Will an ETF approval save Bitcoin in 2018? We don’t think so, here’s why…
There are two points we want to address in this piece:
1- Will a Bitcoin ETF get approved by the SEC in the NT (near term)
2- If an ETF does get approved NT what will be the impact on BTC price
We think right now Bitcoin investor expectations for approval of the VanEck ETF are a bit less than even at this point. While we don’t have any proprietary insight into whether the SEC the VanEck or another Bitcoin ETF application we do think the reasoning for the Winklevoss ETF denial, issued 7/26/18, also apply to the VanEck ETF application. The SEC decision on the VanEck is now expected 9/30. In the Winklevoss denial the SEC cited concerns primarily around Bitcoin market manipulation but also how the NAV would be priced. If you are reading the delay in the SEC decision as a positive, we would note that as Alex Kruger kindly pointed out, the SEC also delayed their decision on the 1st Winklevoss ETF application 45 days and the press release used the exact same wording. And as you know, the Winklevoss application application was subsequently denied.
We tend to think there is a little less chance of the VanEck SEC approval than is broadly expected, but, we also think that besides a strong initial BTC price pop, that the inflows of dollars into the VanEck ETF will be disappointing and have a lower than expected impact on BTC price appreciation in the short to medium term. We’re not going back to all-time highs anytime soon.
What we did learn from this recent price action (see chart on left) that expectations are very high for $BTC price appreciation on an ETF approval. Rumors circulating in mid-July sent $BTC soaring only to be crushed by the 2nd rejection of the Winklevoss ETF on 7/26/2018 and the delay of the SEC decision on the Van Eck ETF 8/7/2018 (see chart on left). However, we think even if the VanEck Bitcoin ETF is approved, while we will get a solid NT pump in price, it will not boost BTC price levels back to all-time-highs- which we think is what is expected by some. We think the VanEck ETF doesn’t have the attributes that make it attractive to draw large investor inflows. The Van Eck Bitcoin ETF is targeted at institutional investors with each share representing 25 Bitcoins. This large minimum purchase effectively locks the vast majority of retail investors out and we think most institutional investors won’t invest in cryptocurrencies because they are too conservative or can’t due to their mandate.
However, we do think a well-designed retail Bitcoin ETF product could be very successful. The resulting high sales volumes will entice more institutions to offer more Bitcoin products and in turn spend real marketing dollars on these products ultimately driving real price appreciation. However, this nice little feedback loop won’t happen in the short or medium term.
So, while we don’t think the current Van Eck ETF will drive significant volume, we do view a Van Eck ETF approval as a stepping stone towards an ETF that will have the right characteristics to drive significant volume of inflows into BTC/crypto. We discuss these traits further down in the body below and think these ETF products would have to drive in the range of $300M/month in cash inflows with today’s Bitcoin capitalization and trading volume in order to drive material BTC price appreciation.
The gold FOMO price chart being passed around highlighting the first gold ETF introduction is a yet another misrepresentation to lure investors into buying $BTC before it has bottomed. The gold ETF charts we have seen either hint or state explicitly that the 2003 gold ETF introduction drove a 10 year 400% plus bull market in gold. We think this is misleading as the early 2000s marked the start of a 10 year commodity bull market where most metals and some other commodities went parabolic.
In terms of BTC trading we haven’t changed our view, we think we are still in a bear market that has at least several months left in it- including several months of consolidation (see our piece on How to Spot THE Bottom). We think we will go below $6K again and keep printing lower lows until one of two things happen:
1- We get some really positive “game changing” fundamental news
2- We exhaust all the sellers.
Please note that most bubbles take many years to work through and most never reflate. ETF or not, BTC needs to find a use case that can drive the valuation and in our next piece we will explore valuation for BTC as a store of value and also as a means of exchange.
An ETF approval and the associated cash inflows will help everyone in the crypto industry. The best way to achieve this is through self-regulation. Exchanges need to ensure transparency in pricing, crack down on spoofing, wash trades, and liquidity bots. The SEC can help by cracking down on pump and dump schemes.
