September 2023

The Bitcoin Spot ETF

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One of the prominent narratives in crypto today surrounds the potential approval of a spot ETF in the US. 20 ETF applications are pending SEC approval, including applications from the largest institutional investors in the world, such as BlackRock, Fidelity, Franklin Templeton and VanEck.

While the SEC has been delaying a decision, the regulator will be forced to arrive at a conclusion in the coming months. While there is no certainty around timing, we are confident that a bitcoin spot ETF will be approved. This will lead to short term trading volatility (euphoria followed by profit taking) and long-term bitcoin demand. This month we will dig into the status surrounding the ETF applications and why we have conviction in approval being granted. We will also explain the potential impact of a spot ETF on the market for bitcoin and more broadly for digital assets.

ETF stands for “exchange traded fund” and is a type of pooled investment security that operates like a mutual fund. ETFs track the price of a specific commodity, sector or index and can be bought and sold on a stock exchange in the way that regular stocks are traded. The way that spot ETFs track prices is by purchasing and holding the underlying asset or assets that the ETF is tracking. In the case of bitcoin, the importance of a spot ETF is that the fund would need to hold BTC as the underlying asset. As investors choose to buy into a bitcoin spot ETF, real BTC will need to be bought by the fund and when investors sell the spot ETF, this BTC will be sold by the fund.

There are two reasons why crypto investors are excited by the prospect of a bitcoin spot ETF. Firstly, it will allow all existing investors in the US (institutional and retail) to easily get direct exposure to bitcoin. This may unlock latent demand for BTC as investors have been waiting on the sidelines for a spot ETF to be available. Secondly, there is only around 1.8m spot BTC available to be bought on exchanges. As spot bitcoin ETFs go live, there will be substantial demand to purchase the BTC for the ETF. If existing bitcoin holders choose not to move their BTC to exchanges to sell, then there will be significant upward pressure on the bitcoin price as ETFs buy up the bitcoin on the market.

A spot bitcoin ETF has been in the works for some time. Back in July 2013, over 10 years ago, Cameron and Tyler Winklevoss submitted the first filing for a bitcoin ETF, called the Winklevoss Bitcoin Trust. Not for the first time the twins were extremely early to the uptake of a new technology and at the time of their application, the price of BTC was only USD 90. This application was rejected by the SEC twice amid concerns about the risky nature of the nascent crypto market. Following the Winklevoss’ application there have been a dozen more proposed and rejected bitcoin ETFs. In August 2018, the SEC rejected 9 proposed ETF applications in one day. These rejections all cited issues with inadequate investor protections, related to concerns surrounding custody and the small size of the market.

In August 2021 Gary Gensler, the then-newly installed chair of the SEC, delivered a speech in which he said, “I look forward to the staff’s review of such [bitcoin ETF] filings, particularly if those are limited to these CME-traded bitcoin futures.” This led to a flurry of applications for bitcoin futures ETFs and the approval and listing of a bitcoin futures ETF in October 2021. This ETF, the ProShares Bitcoin Strategy ETF (BITO), accumulated USD1bn in assets in just two days, faster than any ETF before it, highlighting the latent demand for such a product.

A futures ETF differs from a spot ETF. In a futures ETF, futures contracts are held by the fund and not the underlying asset. In the case of bitcoin, the futures ETF does not provide direct exposure to bitcoin the asset but rather is a derivative product that looks to track the price of BTC. The risk here is that the futures product may fail to perfectly match the price of bitcoin, something that is unlikely to happen with a fund that just holds BTC. In addition, futures-based ETFs generally have higher fees than spot products. For these reasons, a spot bitcoin ETF represents more direct exposure to bitcoin and is likely to have stronger investor demand than an ETF that holds cash-settled bitcoin futures. As discussed above, a spot ETF will also result in a greater impact on the price of BTC as the limited BTC on exchanges will need to be bought to back the ETF. This is not the case in the futures ETF, where futures contracts are bought instead of bitcoin itself.

Today there are 20 outstanding applications for spot bitcoin ETFs, including from BlackRock, Fidelity, Franklin Templeton, VanEck and Galaxy Digital. When it comes to its track record of having ETFs approved, with 575 submissions and only one rejection, it is tough to overlook BlackRock’s almost perfect record of successful applications. The one rejection was in 2014 and was for a novel type of ETF that looked to keep asset holdings within the ETF a secret for months at a time. The SEC took issue with the proposal over concern for the ability of market makers to be able to arbitrage the proposed non-transparent ETF. This was an exceptional case for an unusually designed ETF. While bitcoin is unique as an asset class, the spot ETF applications are not unusual in their design.

Simply by having applications from heavy-weight institutions like BlackRock and Fidelity, it seems highly likely that approval by the SEC is imminent. On top of this is the recent legal victory by Grayscale in its case against the SEC. In late August, a court ruled in favour of Grayscale as it continues to try and convert its GBTC product into an ETF. While this ruling does not amount to an approval itself, it weakens the SEC’s case in prohibiting spot ETFs. This case ruled that the SEC’s rationale for preventing the conversion was not valid. The SEC must now either accept the Grayscale conversion or come up with new reasons as to why a bitcoin ETF should be prevented.

Whether it happens this year or next year, a spot bitcoin ETF is looking increasingly likely to be approved. This will impact the demand for BTC and will likely push prices higher as ETFs become large buyers and long-term holders of bitcoin. But the ramifications of a spot bitcoin ETF go beyond Bitcoin. In the wake of the current wave of bitcoin ETF filings, we are now seeing filings start for a spot ether ETF. It will be challenging for the SEC to approve an ETF for bitcoin, but reject applications for ETH, SOL and other leading crypto assets. This is the start of the legitimization of crypto assets and their introduction into traditional financial markets. The approval of a spot bitcoin ETF is more than just an approval for Bitcoin. It is the approval of crypto as an asset class by the financial system.