Guosheng Securities: What will the approval of Bitcoin spot ETF bring?

Source: Guosheng Securities

Summary

Bitcoin spot ETFs, based on Bitcoin spot as the underlying asset, are a compliant investment tool for traditional capital market investors to hold Bitcoin. Whether the spot ETF can be approved in the U.S. is the focal point of market attention. Bitcoin ETFs allow investors to gain exposure to Bitcoin and related assets without the need to research, purchase, or store actual cryptocurrencies (or derivative assets), making them very suitable for a broader capital market and investors in terms of compliance, costs, liquidity, and management expenses. Therefore, the market has been eagerly awaiting the U.S. SEC to approve Bitcoin spot ETFs as soon as possible.

Severe price volatility is one of the reasons for the SEC's caution, with a recent batch of spot ETF application deadlines set for March next year. In the past, Bitcoin spot ETFs submitted to the U.S. capital markets have been repeatedly rejected by the SEC, mainly due to insufficient investor protection in the Bitcoin market. On October 16, industry media Cointelegraph published false news on X (formerly Twitter), causing a short-term severe fluctuation in Bitcoin prices, resulting in nearly $100 million worth of cryptocurrency positions being liquidated in less than an hour. Such situations are not uncommon in the cryptocurrency market, so the SEC's concerns are not unfounded. The U.S. SEC has successively postponed decisions on Bitcoin spot ETF applications from WisdomTree, Invesco Galaxy, Valkyrie, Fidelity, VanEck, Bitwise, and BlackRock. Currently, the latest review time for the 11 major Bitcoin spot ETF applications will be concentrated in mid-October, with deadlines in March 2024. It can be said that the application for Bitcoin spot ETFs in the U.S. market has entered a peak period, and the Bitcoin halving is expected around the end of April 2024, making the approval of this spot ETF the industry's most focused topic.

Referencing the positive impact of the launch of gold ETFs on gold prices, Bitcoin spot ETFs are worth looking forward to. The launch of gold ETFs has positively impacted gold prices, which provides a positive implication for Bitcoin spot ETFs. It is important to note that the world's recognition of gold did not arise from spot ETFs, but if Bitcoin spot ETFs are approved, it would signify the recognition of Bitcoin, and even the Web 3.0 world, by the vast traditional wealth world, further accelerating the integration of the two. This is a process from 0 to 1, with marginal changes far exceeding the approval of gold ETFs. Of course, another difference is that the total number of Bitcoins is fixed at 21 million, while gold continues to have new production. The approval of Bitcoin spot ETFs in the U.S. is expected to bring in incremental funds. Galaxy Digital's calculations conclude that Bitcoin is expected to rise by 74% in the first year after the approval of the spot ETF (starting from the Bitcoin price of $26,920 on September 30, 2023); over a longer period, the potential funding scale for investing in Bitcoin products is estimated to be between $125 billion and $450 billion.

Information, fundamentals, and capital flows are expected to "resonate" next year. Looking back at the three rounds of bull and bear market transitions since Bitcoin's inception, Bitcoin halvings have always occurred at the starting point of upward trends, which is an "experience benefit" on the information level. Each round of market trends has been supported by industry innovation applications as fundamental support, and of course, the injection of incremental funds is the basis for the initiation of upward trends. Currently, the situation is as follows: Information: The fourth halving is expected at the end of April 2024; Fundamentals: Innovations driven by RWA/intention are giving rise to new industry applications, accumulating new application innovations; Capital: If Bitcoin spot ETFs are approved, it will bring significant incremental funds.

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1. Core Viewpoints

Bitcoin spot ETFs, based on Bitcoin spot as the underlying asset, are a compliant investment tool for traditional capital market investors to hold Bitcoin. Over the past decade, Bitcoin spot ETFs have been repeatedly denied in the U.S. market, but with the growth of the cryptocurrency market and the increasing recognition of crypto assets by traditional capital markets, the situation is changing. While other countries have already approved Bitcoin spot ETFs and some Bitcoin futures ETF products exist in the U.S. market, whether spot ETFs can be approved in the U.S. remains the focal point of market attention.

