For a long time, many industry participants and financial analysts at traditional institutions have viewed cryptocurrency ETFs as potential game-changers. They can attract the attention of institutional investors, increase liquidity and replicate the success of gold-focused exchange-traded funds.
In October 2023, Cointelegraph reported the approval of BlackRock's application to launch a spot Bitcoin ETF. Against the background of the incident, quotes of the first cryptocurrency broke through the level of $29,000.
It later turned out that the journalists published unverified information, and the investment company was still awaiting the regulator’s decision. However, such a market reaction once again proved that its participants expect a lot from these instruments.
The editors of Incrypted figured out what impact spot Bitcoin ETFs can have on the cryptocurrency market and whether it is correct to compare them with gold-focused exchange-traded funds.
What is an ETF?
An exchange-traded fund (ETF) is an index fund that, depending on its structure, tracks a specific sector, a specific commodity, or even a specific strategy.
Unlike other investment funds and trusts like the Grayscale Bitcoin Trust (GBTC), ETF shares are freely traded on the open market. You can carry out the same operations with them as with securities - sell or buy shares at any time during the trading session.
This makes the instrument liquid and, as a result, provides investors with the opportunity to instantly withdraw funds. The product also allows you to optimize management costs because it can track a basket of assets and has a low financial barrier to entry.
For the traditional market, exchange-traded funds are a familiar tool. For example, in the United States, the first ETF appeared in 1993 - Standard and Poor's 500 Depository Receipt (SPDR). It tracks the S&P 500 Index and is still actively trading under the ticker symbol SPY.
However, cryptocurrency exchange-traded funds have appeared relatively recently and not quite in the form in which the community expected them to be seen. A landmark was the launch of the futures Bitcoin Strategy ETF (BITO) from ProShares, which the US Securities and Exchange Commission (SEC) approved in October 2021.
Compromise solutions
The commission has long opposed the launch of exchange-traded funds for digital assets. Among the arguments, the regulator also appealed to the lack of qualified custodial services and a compliance culture in the United States necessary to prevent fraud.
The SEC ultimately approved an ETF based on the Chicago Mercantile Exchange's (CME) settled Bitcoin futures, which includes the aforementioned BITO. The CME is a federally regulated market - the platform is supervised by the US Futures Trading Commission.
Bitcoin futures on CME
CME launched Bitcoin futures in December 2017. In the same month, the price of digital gold reached a new all-time high. In January 2017, a correction occurred and a long flat began - quotes reached the previously established peak only in November 2020.
Since Bitcoin futures appeared almost six years ago, there are already studies that aim to evaluate the effect of the launch of instruments. Opinions in this context vary.
Some believe that the emergence of the futures market has increased the liquidity of Bitcoin and its attractiveness compared to other cryptocurrencies in terms of risk and return.
Others, on the contrary, drew conclusions about the destabilizing influence of the instruments - the influx of liquidity was too small to have a significant positive effect, but market volatility increased, its profitability decreased, and risks increased.
Launching BITO
BITO shares began trading on the New York Stock Exchange on October 19, 2021. The instrument showed one of the most successful debuts in terms of trading activity.
In the first session, its turnover amounted to 24.42 million shares. The volume almost reached $1 billion, and it took BITO only two days to overcome this milestone.
Less than a month after the launch of BITO, Bitcoin quotes reached a historical high of $69,000, and then went into a deep correction.
After BITO, other similar tools appeared Most likely, at the moment they did not have a significant impact on the price of the first cryptocurrency. As in the case of CME futures, their launch occurred at the end of the rally, when the upcoming correction was built into the market. In addition, the community has already talked about certain problems with the Terra ecosystem.
However, we cannot turn a blind eye to the fact that institutional traders were able to take short positions against Bitcoin when it reached its price maximum.
In the long term, futures ETFs have increased the liquidity of the cryptocurrency market and attracted the attention of more traditional players to it. The approval of the instruments by the SEC also removed the “canopy” of the narrative regarding the possibility of the regulator introducing a ban on transactions with digital assets.
At the same time, experts from the Bank for International Settlements believe that with a certain concentration of derivatives managed by exchange-traded funds, the latter can have a negative impact on the market. In particular, by increasing its volatility.
Some also note that as the market becomes institutionalized, CME futures are becoming increasingly important. This is especially noticeable during the recovery of cryptocurrency quotes. At the same time, it is likely that Bitcoin ETFs like BITO make a significant contribution to the dynamics.
Ineffective correlation
Bitcoin futures ETFs have attracted the interest of institutional market participants because they provide them with access to cryptocurrency through a clear and regulated mechanism. But such tools have a number of features that significantly reduce their effectiveness.
One of the goals of any exchange-traded fund is to accurately track a specific index. However, because futures prices are affected by a number of factors such as the expiration date, ETFs based on these derivatives often do not correlate effectively with the underlying assets.
For a futures ETF, the management company takes long positions in short-term derivatives. In the case of BITO, these are CME Bitcoin futures. As the contract expiration date approaches, it closes positions, simultaneously opening new ones in instruments with a longer maturity (performs a rolling operation).
