30 Sep 2021

The Bitcoin ETF Race

This quarter could be an eventful quarter for bitcoin as we await SEC’s final verdict on the ever-growing list of pending bitcoin ETFs.
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Since 2013, there have been several attempts to launch exchange-traded bitcoin funds in the U.S., but so far, all of them have been rejected. Will we see a bitcoin ETF being approved this year, and if approved, what impact could ETFs have on the bitcoin price?

What is a bitcoin ETF

An exchange-traded fund (ETF) is an investment vehicle tracking an index or asset, which can be purchased on a stock exchange. ETFs currently exist in abundance for other equities and commodities, both with and without leverage. Yet, bitcoin-based ETFs have still yet to be accepted by the SEC. Already in 2013, the Winklevii’s attempted to launch an ETF, but it was rejected by the SEC. Since many have tried, and none have succeeded. The SEC has previously argued that the risk of market manipulation within the bitcoin markets is high due to the high concentration of the trading activity in bitcoin occurring on unregulated markets. However, in recent years, the market structure has, by all accounts, adjusted. Now, the institutional footprint in the bitcoin trading ecosystem is massive. Further, as we presented in June, the role of CME’s BTC futures in bitcoin’s price discovery has become very substantial. This could speak in favor of an ETF approval in Q4 or Q1, 2022, but the consensus seems relatively unclear on this matter at the moment.
In general, the U.S. bitcoin ETF application landscape currently consists of two different structures:
  1. “Physically” backed Bitcoin ETFs with direct bitcoin exposure (hereby called spot-based), seeking to mimic the BTC price, with an active redemption program allowing market makers to create and redeem shares at will. This dynamic should lead the ETF share price to reflect the value of the assets under management by the fund, being a more efficient alternative than close-ended funds such as the Grayscale Bitcoin Trust, seeing fluctuating premiums and discounts to its NAV. The fund maintains the custody of the funds, which is convenient for investors seeking pure exposure without going through the hassle of maintaining custody on their own.  
  2. Futures-based ETFs. These are bitcoin ETFs based on other available bitcoin investment vehicles, namely the CME BTC futures.  A majority of the filings within this category also seek to invest in ETFs with direct bitcoin exposure based in Canada or close-ended funds such as Grayscale. These ETFs will not hold direct BTC exposure, have to roll over futures, and/or invest in other funds with direct exposure.
By looking at the differences between these alternatives, it’s clear that the futures-based ETFs will be more expensive and less efficient than the spot-based. This is a result of their complicated structure requiring more maintenance. Nevertheless, the SEC has spoken more favorably of the futures-based ETFs lately, and by now, they seem to be the most likely to get approved.
Why should you care about these ETFs?
So, now you know what an ETF is, and what kinds of bitcoin ETF filings we’re dealing with at the moment. Let me briefly inform you on why you should care about these ETFs. Firstly, for the American retail saver, these ETFs may be traded through the tax-deferred or tax-exempt 401(k) plans. This allows U.S. retail savers to invest their pension savings into investments with direct bitcoin exposure. These investors currently have the opportunity to invest in other kinds of funds with bitcoin exposure through their 401(k)s, but these funds have some undesirable drawdowns. This is best exemplified with the Grayscale Bitcoin Trust (GBTC). GBTC has an unfortunate structure without an active redemption program and lock-up periods. This leads to huge divergences between the share price of the fund and the net asset value of the fund. As of writing, BTC has seen a YTD return of 48%, whereas GBTC has seen a YTD return of -8%. My position on the ETF matter is that further rejections carry more harm than good. U.S. retail investors deserve a well-structured bitcoin ETF, and their interests should be considered by the SEC. Secondly, ETFs could be very bullish for bitcoin. They will allow more institutional investors to invest in bitcoin through an easily accessible investment vehicle, following the regulated standards that they are used to. Initially, these funds could attract a lot of capital, leading to an increased buying pressure, absorbing some of the bitcoin supply. Market participants could try to front-run this, leading to volatility going into the ETF verdict dates, but now I am getting ahead of myself. I’ll add my two cents on the possible price impact of these ETFs later in this post.  
Alternatives today
There are several alternative bitcoin funds in existence today. Close-ended funds such as Grayscale, Osprey, and 3iQ (QBTC) are one of them. Other exchange-traded products, such as exchange-traded notes, are also available, mostly in Europe. Some of these ETNs are based on unsecured debt notes, while others share the same characteristics as the American ETFs and are physically backed, such as CoinShares Physical Bitcoin ETN. According to European regulation, ETFs have to be diversified and cannot be solemnly based on one underlying asset. In addition to the aforementioned funds, we’ve already seen some jurisdictions approving ETFs, with both Canada and Brazil having active bitcoin ETFs today. In sum, the bitcoin funds today hold approximately 800,000 BTC, equalling 4.2% of the circulating BTC supply, with Grayscale alone holding 650,000 BTC.
BTC Under Management by Bitcoin Funds (2020-Today)
Source: Bytetree
The Canadian bitcoin ETFs have seen a growing market share since launch. In early April, they held approximately 3% of the BTC managed by these bitcoin funds, in contrast to 6% today, proving a substantial demand for bitcoin ETFs in the market.
ETF filing overview