Looking back at the three rounds of bull and bear market transitions since Bitcoin's inception, Bitcoin halvings have always occurred at the starting point of upward trends, which is an "experience benefit" on the information level. Each round of market trends has been supported by industry innovation applications as fundamental support, and of course, the injection of incremental funds is the basis for the initiation of upward trends. Currently, the situation is as follows: Information: The fourth halving is expected at the end of April 2024; Fundamentals: Innovations driven by RWA/intention are giving rise to new industry applications, accumulating new application innovations; Capital: If Bitcoin spot ETFs are approved, it will bring significant incremental funds.

2. The Peak Period for Bitcoin Spot ETF Applications

2.1 Why Bitcoin Spot ETFs Are Important

Bitcoin spot ETFs, based on Bitcoin spot as the underlying asset, are a compliant investment tool for traditional capital market investors to hold Bitcoin. Bitcoin spot ETFs are exchange-traded funds with Bitcoin as the underlying asset, functioning as index funds. Bitcoin ETFs allow investors to gain exposure to Bitcoin and related assets without the need to research, purchase, or store actual cryptocurrencies (or derivative assets), making them very suitable for a broader capital market and investors in terms of compliance, costs, liquidity, and management expenses.

In contrast, Bitcoin futures ETFs have Bitcoin futures contracts as their underlying assets. The core difference between Bitcoin futures ETFs and spot ETFs lies in the underlying assets. From the perspective of price volatility, spot ETFs and futures ETFs are very similar, both aiming to accurately track BTC prices and help investors gain BTC exposure; typically, futures ETFs have higher fees because they also involve futures contract operations, which are more complex. Therefore, the market has been eagerly awaiting the U.S. SEC to approve Bitcoin spot ETFs as soon as possible.

According to coinglass data, as of November 5, the Bitcoin balance of the top 20 cryptocurrency exchange wallets was 1.835 million, and 40 listed companies held approximately 208,000 Bitcoins; according to Galaxy Digital's calculations, as of September 30, Bitcoin investment products (including ETPs and closed-end funds) held a total of 842,000 Bitcoins—if calculated at the price of $35,200 on the Coinbase (COIN) trading platform on November 5, the total value of these Bitcoins is approximately $29.6 billion.

Existing Bitcoin investment products face issues such as high fees, low liquidity, and tracking errors. More critically, these products also pose compliance and convenience issues for traditional investors with more substantial funds. Moreover, personally managing Bitcoin involves administrative burdens such as wallet/private key management, self-custody, and tax reporting. Therefore, Bitcoin spot ETFs will be a more ideal investment tool.

2.2 The Bumpy Road of Bitcoin ETF Applications

The earliest Bitcoin spot ETF can be traced back to 2013 when the Winklevoss twins (Cameron and Tyler) attempted to launch a BTC spot ETF. They applied several times over the years but were unsuccessful, and the plan remains shelved to this day. At that time, in 2013, Bitcoin reached the peak of its first bull market at a price of $1,163. As of November 5 this year, Bitcoin's price has exceeded $35,000. The allure of continuously rising prices is the most direct factor for the capital market's attention to Bitcoin spot ETFs. Consequently, many institutions have attempted to launch Bitcoin spot ETFs.

In the past, Bitcoin spot ETFs submitted to the U.S. capital markets have been repeatedly rejected by the SEC, mainly due to insufficient investor protection in the Bitcoin market. On October 16, local time, industry media Cointelegraph reported on X (formerly Twitter) that BlackRock's Bitcoin spot ETF product iShares had received SEC approval. This news caused Bitcoin to surge from $27,900 to $30,000, but after confirming it was false news, it adjusted back down to around $27,900, leading to nearly $100 million worth of cryptocurrency positions being liquidated in less than an hour. Such situations are not uncommon in the cryptocurrency market, so the SEC's concerns are not unfounded.

The U.S. Securities and Exchange Commission (SEC) has successively postponed decisions on Bitcoin spot ETF applications from WisdomTree, Invesco Galaxy, Valkyrie, Fidelity, VanEck, Bitwise, and BlackRock. Currently, the latest review time for the 11 major Bitcoin spot ETF applications will be concentrated in mid-October, with deadlines in March 2024. It can be said that the application for Bitcoin spot ETFs in the U.S. market has entered a peak period, and the Bitcoin halving is expected in April 2024, making the approval of this spot ETF the industry's most focused topic. Compared to ten years ago, this batch of Bitcoin spot ETF applicants includes traditional mainstream financial investment institutions like BlackRock, indicating that the entry of traditional financial institutions into Bitcoin spot ETFs has become a trend. If approved, the funds entering cryptocurrency investments are expected to be primarily traditional financial capital, which is a departure from the past.

