According to iShares, global ETF AUM in Q2 2023 was $9.6tn.
Markets are looking toward the approval of Bitcoin Spot ETFs in the U.S. as the next major catalyst for $BTC, with approvals expected as early as within the next 6 months.
This article attempts to explore:
- ETF Mechanisms: Primary + secondary liquidity, and ETF arbitrage
- Implications of a Bitcoin Spot ETF
- Competitive Landscape
- Timeline for Approval
What is an ETF?
ETFs are passive investment funds that track the performance of a specific index, like the S&P 500. ETFs are:
- Passive: Aims to match the performance of the index, rather than beating it.
- Cheap: Low expense ratios relative to actively managed mutual funds.
- Transparent: Readily available documentation to understand the underlying investments within the ETF.
- Liquid: Traded during market hours on traditional stock exchanges like NYSE and Nasdaq.
How does an ETF actually work?
Given that ETFs and their underlying assets trade throughout the day on stock exchanges, this gives rise to a distinction between an ETF’s market capitalisation (“MC”) and net asset value (“NAV”).
- MC: No. of ETF Shares Outstanding * ETF Share Price; defined by the demand and supply for ETF shares.
- NAV: Value of underlying assets held by ETF; defined by the demand and supply for each individual underlying asset.
Theoretically, MC should equal NAV — though in reality, there may be small deviations between these two prices. Any significant differences can be arbitraged — where Authorized Participants (“APs”) who are appointed by the ETF issuer can create or redeem ETF shares to profit from this spread and bring MC closer to NAV. APs are typically financial institutions (i.e. Citadel, Jane Street, Flow Traders).
ETF Arbitrage
If ETF trades at $101: AP can purchase the basket of securities for $100, create an ETF share, and sell ETF share for $101. Profit $1.
If ETF trades at $99: AP can purchase ETF share for $99, redeem the ETF share, and sell the basket of securities for $100. Profit $1.
We see that there are two layers of liquidity in ETFs: 1) Secondary Liquidity (via on-exchange activity between buyers and sellers of existing ETF shares), and 2) Primary Liquidity (where APs buy or sell the underlying asset in order to facilitate creation and redemption of new ETF shares). This source of primary liquidity also implies that ETFs are net contributors to market liquidity — enabling better price discovery for the underlying asset.
What about a Bitcoin Spot ETF?
Likewise, a Bitcoin Spot ETF is an instrument that is backed by physical Bitcoin — giving investors exposure to Bitcoin without having to hold any in custody. The emergence of Bitcoin Spot ETFs broadens participation into Bitcoin — giving retail investors easier access to Bitcoin through their traditional brokerage accounts, and allowing institutional investors to have exposure to Bitcoin even if their mandate does not allow them to hold cryptocurrency directly.
Bitcoin Spot ETFs came back into the spotlight in June 2023 after BlackRock’s iShares division filed a prospectus with the U.S. Securities and Exchange Commission (“SEC”) for the formation of a Bitcoin Spot ETF. Over the years, the SEC has rejected dozens of applications for Bitcoin Spot ETFs (citing inadequate levels of trading surveillance for underlying Bitcoin Spot markets) — although it had approved a Bitcoin Futures ETF in 2021.
Observers believe that approval for Bitcoin Spot ETFs are on the horizon — given BlackRock’s status as the world’s largest asset manager with $10tn in AUM, and Larry Fink’s (BlackRock’s CEO) influence within Washington. Re-applications from Invesco and Fidelity, two other sizable global asset managers with a combined $7tn AUM, are also likely to influence this approval. Furthermore, in response to the SEC’s concerns on trading surveillance — all issuers have also agreed to work with Coinbase on “surveillance sharing” to ensure there is no market manipulation in the underlying Bitcoin spot markets.
To date, there are 8 issuers who have filed or re-filed their applications with the SEC:
- Ark 21Shares (Decision delayed on Aug 12)
- BlackRock / iShares
- Bitwise
- VanEck
- WisdomTree
- Invesco
- Valkyrie
- Wise Origin / Fidelity
The creation of multiple Bitcoin Spot ETFs is likely to create structural buy pressure into $BTC as APs will need to create new Bitcoin Spot ETF shares in order to accommodate market demand. Later on as these ETFs grow, most ETF activity will happen on on-exchange as secondary liquidity between buyers and sellers.
Precedent Crypto ETFs in the Market
Jacobi FT Wilshire Bitcoin ETF
Jacobi Asset Management listed the world’s first Bitcoin Spot ETF on Euronext Amsterdam on Aug 15, 2023 — and will be regulated by the Guernsey Financial Services Commission (“GFSC”). The issuance comes after GFSC approval for the ETF in October 2021, with original plans to come to market in 2022. Market factors in 2022 prevented the Jacobi Asset Management from launching the ETF.
