LD Capital: A Summary of Key Information on BTC Spot ETF

Author: Yilan, LD Capital

1. The Bull Engine Starts

On October 13, the U.S. Securities and Exchange Commission (SEC) announced that it would not appeal a court ruling regarding Grayscale's lawsuit against its refusal to convert GBTC into a spot ETF. This ruling, which occurred in August of this year, deemed the SEC's rejection of Grayscale Investments' application to convert GBTC into a spot Bitcoin exchange-traded fund (ETF) as erroneous.

This key event ignited the current market rally (as seen in the CME positions, where CME BTC OI began to surge significantly on October 15). During this period, the favorable pause from the Fed continued to fuel the BTC market. The application timelines for Hashdex, Franklin, and Global X have arrived, and the "window period" has been postponed again to November 17, merely providing the market with a reason for adjustment. Looking at the timeline, the most critical point remains the final decision date for Ark & 21Shares' application on January 10, with market sentiment betting heavily on this date. Currently, results on whether it will be approved could come as early as next Wednesday (January 3).

2. Can the Spot ETF Be Approved Under Current Conditions?

According to market expectations for the approval of a spot ETF, Bloomberg ETF analyst James Seyffart believes that the likelihood of a Bitcoin spot ETF being approved before January 10 of next year is as high as 90%. As one of the closest insiders to the SEC, his views are widely circulated in the market.

Griffin Ardern, head of the BloFin Options Desk & Research Department, released a study on potential Authorized Participants (APs) making seed fund purchases for a spot BTC ETF that may pass in January.

Griffin's research concluded that an institution has transferred $1.649 billion to compliant exchanges like Coinbase and Kraken through the same account from October 16 to date, continuously buying BTC and a small amount of ETH. Institutions capable of making a $1.6 billion cash purchase are few in the entire crypto market. Coupled with the fact that the transfer channel is Tron rather than Ethereum, and the activity trajectory of the transfers, it is inferred that this account likely belongs to a traditional institution based in North America.

Theoretically, seed funds have no size restrictions; they only need to prove that they can provide sufficient liquidity on the trading day. Traditional seed fund purchases typically occur 2-4 weeks before the ETF issuance to reduce the position risk for APs (Authorized Participants) such as market makers or ETF issuers. However, due to the impact of the December holidays and settlements, purchases may also start earlier. Based on the above evidence, it is reasonable to speculate that the BTC spot ETF may pass in January, but this cannot be taken as definitive proof of approval.

In terms of the ETF approval process, the maximum time is 240 days, and the SEC must issue a final ruling. As the earliest applicant, Ark & 21Shares must receive a decision from the SEC by January 10, 2024. If ARK is approved, it is highly likely that several subsequent applications will also be approved.

If rejected, ARK will need to resubmit materials, theoretically restarting another 240-day application cycle. However, if any application is approved between March and April 2024 or later, ARK may also be approved earlier.

Regarding the SEC's stance, the SEC previously rejected Grayscale's proposal to convert GBTC into a Spot ETF mainly for two reasons:

First, there are concerns about cryptocurrencies being traded on unregulated platforms, making monitoring difficult, and it points out that market manipulation is a long-standing issue in the spot market. Although the SEC has approved cryptocurrency futures ETFs, these ETFs are traded on platforms regulated by U.S. financial authorities. Second, many investors in BTC spot ETFs use pensions and retirement funds for investment, which cannot bear the high volatility and risk of ETF products, potentially leading to investor losses.

However, the SEC did not appeal Grayscale's case again, and the SEC's more proactive communication during the ETF application process reflects a higher probability of approval. Recently, the SEC's official website disclosed two memoranda. One memorandum indicated that on November 20, Eastern Time, the SEC discussed proposed rule changes for the listing and trading of Grayscale's Bitcoin Trust ETF with Grayscale. On the same day, the SEC held a meeting with BlackRock, the world's largest asset management company, regarding proposed rule changes for the iShares Bitcoin Trust ETF. This memorandum included a two-page PPT created by BlackRock, showing two redemption methods for the ETFs: In-Kind Redemption Model or In-Cash Redemption Model. The In-Kind Redemption Model means that the final redemption is for the Bitcoin shares held by the ETF, while the In-Cash Redemption replaces Bitcoin shares with equivalent cash. BlackRock appears to prefer the former (currently agreeing to the In-Cash conditions). As of November 20, the SEC has held 25 meetings with various ETF applicants. This also indicates that two new conditions have been discussed in multiple meetings: 1) the ETF must use cash to create and remove all physical redemptions; 2) the SEC hopes that applicants can confirm AP (Authorized Participants) information in the next S-1 document update. If these two conditions are met before the anticipated approval date of January 10, it seems that all processes are ready. These are positive signals that the SEC's attitude may have changed.

From a multi-party perspective, the approval of the Spot BTC ETF is a battle of interests between a Democrat-majority SEC, CFTC, asset management giants like BlackRock, and significant lobbying forces in the industry like Coinbase.