We don’t think the lack of an ETF vehicle is what is stopping institutional adoption of Bitcoin. We think an institutional investor who wants to invest in Bitcoin will figure out the custody and mandate issues themselves- some already have. There are already blue chip custodial options available today and many more will be available soon. We think plain conservatism is one issue holding institutional investors back, with pension funds and endowments generally being the most conservative, while hedge funds and some family offices are the most aggressive. We believe institutional investors who manage pension funds and other retirement plans want to see confirmation of large scale interest in Bitcoin, over a longer period of time, before they start marketing these types of product, especially if pitched as a store of value. In addition, most have a fiduciary duty to protect their client’s capital so investing in an asset with zero intrinsic value is a tough sell. To give you some insight how institutional investors act, imagine a conservative pension fund that traditionally invests in conservative fixed income products. What do you think would happen to the manager of a conservative pension fund if they bet the farm on MySpace in 2007, on their first foray into Venture Investing ? They would be fired. Now, back to the present, even a pension fund diversifying into many altcoins doesn’t reduce risk because all crypto is highly correlated and we believe that the vast majority of coins will go to zero. And, cryptocurrencies are a risk asset and as we have seen in the past, in a major financial markets downturn all risk assets are highly correlated.
Institutional investors aren’t jumping in to crypto for 3 reasons — first, we are in a bear market (who wants to catch a falling knife) and, second, is the lack of intrinsic value in crypto in general and 3- lack of a LT track record especially for some pushed as a “store of value”. Another class of investments with no intrinsic value is the global currency market. We don’t see a lot of institutions selling currency products — for example currency mutual funds — to retail investors. The speculative players in the currency markets tend to be macro hedge funds, family offices, and banks. And, many companies buy currencies or derivative instruments to hedge future sales or expenditures. We see some currency ETFs but the market cap is limited compared to the massive capitalization and trading volume of the underlying currencies. It will take a long time for many of these different types of investors to establish that there is client demand for crypto and to attain a comfort level investing in an asset class with no intrinsic value. The other investment class that comes to mind with no intrinsic value is fine art & collectibles. While this asset class has had some uptake from high net worth investors it hasn’t taken off for institutional investors and is still a very small asset class.
In terms of existing products two firms offer Bitcoin tracking funds that hold the underlying Bitcoin. GrayScale has a Bitcoin trust that trades OTC in the US and XBT has an ETN that trades in Stockholm. The US fund, GBTC, has had some success with about $1.5B in assets with inflows at about $30M/month this year (see chart on left). These inflows are not nearly enough to move the needle in terms of Bitcoin price appreciation. The GrayScale Bitcoin Investment Trust (GBTC) is an open-end investment trust with a $50K minimum available to accredited investors only, however we don’t believe it’s issuing shares currently, and this is why there is a large premium of it’s NAV to it’s Bitcoin holdings. Around the time of this writing the GrayScale GBTC traded at a 48% premium to it’s NAV. We have no idea why anyone, especially an institutional investor, would buy an asset, with no intrinsic value, for a 48% premium, with a 2% management fee. Those are stiff headwinds against which to eke out a return for your clients. About half of the GrayScale fund is institutional investors, 20% wealthy retail, retirement accounts are 16% and family offices make up the rest 8%.
The Van Eck ETF product that the SEC will weigh in by 9/30/2018 is targeted at institutional investors and for this reason, and other reasons, we don’t think this will be the dominant ETF fund with huge inflows. We believe the fund that will become the dominant Bitcoin ETF fund will have the following traits:
1. Small minimum purchase — accessibility to all investors and to be able to scale in and out of positions so a minimum investment size of less than $5K is important.
2. Open ended — so that there is no premium and the fund buys more Bitcoin if there are significant inflows.
3. IRA/401K eligible — Americans have $28T in retirement plans ($5T in IRAs) so even a small portion of this channeled into Bitcoin would be a huge driver. Much of this is institutionally managed such as mutual funds or defined benefit plans however if a material amount of the self-directed funds went into a Bitcoin ETF this may lead to institutionally managed Bitcoin products like other ETFs or even crypto mutual funds.
4. 24/7 trading — there is nothing more frustrating than trading CBOE XBT futures and having your orders not go through for one hour each day and having to close out your short positions on the weekends. Enough said.
