The Truth About Bitcoin ETF Approval: Thought-Provoking!

Author: Arthur Hayes

(The views expressed here are solely those of the author and should not be taken as investment advice or recommendations for participating in investment transactions.)

From a healthcare perspective, the last moments of life are the most expensive. We are willing to spend unlimited amounts of money to purchase any treatment advertised to prevent the inevitable. Similarly, the elites who govern the peace under American rule and their followers are also willing to maintain the current world order at all costs, as they benefit the most from this existing order. However, since 2008, the illegal mortgages issued to impoverished Americans have triggered a global economic crisis, severe enough to rival the Great Depression of the 1930s. What prescription did the medieval new Keynesian barber, blindly led by Ben Bernanke, prescribe? It was the same simple remedy given to a dying empire… just print more money.

The empire, along with its European, Chinese, and vassal Japan, strategic competitors, and allies, is printing money to address different symptoms of the same problem. The issue lies in the severely imbalanced global economic and political structure. The United States, led by the Federal Reserve (Fed), prints money and buys U.S. government bonds and mortgages. Europe, led by the European Central Bank (ECB), prints money and buys government bonds from Eurozone member states to maintain the currently flawed monetary union (rather than a fiscal union). China, led by the People's Bank of China, demands that the banking system lend to industrial enterprises for building apartments, steel mills, and other large infrastructure projects. Japan, led by the Bank of Japan (BOJ), continues to print money in an attempt to create the illusory inflation that disappeared after the 1989 real estate crash.

The result of reckless money printing is an accelerated rise in the global debt-to-GDP ratio. Global interest rates have reached their lowest levels in 5,000 years. Nearly $20 trillion in corporate and government bonds experienced negative yields at their peak. Since interest is compensation for the time value of money, can we say that time has no value if interest is negative?

Thanks to Danielle DiMartino Booth of Quill Intelligence for this chart.

As you can see, interest rates fell to their lowest levels in 5,000 years after the outbreak of the 2008 global financial crisis (GFC).

This is the Bloomberg index of the total amount of global negative-yielding debt. From being nonexistent before the 2008 global financial crisis, it reached a peak of $17.76 trillion in 2020. This was due to global central banks lowering interest rates to 0% or below.

Most people in the world do not have enough financial assets to benefit from the devaluation of global fiat currencies. Inflation of various commodities is springing up everywhere. Do you remember the Arab Spring of 2011? Do you remember that in major financial centers around the world, an avocado toast cost less than $20? Do you remember that a middle-income family could afford a moderately priced home without relying on parental bank account handouts?

The only way out is to own a little gold. But owning gold is impractical. It is heavy and difficult to hide in large quantities from greedy governments. The result is that people can only eat their "humble pie," while the elites continue to revel in Davos, Switzerland, just like in 2007.

But just like a lotus blooming in a cesspool, Satoshi Nakamoto published the Bitcoin white paper at a time when the empire was morally, politically, and economically bankrupt. The white paper proposed a peer-to-peer system where people could use networked machines and cryptographic proof to separate money from the state in a globally scalable way for the first time in human history. I say "globally scalable" because Bitcoin has no weight. Whether you hold 1 satoshi or 1 million bitcoins, the weight is the same.

Moreover, you can protect your bitcoins by remembering the mnemonic phrase to unlock your Bitcoin wallet. Bitcoin provides a complete financial system for everyone, as long as you have a device connected to the internet, allowing you to operate independently of ancient regimes.

People finally found a way to escape the global fiat currency devaluation frenzy. However, Bitcoin was still too immature to provide a reliable escape valve for loyal believers after the 2008 financial crisis. Bitcoin and the entire cryptocurrency market must increase their user base and prove they can withstand severe crises.