Coinbase is widely regarded as the custodian for most asset management companies, which is beneficial for its revenue growth. However, the actual custody fees (generally ranging from 0.05% to 0.25%) and the new international perpetual trading revenue, as well as the new scale trading revenue from spot, are not significantly impactful. Nevertheless, Coinbase remains one of the biggest beneficiaries in the industry if the spot BTC ETF is approved and has become a major lobbying force in the U.S. crypto industry following the collapse of FTX.

BlackRock has launched a cryptocurrency-related stock fund, the iShares Blockchain and Tech ETF (IBLC). However, despite being launched for over a year, its asset size is less than $10 million. BlackRock also has sufficient motivation to push for the approval of the spot BTC ETF.

Moreover, traditional asset management giants like BlackRock, Fidelity, and Invesco play a unique role in government regulation. BlackRock, as the world's largest asset management company, currently manages approximately $9 trillion in assets. BlackRock has maintained close contact with the U.S. government and the Federal Reserve. American investors are eagerly awaiting the legal ability to hold Bitcoin and other crypto assets to combat the inflation risks of fiat currency. Institutions like BlackRock have fully recognized this and are using their political influence to pressure the SEC.

In the political game of the 2024 election, cryptocurrencies and artificial intelligence have become hot topics.

The Democratic Party, Biden, the White House, and the current regulatory agencies appointed by the president (SEC, FDIC, Fed) seem largely opposed to cryptocurrencies. However, many young congressional members within the Democratic Party support cryptocurrencies, as do many of their constituents. Therefore, there may be a chance for a turnaround.

Republican presidential candidates are more likely to support crypto innovation. Republican leader Ron DeSantis has stated that he will ban CBDCs and support innovations related to Bitcoin and crypto technology. As governor, DeSantis made Florida one of the most crypto-friendly regions in the U.S.

Trump has previously made negative comments about Bitcoin, but he also launched an NFT project last year. Moreover, his main supporting states, Florida and Texas, largely support the crypto industry.

The greatest uncertainty comes from the Democratic SEC leader Gary Gensler. Gensler believes that, aside from Bitcoin, most tokens traded on Coinbase are illegal. Under Gensler's leadership, the SEC has taken a tough stance on crypto. Coinbase is currently facing an SEC lawsuit regarding its core business practices. Binance is facing a similar lawsuit and is defending itself in court. In the worst-case scenario, regulatory crackdowns could reduce Coinbase's revenue by more than a third, according to Berenberg Capital Markets analyst Mark Palmer. "There is almost no hope of changing the stance of most SEC commissioners in the short term."

What Coinbase and other companies hope for is not to wait for a court ruling but for Congress to strip crypto from securities regulations. Executives from companies like Coinbase have been pushing for legislation to limit the SEC's regulatory power over tokens and establish rules for "stablecoins" (such as the USDC digital dollar token held by Coinbase).

Crypto companies are also trying to defend themselves—lobbying against bills that require them to comply with anti-money laundering requirements, which executives say are expensive or impossible to comply with in a decentralized world based on blockchain assets and transactions. However, with each instance of ransomware attacks or terrorist attacks utilizing token-based fundraising, their task becomes more challenging. Before and after the attacks on Israel, organizations linked to Hamas issued requests for crypto donations.

Several bills are making progress toward this goal. For example, the House Financial Services Committee has passed a bill supported by Coinbase regarding crypto market structure and stablecoins, paving the way for a vote in the full House. However, there are no signs that Senate Democrats will introduce this bill, or whether President Joe Biden will sign a crypto bill.

Given that this year's spending bill may be a major priority for Congress, and Congress will enter election mode in 2024, controversial crypto bills may struggle to make progress for some time.

The collapse of FTX was a setback, but some in Congress recognize that crypto is inevitable, said Kristin Smith, CEO of the Blockchain Association. For now, the industry may have to be content with Bitcoin exchange-traded funds, while its lobbying army continues to work towards pushing legislation across the finish line next year.

According to a recent study by Grayscale, 52% of Americans (including 59% of Democrats and 51% of Republicans) agree that cryptocurrencies are the future of finance; 44% of respondents indicated they would like to invest in crypto assets in the future.

For the SEC, the most important reason for opposition and the ongoing conflict with cryptocurrencies remains the inherent manipulability of BTC, which cannot be fundamentally resolved. However, we will soon know whether the SEC will approve the BTC spot ETF under the pressure of various competing forces.

3. Spot BTC ETF & BTC Price Impact Sensitivity Analysis

Although the U.S. has not yet launched an ETF directly related to spot Bitcoin, investors have already participated in the Bitcoin market through existing product structures. The total assets under management of these products have reached over $30 billion, with approximately 95% invested in products related to spot Bitcoin.