2.3 Grayscale's Victory Over the SEC Brings Confidence to the Market

Before the approval of Bitcoin spot ETFs, Grayscale's Bitcoin and cryptocurrency trusts served as alternative products for traditional financial market investments in cryptocurrency assets. As of November 4, Grayscale has launched various cryptocurrency trusts, including BTC, ETH, and cryptocurrency market indices.

Products like GTBC allow investors to directly purchase and trade GTBC shares in the secondary market, but as a closed-end fund, there are currently no clear redemption rules. For a long time, GTBC has maintained a negative premium. To address liquidity issues, Grayscale attempted to convert GBTC into an ETF. On June 29, 2022, the SEC rejected Grayscale's application to convert its Bitcoin trust (GTBC, Grayscale Bitcoin Trust) into an ETF. After Grayscale's appeal, on October 23, 2023, the Washington D.C. Circuit Court of Appeals made a final ruling, ordering the SEC to reverse its decision to reject Grayscale's Bitcoin spot ETF application, stating that the SEC's rejection of Grayscale's attempt to convert its approximately $17 billion Grayscale Bitcoin Trust (GBTC) into a spot ETF was "arbitrary and capricious." This means the SEC must reconsider Grayscale's application to convert GBTC into a spot ETF, and while the outcome may still be a rejection, the SEC must provide new persuasive reasons. To emphasize the importance of the ETF to Grayscale, they specifically created a litigation page on their official website, presenting their lawsuit against the SEC in a timeline format, reflecting Grayscale's dedication and determination regarding Bitcoin spot ETFs.

Although Grayscale's victory in the lawsuit does not mean GBTC will immediately convert to an ETF, the market believes that Bitcoin spot ETFs are getting closer, and this victory has injected significant confidence into the market. As a result of this series of news, as of November 4, the negative premium rate of Grayscale's Bitcoin Trust has continued to narrow to 12.77%.

Grayscale's victory indicates that there are no "hard injuries" on the legal level for launching Bitcoin spot ETFs, bringing great confidence to the market. Consequently, Bitcoin spot ETF applications have entered a peak period, and market expectations are showing considerable enthusiasm.

3. What Is the Current Bitcoin ETF Market Like?

3.1 Status of Bitcoin Spot ETFs

Although the application for Bitcoin spot ETFs in the U.S. market has not been smooth, several other countries' capital markets have already approved Bitcoin spot ETFs ahead of the U.S. Notable Bitcoin spot ETFs include:

• Purpose Bitcoin ETF (BTCC) launched in February 2021, which trades on the Toronto Stock Exchange (TSX) and has been very popular;
• 3iQ CoinShares Bitcoin ETF (BTCQ) is another Bitcoin spot ETF traded on the TSX;
• QBTC 11 by QR Asset Management (QBTC 11) is the first Bitcoin ETF in Latin America, launched on the Brazilian Stock Exchange (BVMF) in June 2021. As of November 4, 2023, QBTC 11 ETF holds 727 Bitcoins.

These Bitcoin ETFs can effectively track the performance of Bitcoin spot prices, allowing holders of the ETFs to gain Bitcoin exposure. These ETFs successfully demonstrate strong investor demand. Based on the price of Bitcoin at $35,200 on the Coinbase (COIN) trading platform on November 5, Bitcoin's market capitalization of approximately $700 billion indicates that the scale of the ETFs still has significant room for growth. Although Bitcoin ETFs can already be traded in Canada, Brazil, and Europe, the U.S. market's spot Bitcoin ETF still faces regulatory hurdles and is the most anticipated product in the market.

3.2 Bitcoin Futures ETFs Are Already Ahead

As Bitcoin leads the growth of the cryptocurrency market, crypto assets are gradually entering the sight of traditional financial investment institutions. On December 18, 2017, the Chicago Mercantile Exchange (CME), one of the world's largest futures exchanges, launched Bitcoin futures contracts, and just eight days earlier (December 10, 2017), the Chicago Board Options Exchange (CBOE) launched the world's first (traditional financial market) Bitcoin futures contracts.

