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Newsletter - Bitcoin ETFs: A New Era for Cryptocurrency Investments and its Impact

The prospect of a Bitcoin exchange-traded fund (ETF) has been a topic of intense discussion and anticipation within the cryptocurrency community for the last several months. A Bitcoin ETF would allow investors to gain exposure to the price of Bitcoin without having to purchase and store the cryptocurrency themselves. Beyond that, an ETF would legitimize the crypto space, derisk regulatory concerns, bring in a new class of investors, and potentially solidify “crypto” as a new and emerging asset class akin to commodities or emerging markets.


ETFs vs. Other Investment Vehicles

The obvious first question surrounding this decade long BTC ETF debate is, “Why an ETF?” To answer that, let’s first look at what an ETF is and how it differs from other investment vehicles and simply holding BTC natively.

An Exchange-Traded Fund (ETF) is an investment fund traded on stock exchanges, much like stocks. An ETF holds assets such as stocks, commodities, or bonds and generally operates with an arbitrage mechanism designed to keep it trading close to its net asset value (although deviations can occasionally occur). A Bitcoin ETF, for instance, would allow investors to gain exposure to Bitcoin without the complexities of directly buying and securely storing the digital currency. It would be valued based on a specific Bitcoin index and offer the ease of trading akin to conventional stocks. Like other ETFs, a BTC ETF would be subjected to fees issued by the broker.



Several crypto investment products and the fees associated with them. Different from ETFs, Exchange Traded Notes (ETNs) are debt securities issued by financial institutions. Trading on major exchanges, ETNs provide returns linked to the performance of a market index or other benchmark, minus issuer fees. While they are traded like stocks, the ownership of the underlying asset is not transferred to investors. Instead, ETNs are backed by the credit of the issuer, which means they carry an additional risk of default. Several BTC ETNs already exist, like the Vaneck BTN and others (chart below).




Exchange Traded Certificates (ETCs) or Synthetic ETNs are debt instruments that emulate the performance of other asset classes using derivatives. ETCs are typically uncollateralized, meaning they do not require the backing of physical assets or collateral, which can add a layer of risk for the investor due to the lack of tangible backing.

Finally, an Investment Trust is a publicly traded company that pools investors' funds to invest in a portfolio of assets. As a closed-end fund, it does not continuously offer new shares or redeem its own; instead, the shares of the trust are bought and sold on the market. The value of an investment trust's shares is directly tied to the value of the assets it holds, known as the net asset value (NAV). However, unlike open-end funds, the market price of a closed-end fund's shares can significantly deviate from its NAV. The most (in)famous crypto example of a trust is Grayscale’s GBTC.

The choice between these investment vehicles depends on the investor's risk tolerance, investment goals, and the need for liquidity. Each vehicle offers a different level of exposure, risk, and complexity, with ETFs generally considered a more direct and less risky investment into an asset class compared to ETNs and ETCs, while investment trusts offer a more traditional approach to fund management.


Spot vs. Futures

Within the ETF landscape, two distinct models prevail: spot and futures. Spot ETFs provide investors with exposure to Bitcoin's current market price by holding the actual cryptocurrency, whereas futures ETFs engage with contracts that forecast and agree upon a price for future exchange, circumventing direct ownership of the digital asset.

The resistance of the U.S. Securities and Exchange Commission (SEC) to the spot ETFs underscores the regulatory unease regarding the tangible handling of cryptocurrencies, primarily due to concerns over market manipulation and the reliability of trading volume data from crypto exchanges. Contrastingly, the Commodity Futures Trading Commission (CFTC) regulates Bitcoin futures, which are openly traded on established platforms like the Chicago Mercantile Exchange (CME), offering a more sanctioned avenue for investment.

ProShares Bitcoin Strategy ETF (BITO), the largest Bitcoin futures ETF in the U.S., exemplifies the rapid market appetite, having amassed $1.2 billion within days of its launch in October 2021. However, the size disparity among futures ETFs is notable, with competitors like VanEck Bitcoin Strategy ETF and Valkyrie Bitcoin Strategy ETF managing considerably less capital.

The fervor for spot Bitcoin ETFs persists despite the availability of futures ETFs. The rationale lies in the spot funds' capacity for holding Bitcoin indefinitely, reduced fees, and their closer tracking of Bitcoin's actual price. Futures ETFs, conversely, confront monthly contract renewals which can impose additional costs on investors. The limitation on the number of contracts an ETF can hold further exacerbates the potential for these costs.