Here we provide a detailed overview of the current ETF application landscape. Throughout the spring, all ETF filings were spot-based (“physical bitcoin”). During this period, both Canada and Brazil approved BTC ETFs, while the U.S. picture remained unclear with several postponements of the final call.Currently, there are 12 pending spot-based ETF applications and 7 futures-based ETF applications. All the futures-based applications came en-masse following Gary Gensler's August 3rd comments (later reiterated on Sept 30th).
“Given these important protections, I look forward to the staff’s review of such filings, particularly if those are limited to these CME-traded Bitcoin futures” - Gary Gensler
ETF Timeline
We are rapidly approaching some very important dates in the bitcoin ETF landscape. Several spot-based ETF applications will receive the final SEC verdict in a couple of months, while the futures-based ETFs will get their first SEC response in October.
ETF Timeline - Important Dates
he final decision date for the spot ETFs (illustrated within the red rectangle in the chart above) is rapidly approaching. VanEck will receive the final verdict by November 14th, while the verdict for other funds follows shortly. We expect that we will see action in the market running up towards these dates.One rejection of the spot-based ETF applications doesn’t necessarily imply that all the following ETF filings will receive the same verdict. There are some hard hitters coming later, with the likes of Scaramucci’s application on Jan 16th, Fidelity’s application on Jan 20th, and ARKs application due to receive the final verdict on March 30th.  The futures-based ETFs receive their first response shortly as well. Within the next 40 days, six futures-based bitcoin ETF applications will receive the first response from the SEC. Final verdictFollowing the August 3rd quotes from Gensler, a futures-based ETF seems most likely to get approved as of now, so the ETF response bonanza in October could be an exciting period to follow.Meanwhile, more uncertainty looms surrounding the spot-based ETFs. As of now, consensus regarding these filings seems to be relatively divided. However, there are, as mentioned previously, several notable entities working hard for an ETF approval, with Fidelity recently making a push for an ETF approval in a private SEC meeting.
Possible price impact
I want to wrap up this mini-report by sharing my thoughts on the possible price impact of the ETF race. I'll provide my two cents on the super-short time horizon (pre-ETF verdict), the short-term (in a scenario where the ETFs are approved), and a long-term scenario, where the ETFs have been approved and time has passed by. By the way, this is not investment advice, do your own research, and feel free to challenge me on my thoughts on this one. 
The super-short term (pre-verdict)
The bitcoin market could be heating up shortly, caused by anticipations leading into the ETF verdicts. Traders might seek to front-run in case of approvals. This might create a spiral where market participants see that the momentum is brewing, seeking to add exposure as well. This could be a dicey period with high volatility. If the first final verdicts are negative, I would not be surprised to see turmoil in the futures market and new rounds of liquidations. A positive verdict, on the other hand, could lead to the opposite scenario. However, it could also unfold as a classic sell-the-news event, bitcoin tends to be unpredictable. Nevertheless, the ETF race could be a catalyst worth paying attention to onwards in the very short term. If I were to look into the crystal ball, I’d say we could be in for volatile and exciting days in the market. Beware, though. Narratives and stories could change quickly. 
Short-term (assuming a positive verdict)
A futures-based ETF is approved:This could lead to more constant buying pressure on CME, causing the open interest to rise. This will attract more cash and carry opportunities, leading to buying pressure in the spot market. A spot-based ETF is approved:The approval causes more spot buying pressure initially, with the ETFs attracting capital. This props up the spot markets leading to higher prices as more of the circulating BTC supply gets absorbed.  While the futures-based impact is less straightforward than the spot-based impact, both could be very bullish for bitcoin in the short-term. However, the higher costs affiliated with the futures-based instruments may be less attractive for investors, attracting less capital, leading to a smaller impact on price.The Grayscale effect?Grayscale has amassed 650,000 bitcoin, and the flagship fund GBTC is currently trading at a sharp discount. In April, Grayscale stated publicly that they intend to convert GBTC into an ETF when the time is ripe. In the short-term, investors might buy Grayscale in the secondary market, anticipating that Grayscale will follow suit on their comments on their desire to turn the now close-ended fund into an ETF, leading the Grayscale discount to narrow. As Grayscale eventually transitions to an ETF, this could lead to selling pressure, with these investors seeking to realize the profits made from buying BTC at a discount.
Long-term (assuming a positive verdict)
Once approved, and time passes by, these ETFs will become just another investment vehicle available for traders seeking exposure. As they’ve amassed capital, they could become important in bitcoin’s price discovery, but buying and selling pressure within these ETFs will then impact the broad bitcoin markets. Thus, in the long run, these ETFs should not really matter all that much. Nevertheless, the convenience of letting go of self-custody could have a sustained positive long-term impact on prices for investors currently sitting on the fence.As of now, we don’t know if any ETFs will be approved this quarter. However, it’s fair to assume we could be in for a couple of volatile news-driven months. Buckle up!
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