The listing of this ETF on Euronext Amsterdam also means that Europe will have a Bitcoin Spot ETF before the U.S., and offering a precedent to other regulators worldwide.
Key Statistics
- Ticker: $BCOIN
- Venue: Euronext Amsterdam
- Management Fee: 1.5%
- Index Provider: FT Wilshire Bitcoin Blended Price Index
- Bitcoin Custody: Fidelity
- Authorized Participants: Jane Street, DRW
- Market Makers: Flow Traders
Grayscale Bitcoin Trust $GBTC
Issued by Grayscale, the Grayscale Bitcoin Trust (“GBTC”) was launched in 2013 as one of the first securities to provide exposure to Bitcoin. Unlike other U.S. ETFs registered under the Securities Act of 1933, GBTC was exempt by the registration by Rule 506(c) of Regulation D — as shares were only sold to accredited investors via private placement.
GBTC’s structure has some shortcomings relative to ETFs — mainly that its MC deviates NAV due to a lack of a redemption mechanism. In the early days, $GBTC traded at a large premium due to retail and institutional demand for the only publicly traded Bitcoin fund. As demand for $GBTC dissipated, shares moved to trading at a discount due to launch of other publicly traded Bitcoin funds, Bitcoin Futures ETFs, and easier direct access to Bitcoin.
Due to these shortcomings, Grayscale has sought to convert GBTC into an ETF over the years. Its most recent attempt in Oct 2021 was rejected in Jun 2022, resulting in Grayscale launching a lawsuit against the SEC.
Converting GBTC into an ETF would mean that:
- GBTC can trade on a stock exchange like Nasdaq or NYSE Arca, rather than being on the OTCQX market.
- Allow GBTC redemptions, allowing GBTC to trade closely with NAV.
Key Statistics
- Ticker: $GBTC
- Exchange: OTCQX
- Management Fee: 2%
- Index Provider: CoinDesk Bitcoin Price Index
- Bitcoin Custody: Coinbase Custody
- Authorized Participants: Grayscale Securities
- Market Makers: n.a.
ProShares Bitcoin Strategy ETF
The Proshares Bitcoin Strategy ETF was the first Bitcoin Futures ETF to be issued, after a shift in the SEC’s positioning led to the approval of Bitcoin Futures ETFs. Bitcoin Futures ETFs allow investors to gain exposure to Bitcoin via Bitcoin Futures, rather than holding Bitcoin directly.
Bitcoin Futures are cash-settled derivative contracts where two parties enter into an agreement to buy or sell Bitcoin at a predefined price at an expiration date, with trading happening on a commodities exchange like the Chicago Mercantile Exchange (“CME”). On CME, holders of Bitcoin Futures can sell their contracts to another party before expiration date or wait until expiration to cash-settle the contract with the counterparty. Coming to the end of expiry, Bitcoin Futures ETFs will need to “roll” their contracts, by selling them and purchasing new contracts with a further out expiration date.
Given that the ETF purchases Bitcoin Futures rather than Spot, Bitcoin Futures ETFs have no “real” buy or sell pressure on Bitcoin — which is why Bitcoin Spot ETFs are more widely anticipated from a buy pressure perspective.
Key Statistics
- Ticker: $BITO
- Exchange: NYSE Arca
- Management Fee: 0.95%
- Index Provider: Bloomberg Galaxy Bitcoin Index
- Bitcoin Custody: n.a.
- Authorized Participants: Undisclosed
- Market Makers: Undisclosed
What is the timeline on a Bitcoin Spot ETF?
Per GSR, after an Exchange (i.e. Nasdaq, NYSE Arca, CBOE BZX) files a 19b-4 seeking approval to list a new ETF — the SEC will conduct an initial review of the filing before publishing it in the Federal Register. Once published, a formal review window begins — where the SEC has at most four decision points, with the ability to approve, deny, or extend the review period except at the last decision point. Thereafter, the review period can no longer be extended. These formal review deadlines are at the 45, 90, 180, 240 day marks — where failure to respond after 240 days results in the filing being approved.
Below, GSR outlines key SEC review milestones — based on iShares’ 19b-4 being published on the Federal Register on Jul 13. Other issuers also re-filed their 19b-4s shortly after iShares, meaning that review deadlines for different issuers are within a few days of each other.
Conclusion
Looking forward to monitoring review deadlines of these upcoming Bitcoin Spot ETFs — and seeing if Bitcoin Spot ETFs can truly broaden participation into Bitcoin and create structural buy pressure.
