Markets Expect Bitcoin ETF

What is a spot Bitcoin ETF, and why is it all over the news?

ETFs can be confusing, so we are going to make you smart on this.

First of all, an ETF is a security listed on an exchange, and so the price will fluctuate throughout the day, according to the performance of the underlying index or asset/security, and investors can buy or sell throughout the day as they wish.

The most common asset ETFs are ones for gold and silver.

In essence:

An investor buys or sells the ETF, the ETF manager then buys or sells the underlying asset to match the NAV of the total amount invested in the ETF. Some of the best ETFs allow for the investor to exchange their shares for the underlying asset (gold, etc).

So, what about Bitcoin and the various ETFs out there and up for approval?

Now let’s get something rail-straight: Spot ETFs and Futures ETFs are not equal.

As you undoubtedly already know, while there are currently a number of Bitcoin futures ETFs available and trading, and there have been for years now.

Meanwhile, we are still waiting for the SEC to approve the spot version of a Bitcoin ETF. Something they have been reluctant (read: have refused) to do yet. Even though there are various Bitcoin spot ETFs that trade outside of the US, such as the Fidelity Bitcoin Spot ETF in Canada.

Still, you may ask: if both types of ETFs are seeking to track the price of the underlying asset or assets, so what’s the difference?

Turns out, the difference, while seemingly simple, is quite significant.

First off, a futures ETF is more of a betting contract than an actual security. See, this type of ETF owns no assets other than paper futures (contracts to buy and sell BTC at a given price on a future date). When you buy a futures ETF (or sell one), you are only really exchanging cash for the underlying futures contracts (not actual BTC).

And while the futures ETF somewhat tracks the price of BTC, the reality is that it is almost impossible for it to be 100% accurate.

See, because futures contracts expire at the end of each month, a futures ETF like Valkyrie’s BITO must sell its position before expiration and then purchase contracts for the next month. As a result, the price of the underlying asset, BTC here, can be much different than the futures contracts that are trading, and the buying and selling of the contracts can be costly (estimated at ~10% annual currently).

Most importantly from all this, because institutional investors understand the poor price tracking and expensive proxy for actual Bitcoin, they are reluctant to use a BTC futures ETF to gain exposure to Bitcoin. Rather, the futures ETF has become a way for institutions to short exposure to Bitcoin in an, albeit sloppy and inefficient, attempt to hedge out volatility in their portfolio instead.

And of course, use the Futures ETFs to arbitrage the price difference. This is usually done by leveraged hedge funds.

In contrast, a spot ETF actually owns the underlying asset it is seeking to emulate. In the case of a spot Bitcoin ETF, the ETF sponsor would actually buy and sell BTC, according to inflows and outflows of capital, and maintain the storage and keys of the underlying BTC through an institutional custodian.

As a result, most large institutions and Registered Investment Advisors (RIAs) are waiting for the approval of a spot ETF to gain exposure to BTC.

An obvious question would then be: why don’t these portfolio managers just buy actual Bitcoin instead?

While it may sound simple, it is truly far more complicated for institutions to own Bitcoin than individuals. This primarily has to do with internal policies, investment mandates, regulatory and compliance issues, as well as logistics such as settlement, pricing, and custody of an asset like Bitcoin.

Because of this, buying and owning of actual Bitcoin presents not just portfolio risk, but career risk for them.

Bottom line, many institutions are just waiting for an SEC-approved US-based spot ETF to gain their exposure to Bitcoin.

Spot Bitcoin ETF Approval Is Imminent

There are currently at least 12 spot bitcoin ETFs seeking approval—all of them are amending their prospectus’ regularly as the SEC issues new guidance in an effort to speed approval times:

You will notice that one of them is GBTC, which is already trading.

GBTC was created as a closed end trust, because it was a way to do an end-zone run around the SEC and list a security with underlying Bitcoin without going through the ETF approval process.

Because of creation and redemption limitations, though, GBTC has proven to be problematic and a poor proxy for Bitcoin ownership. And so, the managers are seeking to convert GBTC from a trust into a spot ETF.

This would allow for daily creation and redemption, something not possible with the trust structure, and GBTC would instantly become a proxy with much less delta between the trading price and actual Bitcoin price.

A number of these applications have been rejected and delayed for over a year now.

So, what is taking so long?

According to the SEC, because exchanges that trade Bitcoin are all over the world, the SEC has claimed that there is a possibility of manipulation. They have insufficient oversight of the trading and custody of the underlying asset.

Apparently Gary Gentler has not looked too closely at the futures Bitcoin ETFs, or gold for that matter.

In any case, we don’t believe there is any legitimate reason for the SEC to continue to outright reject the applications for the spot ETFs, and we expect imminent approvals.

We are talking weeks or or a few months, at most.

Question is: what happens historically to the price of underlying spot assets when their ETFs are approved?

Well, since this type of situation has not truly occurred before, it is hard to say.

Especially because the best proxy would be gold.

But gold can be manipulated and re-hypothecated, as it is extremely difficult for oversight. Gold can be claimed to be stored in vaults, but not actually be all there. Gold can be claimed to be real, but be gold plated iron bars.

Yes, this happens.

In direct contrast to gold, however, Bitcoin is easily verifiable, tracked, and audited through a public ledger. This makes it exceedingly difficult for the spot ETF managers to commit fraud or be defrauded with the physical holdings of their Bitcoin.

The appetite?

​Ernst & Young accounting firm is estimating that over $200 trillion of institutional assets are available but unable to purchase Bitcoin.

Yet.

But when a spot Bitcoin ETF is approved, they will be open to allocate to Bitcoin as an investable asset.

Some quick math: a 1% allocation of that $200 trillion would give us $2 trillion of capital inflows to an asset that currently has a total market cap of $670 billion.

Even without any trading friction whatsoever, this more than triples the price of Bitcoin.

But let’s not get ahead of ourselves. Let’s look at some more real-world data, such as price activity of GBTC, to gauge an immediate appetite for investors.

You notice that GBTC is rapidly converging with NAV, as investors front-run the institutional-sized flows that are expected to follow spot ETF approval.

And one more security to note, BITO, the most popular US-listed Bitcoin futures ETF, had its largest week of trading at $1.7 billion — again, as traders front-run the flows and spot appreciation of the coming spot ETFs:

In these two ways, and as we demonstrated in last week’s report on Bitcoin’s recent rally, the market is voting with its capital that a spot ETF is coming to market imminently.

Do ETF analysts think a spot BTC ETF is almost here?

Looking at a timeline from Bloomberg analyst, the latest survey points to late November at the earliest, with early-mid Q1 2024 being the most likely time that spot ETFs are approved.

As you can see, with Bitcoin’s price diverging positively from a negative risk asset market this past two weeks, and all signs pointing to high degrees of confidence from the markets that Bitcoin ETFs are coming, it is challenging to maintain level-heads.

But even without the price activity and market enthusiasm, we can objectively agree that there is little left for the SEC to do but concede that it’s time.

The markets are ready, and the markets are demanding it.

A spot Bitcoin ETF (or perhaps a dozen of them) is coming.

Prepare accordingly.