While there are currently no Bitcoin spot ETFs listed in the U.S., there are already some Bitcoin futures ETFs listed in the U.S. As of November 4, the total assets managed by the five major Bitcoin futures ETFs—BITO, XBTF, BTF, BITS, and DEFI—have reached $1.19 billion. Among them, BITO, issued by ProShares in October 2021, is the largest futures ETF in the statistical scope, with total assets reaching $1.08 billion. The second largest is XBTF and BTF, issued by VanEck and Valkyrie, with total scales of $58.66 million and $31.94 million, respectively.

These Bitcoin futures ETFs typically track Bitcoin futures contracts primarily from the Chicago Mercantile Exchange (CME). Among them, the largest BITO is the only futures ETF fully allocated to CME futures contracts and implements a "rolling" futures contract strategy. In addition, other futures ETFs, while allocating CME futures contracts, also allocate a certain proportion of other assets, such as XBTF and BTF allocating U.S. Treasury bonds, and BITS allocating other institutions' blockchain ETFs, etc.

Before the U.S. approves Bitcoin spot ETFs, the futures ETFs partially meet some investment institutions' demand for Bitcoin-related assets. However, the $1.19 billion scale is clearly far from meeting the market's demand compared to Bitcoin's nearly $700 billion market capitalization. Therefore, spot ETFs are receiving such market attention.

4. What Will Bitcoin Spot ETFs Bring?

U.S. Global Investors, after summarizing the experience of launching gold ETFs, believes that after the launch of gold spot ETFs in 2004, with increased liquidity and programmatic trading, gold prices rose by 420%. The experience of gold indicates that spot ETFs are indeed important, providing a reference and inspiration for the market impact after the launch of Bitcoin spot ETFs; thus, it is believed that the launch of Bitcoin spot ETFs will also open up space for related sectors to rise.

It is important to note that the world's recognition of gold did not arise from spot ETFs, but if Bitcoin spot ETFs are approved, it would signify the recognition of Bitcoin, and even the Web 3.0 world, by the vast traditional wealth world, further accelerating the integration of the two. This is a process from 0 to 1, with marginal changes far exceeding the approval of gold ETFs. Of course, another difference is that the total number of Bitcoins is fixed at 21 million, while gold continues to have new production.

The approval of Bitcoin spot ETFs in the U.S. is expected to bring in certain incremental funds. As of October 2023, the total assets managed by the U.S. wealth management market, including brokers ($27.1 trillion), banks ($11.9 trillion), and registered investment advisors ($9.3 trillion), reached $48.3 trillion. Based on this, Galaxy Digital's calculations conclude:

• Bitcoin is expected to rise by 74% in the first year after the approval of the spot ETF (starting from the Bitcoin price of $26,920 on September 30, 2023);
• Over a longer period, the potential funding scale for investing in Bitcoin products is estimated to be between $125 billion and $450 billion.

Looking back at the three rounds of bull and bear market transitions since Bitcoin's inception, Bitcoin halvings have always occurred at the starting point of upward trends, which is an "experience benefit" on the information level. Each round of market trends has been supported by industry innovation applications (including the emergence of Bitcoin competitors, initial explorations of industry applications driven by Ethereum smart contracts, and innovations brought by DeFi/metaverse, etc.) as fundamental support, and of course, the injection of incremental funds is the basis for the initiation of upward trends. Currently, the situation is as follows:

• Information: The fourth halving is expected at the end of April 2024;
• Fundamentals: Innovations driven by RWA/intention are giving rise to new industry applications, accumulating new application innovations;
• Capital: If Bitcoin spot ETFs are approved, it will bring significant incremental funds.

Therefore, we believe that from the perspective of the three-driver model, if Bitcoin spot ETFs are approved, they are expected to bring positive factors to the market.

As the SEC approaches the final approval deadline, the market is more focused on the outcome of this approval and the specific opinions regarding it. According to reports from Fox Business journalists, during meetings with ETF applicants, the SEC proposed new conditions for the approval of spot Bitcoin ETFs, including the need for ETFs to use cash for creation, etc. This indicates the continuous advancement of Bitcoin spot ETFs in the U.S. capital market, which is the most concerning topic in the cryptocurrency market at present.