5. ETF must own the underlying Bitcoin — this is as opposed to futures or some other derivative instrument. We believe that the derivatives contracts, like futures, actually take liquidity away from underlying Bitcoin trading. And, these derivatives contracts don’t drive the BTC price because the pricing of the derivative contracts is based on the trading the underlying Bitcoin, not the other way around. Derivatives contracts do lead to some price discovery however the way to think about it is that the underlying security is the dog and the derivative contract is the tail. We can, however see using some futures contracts on the margin to improve the tracking of the ETF to the underlying in a liquidity crunch.
6. Transparency in pricing — We’re not sure whether it matters if the ETF is priced off of exchanges or OTC transactions however we do think it’s important that the pricing mechanism and inputs to the pricing are transparent, and not a black box.
There is already also a couple of exchange traded Bitcoin ETNs In Europe. Stockholm based XBT Providers have two Bitcoin ETNs (Exchange Traded Notes) funds, one that trades in Swedish krona (AUM of USD product in left chart) and the other in the Euro. In the Krona version 20 shares = one Bitcoin while the Euro version 200 shares = one Bitcoin. This ETN holds the underlying but also forward contracts to replicate Bitcoin price movement. Sweden is a small market and the USD denominated Bitcoin tracker has $190M in AUM while the EUR denominated product has 230M EUR in AUM.
A gold ETF introduction didn’t drive the price of gold up 455% as many on crypto twitter would have you believe to drive FOMO. Many have been posting a version of a 10–15 gold price chart of the early 2000s that shows gold highlighting when the first gold ETF was introduced (see example of Gold ETF FOMO chart above).
However, we don’t believe the gold ETF introduction drove this price appreciation. Of course, it helped, but after the internet bubble burst in 2000 we saw a 10 year commodity bull market. It was not just gold that went up, it most metals and many commodities. If you doubt this please take a look at the Oil WTI daily price chart below. The first oil ETF started trading July 15, 2005 and as you can see oil started its rapid appreciation in 2003 also and even traded down for most of the 2H of 2005 right after the oil ETF was introduced. We’re not saying the ETF introduction didn’t help gold price appreciation, as it did create more demand for the underlying. However, the way it has been presented is not balance and misleading. It’s true that the total capitalization and supply of Bitcoin is much lower than gold so the introduction of a successful BTC ETF will likely have large impact on price however gold is not the right comparison, just a convenient coincidence to drive FOMO.
Industry self-regulation may the most helpful to pave the way for the SEC approval of a Bitcoin ETF. The incentives of most players are aligned here- all players in Bitcoin will benefit from price appreciation. Price appreciation will lead to higher unit trading volumes- which together means higher transaction fees for the exchanges. And as discussed above, we believe that a well-designed retail ETF will lead to significant new money inflows driving price appreciation. We recommend exchanges banning liquidity bots outright (instead of encouraging them) and increasing surveillance for liquidity bots, wash trading, spoofing, and other forms of manipulation. In addition, transparency with respect to coin listing fees, and ending zero transaction costs for wales, would all be a step in the right direction. Finally, we would like to see either self-regulatory organizations or even the feds go after some of these pump and dump groups that make concerted efforts to shill illiquid altcoins. This is fraud, pure and simple, and we think this is partially an education problem that can be fixed with a few well publicized prison sentences.
We aren’t HODLers of BTC even below $6K because there is no intrinsic value and the miner’s cost (akin to a company’s book value) to produce a Bitcoin doesn’t create any kind of hard valuation floor. Even for stocks book value doesn’t always create a hard floor for the stock price — just ask bank investors in 2008 how well book value supported bank stocks. For more details, please see our last piece on How to Spot THE Bottom in Bitcoin. To end on a positive note we are finally seeing some positive signs. The data flow is improving, especially on the regulatory front, and we did see an encouraging small uptick in the trading volume in the most recent rally (see black trend line in vol chart above). And, we have noted that in the 2H July rally there was much less short covering than previous bear market rallies -especially vs the 4/12 big squeeze rally. However, we are back up in the 28K range for short interest (bottoming NT at ~18K), which means we are susceptible to a squeeze in the near term.