We loyal believers endured a severe test in 2022. The Fed and most global central banks embarked on a journey to tighten financial conditions at the fastest pace since the 1980s. The U.S. banking system and debt markets could not withstand the Fed's shock. In March 2023, three U.S. banks (Silvergate, Silicon Valley Bank, and Signature Bank) collapsed in succession within two weeks. If we calculate the market value of their holdings of U.S. Treasuries and mortgage-backed securities, the U.S. banking system has been insolvent both in the past and present. Therefore, as a covert way to save the entire U.S. banking system, U.S. Treasury Secretary Janet Yellen (Bad Gurl Yellen) devised the Bank Term Funding Program (BTFP).

Cryptocurrencies also did not escape the disruption caused by high and rising interest rates. With loans being issued to over-leveraged trading firms like Three Arrows Capital, centralized lending institutions like BlockFi, Celsius, and Genesis went bankrupt. The stablecoin Terra Luna, pegged to the dollar, also went bankrupt due to the price drop of the governance token Luna that supported the issuance of the UST stablecoin. This event wiped out over $40 billion in just two days. Subsequently, centralized exchanges began to collapse, with FTX being the largest. FTX, run by the "right" American white boy Sam Bankman-Fried, who stole over $10 billion of customer funds, saw his scam exposed as cryptocurrency asset prices plummeted.

What happened to Bitcoin, Ethereum, and DeFi projects like Uniswap, Compound, Aave, GMX, and dYdX? Were they on the verge of collapse? Did they call home for a bailout from the central bank of cryptocurrencies? Absolutely not. Over-leveraged positions were liquidated. Prices fell. People suffered heavy losses. Centralized companies disappeared. But Bitcoin still produced a block on average every 10 minutes. The DeFi platforms themselves did not go bankrupt. In short, there were no bailouts because cryptocurrencies cannot be bailed out. We took a hit but continued to move forward.

In 2023, the American peace and its followers emerging from the ashes clearly could not continue to tighten monetary policy. Doing so would bankrupt the entire system due to excessive leverage and debt accumulation. As U.S. long-term Treasury yields began to rise in a stair-step manner, something strange happened. Bitcoin and cryptocurrencies rebounded while bond prices fell.

Bitcoin (white) vs. U.S. 10-Year Treasury Yield (yellow)

As shown in the above chart, when interest rates rise, Bitcoin performs like all other long-term assets… it falls.
After the BTFP, this relationship changed. Bitcoin and yields rose simultaneously. The rising yields, especially those rising in a bear market stair-step manner, indicate that investors do not trust the "financial system." In response, they are selling the safest government bonds in the empire—U.S. Treasuries. These funds are primarily flowing into the seven major AI tech stocks (Apple, Alphabet, Microsoft, Amazon, Meta, Tesla, Nvidia) and a small amount into cryptocurrencies. After nearly 15 years, Bitcoin finally shows its true nature as "the people's currency," rather than just another risk asset derivative of the empire. This presents a very tricky problem for TradFi.

Capital must remain in the system to eliminate a large amount of non-productive debt through inflation. Bitcoin exists outside the system and is now zero or even slightly negatively correlated with bonds (remember, when yields rise, bond prices fall). If bond vigilantes express their dissatisfaction with government bonds by selling them and buying Bitcoin and other cryptocurrencies, the global financial system will collapse. The reason for the collapse of the financial system is that people finally recognize the inherent losses of the financial system, and large financial companies and governments will have to significantly downsize.

To avoid this liquidation, the elites must financialize Bitcoin by creating highly liquid exchange-traded funds (ETFs). This is akin to the tricks they played in the gold market when the U.S. Securities and Exchange Commission (SEC) approved ETFs like SPDR GLD in 2004, which supposedly stored gold bars in vaults around the world. If all the capital hoping to escape the collapse of the global government bond market buys Bitcoin ETFs managed by large TradFi companies like BlackRock, then that capital can still safely remain in the system.