In addition, the management company holds liquid cash or cash equivalents such as Treasury bonds. When the price of the underlying asset rises, it uses profits from derivatives to expand the liquid pool. In the opposite situation, the pool offsets losses on contracts.
Such a strategy can negatively impact an ETF's performance over time as inevitable contango and backwardation, coupled with rolling costs, cause its quotes to lag behind spot prices .
K33 analysts noted that BITO shares have underperformed spot Bitcoin by 2.6% to 13.8% since the start of 2023.
How is a spot ETF different from a futures ETF?
As the name suggests, spot ETFs do not invest in derivatives, but directly in assets. Therefore, while having all the advantages of futures exchange-traded funds, they are deprived of a number of their disadvantages, such as the need to perform rolling operations.
Operators of spot Bitcoin ETFs, if such instruments are approved in the United States, will hold cryptocurrency in the accounts of registered custodians. Judging by filings with the SEC, most management companies chose Coinbase Custody as such. The exception is structures that control similar services.
However, the very fact of eliminating derivatives increases the effectiveness of the instrument. Since the management company directly owns the target asset, the fund tracks its quotes more accurately.
Moreover, a spot ETF offers more attractive fees: the provider does not need to roll, and there is no contango or backwardation, which reduces transaction costs. This will be especially noticeable with long-term investments.
Some analysts also consider such funds to be less volatile than futures structures and trusts like GBTC.
Can Spot Bitcoin ETFs Be Comparable to Gold Funds?
The community is overwhelmingly positive about the impact that spot exchange-traded funds can have on the cryptocurrency market. One view on future developments is inextricably linked with the narrative in which these instruments are compared to gold ETFs.
According to Galaxy Digital , in the first year of trading, the inflow of funds into spot Bitcoin ETFs could exceed $14 billion, which will ensure a 74% increase in the underlying asset's quotes.
The analysts' assessment is based on the assumption that 10% of all institutional investors invest in Bitcoin with an average allocation of 1%. They also cite the effect that ETFs have had on the gold market as part of their argument.
Other experts additionally point to a “systemic deficit” caused by the Bitcoin halving cycle, and the presence of a stable group of long-term holders of the asset who do not intend to sell it.
Indeed, since the launch of gold-focused exchange-traded funds, the price of the precious metal has roughly quadrupled. At the time of writing, the value of assets under management of gold ETFs, whose shares are traded on the US market, is estimated at more than $115 billion.
Before the advent of trust funds, investing in gold was quite problematic. It was necessary to purchase physical bars or coins, transport them, and then take care of their safety. All this cost money, the market was fragmented and low-liquidity.
Therefore, institutions had to bear the associated costs, and retail investors practically did not participate in large transactions. Gold-focused funds have solved these problems.
For institutional investors, Bitcoin futures and then derivatives ETFs would do the same. However, as mentioned above, these instruments are not very efficient, so spot funds are a much more attractive entry point.
A retail user with cryptocurrencies has no such difficulties in principle. This is not the first year they have had direct access to digital assets through exchanges and other trading platforms.
In addition, tokens are easy to store and transport, since the entire contents of the wallet take up exactly the same amount of space as a piece of paper with a seed phrase written on it.
Given the above, it is not entirely fair to compare spot Bitcoin ETFs with gold-focused structures. Therefore, the effect of instrument endorsement should be assessed more conservatively.
What impact will spot Bitcoin ETFs have on the market?
Assessing the short-term impact of spot ETFs on cryptocurrency prices is quite difficult.
On the one hand, for certain market participants their approval may become a signal to take profits, as may have been the case with Chicago Mercantile Exchange derivatives and futures funds. However, these instruments appeared at the end of the rally, while the situation with spot Bitcoin ETFs is different - the industry is just emerging from a bearish phase.
On the other hand, being more efficient than futures funds and derivatives themselves, these structures can attract the attention of more institutions and, as a result, the liquidity necessary for growth.
Some community members also believe that ETF providers benefit from a short-term drawdown in quotes - this will allow them to attract assets at a lower rate.
There is also a polar opinion - from the point of view of structures like BlackRock, it is more advisable to gradually increase positions, trying to avoid impulse effects on the price. Both scenarios are likely, so it's worth keeping in mind the potential for increased volatility.
It is also important that, following Bitcoin-focused funds, the market will likely see structures accumulating Ethereum and other Proof-of-Stake-based assets.
Industry companies such as exchanges, custodial services and other service providers will also benefit from the approval of spot funds, since the infrastructure built around these products must be maintained. In theory, they will receive a huge influx of funding, which will have a positive impact on the development of the entire industry.
Thus, even if spot Bitcoin ETFs do not replicate the success of gold-focused products, the positive effect of their adoption will be felt by all market participants, including ordinary users.
In the future, the latter will receive better and more reliable services, greater liquidity in the markets, as well as a whole range of new products, the catalyst for the emergence of which will be institutions.