Additionally, a spot BTC ETF could attract a new segment of the financial markets such as Registered Investment Advisors (RIAs), retirement funds, and other institutions that have, until now, been largely sidelined in the crypto domain. The implications of introducing one or more spot Bitcoin ETFs are substantial. The wealth management sector, which governs over a third of the wealth in the U.S., is particularly positioned to benefit. This cohort, typically reliant on ETFs for crafting investment strategies, is unlikely to engage in direct purchase and self-custody of Bitcoin. Spot Bitcoin ETFs offer a structured and familiar vehicle for inclusion in their diverse investment approaches.


BTC ETF Importance

Over the long haul, the establishment of spot Bitcoin ETFs is anticipated to funnel billions of dollars into the total cryptocurrency market capitalization and ignite a host of new investment opportunities within the asset class. As of the third quarter of 2023, Bitcoin investment products, including Exchange-Traded Products (ETPs) and closed-end funds, held approximately 840,000 Bitcoin, valued at around $22 billion. Their popularity can be partially attributed to the complexity of managing wallets, private keys, and the associated tax reporting involved in direct Bitcoin ownership.

A spot Bitcoin ETF stands to address these inefficiencies by offering more competitive fees, improved liquidity, and accurate price tracking. Although specific fee structures are yet to be disclosed by ETF applicants, the competitive nature of the ETF landscape suggests a lean towards affordability. Additionally, the tradeability of spot ETFs on major exchanges promises enhanced liquidity and more precise adherence to Bitcoin’s market price, unlike futures-based products or other indirect Bitcoin exposure methods.

The significance of a Bitcoin ETF includes:

  • Legitimacy: The endorsement of Bitcoin ETFs by reputable financial entities could enhance Bitcoin’s legitimacy as an asset class, fostering wider acceptance into the everyday portfolio construction.

  • Regulatory Clarity: SEC approval of a Bitcoin ETF would address safety and compliance reservations, providing clarity and encouraging further investment and development within the crypto space.

  • Expanded Reach: Current Bitcoin investment funds are largely confined to wealth advisors or institutional platforms. A regulated ETF would democratize access, allowing a broader investor base, including retail and affluent individuals, to participate.

  • Distribution: Many financial advisors and fiduciaries are currently precluded from including Bitcoin in wealth management strategies. An approved spot ETF would enable them to allocate client assets to Bitcoin investment, potentially unlocking significant capital.

The introduction of a Bitcoin spot ETF would likely be a transformative development for the cryptocurrency market, offering a more accessible, efficient, and regulatory-compliant vehicle for Bitcoin investment, appealing to a diverse investor base and potentially fostering a new era of institutional adoption and mainstream acceptance.


The SEC May Not Agree

The SEC's apprehension towards spot Bitcoin ETFs is rooted in the potential for investor exposure to market manipulation, given the direct correlation with Bitcoin's price. SEC Chair Gary Gensler has articulated concerns over the integrity of the cryptocurrency industry, thus far resulting in the rejection of dozens of spot Bitcoin ETF proposals from various investment firms. The commission's stance may shift pending regulatory authority over crypto exchanges.

The deliberation over ETFs encapsulates the broader discourse on cryptocurrency's place within the regulatory and investment spheres. As the largest investment management firm, BlackRock's proposal represents a significant test of the SEC's current policy and the future trajectory of cryptocurrency ETFs. The outcome of this proposal may well set a precedent for the integration of cryptocurrencies into mainstream financial frameworks.


BlackRock’s Filing

BlackRock, the global investment management corporation with a staggering $8.6 trillion in client assets, has finally decided to become a major player in the cryptocurrency/Bitcoin ecosystem. Its ETF subsidiary, iShares, which manages over $2 trillion across more than 800 ETFs globally, including nearly 400 in the United States, filed their own Bitcoin ETF application in June 2023 that is currently under review.


The long list of BTC ETF applications and their review deadlines.



In the proposed arrangement, Coinbase Custody is slated as the custodian for the Bitcoin reserves, and Coinbase Inc. as the prime broker. To address the SEC’s concerns over potential fraudulent and manipulative practices, iShares has outlined protective measures, including sourcing Bitcoin’s spot price from CF Benchmarks of the Chicago Mercantile Exchange and intending to establish a surveillance-sharing agreement with the Nasdaq exchange, satisfying a stipulation set forth by the SEC for listing a spot Bitcoin ETF.