Clearly, to protect the global bond market, the Fed and all other major central banks must turn to printing money again, which is why BlackRock officially applied for a Bitcoin ETF in June 2023. BlackRock is one of many companies hoping to gain approval for a spot Bitcoin ETF in the U.S. However, in 2023, the SEC seems to have finally accepted this application. I introduce the following to highlight the strangeness of the events surrounding the ETF approval process. The Winklevoss twins applied for a spot Bitcoin ETF in 2013, and the SEC rejected their application for over a decade. BlackRock submitted its application and received approval within six months. Makes you go "hmm."

As I wrote in my previous article "Expression," a spot Bitcoin ETF is a trading product. You buy it with fiat currency to earn more fiat currency. It is not Bitcoin. It is not a path to financial freedom. It does not exist outside the TradFi system. If you want to escape, you must buy Bitcoin, withdraw it from the exchange, and self-custody.

I wrote this lengthy preface to explain "Why now?" Why will the spot Bitcoin ETF finally be approved at this critical moment for the empire and the financial system? I hope you understand the seriousness of this development. The global bond market is estimated to be $133 trillion; imagine if bond prices continue to fall, even if the Fed might start cutting rates in March, the inflow into Bitcoin ETFs could be substantial. If inflation bottoms out and continues to rise, bond prices may continue to fall. Remember, wars lead to inflation, and the empire's periphery is undoubtedly in a state of war.
Moreover, don't forget that China will launch products identical to U.S.-listed ETFs in the Hong Kong financial market to capture funds from China and the Asia-Pacific region. The peace under American rule leads, and its friends and foes will follow closely.

The remainder of this article will discuss the market impact of the spot Bitcoin ETF. I will focus solely on the BlackRock ETF because BlackRock is the largest asset management company in the world. They have the best ETF distribution platform globally. They can sell products to family offices, retail financial advisory firms, retirement and pension plans, sovereign wealth funds, and even central banks. All other companies will try their best, but in terms of asset management, the BlackRock ETF will undoubtedly be the winner. Regardless of whether this prediction is correct, if any issuer's ETF is substantial, the following strategies will work.

This article will discuss the following, and how the internal workings of the ETF will create amazing trading opportunities for those who can trade in both TradFi and cryptocurrency markets:

- Creation and redemption process

- Spot trading arbitrage and time series analysis

- Listed options and other ETF derivatives

- Impact of ETF financing trades

Having said all that, let's make some money!

Cash rules everything around me

It has been settled. The inflow (creation) and outflow (redemption) of funds can only be done using cash. The most concerning aspect of this ETF is that it allows the public to purchase the ETF with fiat currency and choose to redeem the ETF with Bitcoin. The significance of this product lies in providing a position for fiat currency, rather than offering a simple way to purchase physical Bitcoin with retirement accounts.

Creation

To create shares of the ETF, authorized participants (APs) must send the fund the dollar value of the creation basket, which is a certain number of ETF shares, before a certain time each day.
Authorized participants are large TradFi trading firms. Celebrities among the TradFi bloodsucking creatures have signed on to be APs for various ETF issuances. Companies like JPMorgan, whose CEO Jamie Dimon has called for the government to ban cryptocurrencies, will also participate. This surprises me ;)

For example:

Each ETF share is worth 0.001 BTC. The creation basket is 10,000 shares; at 4 PM EST, these bitcoins are worth $1,000,000. The AP must wire this money to the fund. Then, the fund will instruct its counterparties to purchase 10 bitcoins. Once the bitcoins are purchased, the fund will credit the ETF shares to the AP's account.

1 basket = 0.001 BTC * 10,000 shares = 10 BTC

0 BTC * 100,000 BTC/USD = $1,000,000

Redemption

To redeem ETF units, the AP must send the ETF shares to the fund before 4 PM EST. Then, the fund will instruct its counterparties to sell 10 bitcoins. Once the bitcoins are sold, the fund will deposit $1,000,000 into the AP's account.

1 basket = 0.001 BTC * 10,000 shares = 10 BTC

10 BTC * 100,000 BTC/USD = $1,000,000

For us traders, what we want to know is where Bitcoin must be traded. Of course, the counterparties helping the fund buy and sell Bitcoin can trade wherever they like, but to minimize slippage, they must match the fund's net asset value (NAV).