Before the emergence of a U.S. spot BTC ETF, investment methods and product structures for BTC include trusts (such as Grayscale Bitcoin Trust GBTC), BTC futures ETFs, spot ETFs already launched outside the U.S. (such as in Europe and Canada), and other private funds configured with BTC. The AUM of GBTC alone has reached $23.4 billion, the largest BTC futures ETF BITO has an AUM of $1.37 billion, and Canada's largest spot BTC ETF BTCC has an AUM of $320 million. The configuration of BTC in other private funds is not transparent, and the actual total may far exceed $30 billion.

Compared to existing alternative investment product structures, spot ETFs have lower tracking errors than trusts/closed-end funds (CEFs) (the returns of BITO, BTF, and XBTF lag behind the spot Bitcoin price by 7%-10% annually), better liquidity than private funds, and potentially lower management fee costs (compared to GBTC), for example, Ark has set the fee rate at 0.9% in its application documents.

Potential Capital Inflows

• Existing Demand
• It is foreseeable that, unless the fee structure of GBTC undergoes significant improvement, a large portion of GBTC's AUM will experience outflows, but this will be compensated by new ETF demand. Assuming that 1% of the current $58.44 trillion in wealth management AUM flows into BTC, with 5% flowing in the first year, this would bring about $29 billion in existing wealth management capital inflow. Assuming that 10% of the funds enter on the first day, this could create a buying pressure of $2.9 billion (10% * $29 billion). This capital inflow, combined with the pressure points for BTC's rise, indicates that on October 13, BTC's market capitalization was $557 billion (BTC price = $26,500). Starting from October 13, considering the capital inflow from the spot ETF without accounting for other factors, the target price for BTC would be $53,000 (mainly considering the pressure points for the rise; the impact of the capital inflow factor on price changes is difficult to predict due to the dynamic changes in market trading volume). However, due to the complexity of market sentiment, it is very likely that there will be a situation where prices rise and then fall.

Comparing with the $209 billion AUM of gold ETFs, the total market capitalization of BTC is one-tenth that of gold. Therefore, if the BTC spot ETF AUM can reach 10% of the Gold ETF's $209 million AUM, i.e., $20.9 billion, then assuming that in the first year, 1/10 * $20.9 billion flows in (the first year after the gold ETF's approval retains about 1/10 of the total AUM, AUM gradually accumulates, with the second year's AUM being 1.2 times that of the first year, experiencing the largest inflow in the 6th-7th year, after which AUM begins to decrease. The remaining buying pressure will be realized over several years), this would bring about $2.1 billion in net inflow in the first year.

Thus, if we compare with SPDR Gold (an ETF issued by State Street Global Advisors, the largest and most popular one), we see that SPDR's AUM is $57 billion. Assuming the BTC spot ETF AUM can reach 10%-100% of SPDR's $57 billion AUM, i.e., $5.7 billion-$57 billion (assuming 1/10 * $5.4 billion = $540 million-$5.4 billion in capital inflow in the first year, the first year after the gold ETF's approval retains about 1/10 of the total AUM, AUM gradually accumulates, with the second year's AUM being 1.2 times that of the first year, experiencing the largest inflow in the 6th-7th year, after which AUM begins to decrease. The remaining buying pressure will be realized over several years), the estimated capital inflow of $540 million to $5.4 billion in the first year derived from the gold SPDR is a very conservative estimate.

Using a very conservative approach by comparing with gold and estimating that 1% of the $58.44 trillion in wealth management AUM flows into BTC, it is expected that the capital inflow in the first year after the approval of the BTC spot ETF will be around $5.4 billion to $29 billion.

• New Demand
• Considering the new adoption from the retail side, the proportion of BTC holdings in the U.S. has been 5%, 7%, 8%, 15%, and 16% from 2019 to 2023, ranking 21st among all countries. The approval of the spot BTC ETF is likely to further increase this proportion. Assuming this proportion rises to 20%, adding 13.2 million retail customers, with an average household income of $120,000, and assuming an average holding of $1,000 in BTC, this would generate $13 billion in new demand.

4. Conclusion

As more and more investors begin to appreciate Bitcoin as a store of value or digital gold, combined with the increasing certainty of ETF launches, the approaching halving, and the cumulative effects of the Federal Reserve halting interest rate hikes, it is highly likely that BTC's price will be pushed to $53,000 in the first half of next year.

In contrast, the approval of the Ethereum spot ETF, combined with the 240-day application process for the BTC spot ETF and the existing securities classification disputes regarding Ethereum compared to BTC, will likely occur much later than the approval of the BTC spot ETF. Therefore, it may be when Gensler is replaced by a more crypto-friendly leader that Ethereum will see its own ETF market.

Note: This article aims to summarize events and data related to the BTC spot ETF; price predictions are based on premises and do not constitute investment advice.

Reference:

[1]"ETF on the verge: dozens of meetings with the SEC lead to the last two conditions before approval, 2023-12-24, jk, Odaily."

[2] https://www.galaxy.com/insights/research/sizing-the-market-for-a-bitcoin-etf/

[3] https://www.panewslab.com/zh/articledetails/u197e68t.html