The potential approval of BlackRock’s Bitcoin ETF is widely perceived as a significant challenge to the SEC, with speculation of a symbolic "battle" between SEC Chair Gary Gensler and BlackRock CEO Larry Fink. Market analysts speculate that the approval of a spot Bitcoin ETF could catalyze a short-term Bitcoin rally, reminiscent of the price surge preceding the launch of ProShares' futures ETF (BITO) in October 2021.


Potential BTC Price Impact

Market dynamics suggest that the approval of a spot Bitcoin ETF could also induce a supply shock, as issuers would need to accumulate Bitcoin to back new shares, countering the existing downward trend in BTC balance on exchanges. Yet, projections about the extent of a possible price surge vary significantly, with Morgan Creek Capital’s Mark Yusko suggesting a $55,000 target and Fundstra postulating a potential rise to $180,000. Galaxy Digital has ventured into this analysis, identifying $14.4 trillion in addressable assets within the U.S. If we speculate that a conservative 10% of these assets might engage with a spot Bitcoin ETF with an average allocation of 1%, it suggests possible inflows of $14.4 billion in the initial year. This figure would set a new precedent, surpassing the record inflows of 2021, which totaled $7.24 billion, accounting for 11.5% of assets under management (AuM).


As the wide price range insinuates, estimating the potential inflows into spot Bitcoin ETFs is a complex and uncertain task. Several challenges contribute to the difficulty of accurately forecasting these flows.


Firstly, the novelty of Bitcoin as an asset class poses a significant challenge in predicting inflows. Traditional models based on historical data are less reliable due to the time it typically takes for demand to develop within the general population and the wealth management industry.

Secondly, the dynamic nature of the current investment landscape, marked by heightened opportunity costs and scarcer capital than in previous years, provides few precedents to inform analysis. The unique financial environment we find ourselves in today offers limited historical parallels to draw upon for flow analysis.

Thirdly, inflow patterns are often dependent on a variety of factors that can influence initial allocations to ETFs. For instance, the $22 billion in assets under management in Grayscale's GBTC product, which cannot be converted into Bitcoin until GBTC transforms into an ETF, could significantly impact flows in multiple directions once such conversions are possible, depending on factors like market sentiment, competitive expense ratios, and liquidity.

Long-term market impact considerations may prove more insightful than short-term flow tracking upon the launch of these products. The ongoing generational wealth transfer from baby boomers to millennials—a demographic more open to crypto in their portfolios—underscores the potential for growth in crypto adoption through traditional investment vehicles like ETFs.


Conclusion

In conclusion, the potential establishment of a spot Bitcoin ETF marks a pivotal juncture in the maturation of cryptocurrency as a viable asset class. While the SEC's hesitations highlight the ongoing regulatory and market integrity concerns, the possibility of an ETF, especially from a powerhouse like BlackRock, carries the promise of unlocking new investment horizons, facilitating widespread adoption, and solidifying cryptocurrency's position within the financial ecosystem. The industry stands at the cusp of a significant transition, wherein the approval of a Bitcoin ETF could not only reshape investment flows but also redefine the cryptocurrency market's very fabric. Amidst regulatory scrutiny and market anticipation, the future of Bitcoin and the broader crypto market hangs in the balance, with potential implications that reach far beyond immediate price movements, heralding a new chapter of integration into the mainstream investment narrative.


Our Take

At Event Horizon Capital (EHC), we believe select cryptoassets will outperform all other asset classes over the next five, ten, and possibly even twenty years due to their superior qualities as new money/assets for the internet age. Because of this, we seek the best risk-adjusted exposure to protocols that personify the blockchain benefits outlined above. With crypto markets being one of the world’s most dynamic markets, our agile and active management provides the flexibility required for swift, decisive action while also never compromising on security.

EHC’s multi-strategy approach is built upon:

  • Qualitative fundamental research,

  • Quantitative tools and valuation metrics

  • Narrative and sentiment-driven market swings



This newsletter from Event Horizon Capital is intended for informational and illustrative purposes only and has been prepared to provide insights on the market. It should not be construed as an offer, solicitation, or recommendation to buy or sell any security or financial instrument, nor participate in any investment strategy. The opinions and information expressed in this newsletter are as of the date it was written and are subject to change without notice due to various factors, including changing market conditions and regulations. This newsletter is not intended as investment advice and should not be considered as such. Third-party data presented in this newsletter is sourced and deemed reliable, but no guarantee is made as to its accuracy or completeness. All investments carry risk, and there is no assurance that any specific investment, strategy, or product referenced directly or indirectly in this publication will be profitable or suitable for your portfolio.






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