 1.5%, the rest of the competitors are asking for fees lower than 0.5%. Many also throw in fee waivers for the first couple of months or the first few billion in assets. All things being the same, it is likely Grayscale will see some outflows to its competitors. After all, these funds aren't doing any other value-adding stuff other than buying and holding Bitcoins.
Does all this make a difference?
We do expect more investor participation from the mainstream for a host of reasons. Some look at Bitcoin as a lottery ticket, some consider it for diversification, and some just want another asset to trade. But whatever the case, the ease of access and stronger regulatory and cybersecurity safeguards will likely sway more people over.
But at AllQuant, we have not ventured yet into Bitcoin or any crypto despite the heightened adoption. Because for us, nothing changed materially and the key concerns remained. The means of access does not fundamentally impact what the underlying asset is. Bitcoin is still Bitcoin. Its fundamental value and actual utilization purpose remain a question mark - whether it is to become digital gold as an alternative store of value, a replacement for fiat currency, or a hedge against other assets. So far, none has given a compelling case. We have written about these before. You can read more about them in the links below:
Investing in something simply because enough people are willing to put a price tag on it runs against our principles of investing in things we can understand. Something useful may evolve out of this in the future, but until then, we will continue keeping watch.
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