The fund's NAV is based on the price of BTC/USD at 4 PM EST on the CF benchmark. The CF benchmark accepts prices from Bitstamp, Coinbase, itBit, Kraken, Gemini, and LMAX between 3-4 PM EST. Any trader wishing to perfectly match the NAV by taking on minimal execution risk can trade directly on all these exchanges.

Bitcoin is a global market, and price discovery mainly occurs on Binance (I guess headquartered in Abu Dhabi). Another major Asian exchange excluded from the CF benchmark is OKX. For a long time, the Bitcoin market will see predictable long-term arbitrage opportunities. I hope billions of dollars of flow can concentrate in exchanges with lower liquidity, which follow the price of larger Eastern competitors within an hour. I expect there will be a lot of spot arbitrage opportunities.

Clearly, if the ETF is a huge success, price discovery will shift from the East to the West. But don't forget about Hong Kong and its copycat ETF products. Hong Kong only allows its listed ETFs to trade on regulated exchanges in Hong Kong. Binance and OKX may service this market. But new exchanges will emerge to provide services for southbound liquidity from China.

Regardless of the situation in New York and Hong Kong, neither city will allow fund managers to trade Bitcoin at the best price; they can only trade on "specific" exchanges. This unnatural state will only create more market inefficiencies, from which we as arbitrageurs can profit.

Here’s a simple arbitrage example:

Average Daily Volume (ADV) = (Exchange CF benchmark weight * Daily Closing Price (MOC) nominal value in USD) / CF benchmark exchange's USD ADV

Choose the least liquid exchange in the CF (Contract for Difference) benchmark, which has the highest ADV days. If pressure is on the buy side, the Bitcoin price on the CF benchmark exchange will be higher than on Binance. If pressure is on the sell side, the Bitcoin price on the CF benchmark exchange will be lower than on Binance. Then, you sell Bitcoin on the expensive exchange and buy Bitcoin on the cheap exchange. You can estimate the direction of the creation/redemption process by trading the ETF at a premium or discount relative to its intraday NAV (INAV). If the ETF is at a premium, the creation process will occur. The AP shorts the ETF at a high price and creates the ETF at a lower NAV. If the ETF is at a discount, the redemption process will occur. The AP buys the ETF at a low price in the secondary market and redeems it at a higher NAV.

To conduct this trade in a price-neutral manner, you need to trade USD and Bitcoin on the CF benchmark exchange and Binance. However, as a risk-neutral arbitrage trader, your Bitcoin needs to be hedged. To do this, buy Bitcoin with USD and short the BitMEX Bitcoin/USD Bitcoin margin inverse perpetual swap contract. Deposit some Bitcoin as margin on BitMEX, while the remaining Bitcoin can be spread across relevant exchanges.

ETF Options

To truly casino-ize the ETF, we need leveraged derivatives. The zero-day-to-expiration (0DTE) options market in the U.S. has seen explosive growth. Options expiring in one day are like lottery tickets, especially when purchased out of the money (OTM). 0DTE options are now the most traded options instrument in the U.S. Uh, Mofos love to gamble.

After the ETF has been listed for a while, listed options will begin to appear on U.S. exchanges. Now, the real fun begins.

It is hard to get 100x leverage in TradFi. They don't have places like BitMEX that can solve the problem. However, the premiums on OTM options with shorter expiration dates are low, which creates high asset-liability ratios or leverage. To understand why, learn about theoretical options pricing theories like Black-Scholes.

Degen traders with brokerage accounts that can trade options on U.S. exchanges now have a liquid way to make high-leverage bets on Bitcoin prices. The underlying asset of these options will be the ETF.

Here’s a simple example.

ETF = 0.001 BTC per share

Bitcoin/USD = $100,000

ETF share price = $100

You think Bitcoin's price will rise by 25% by the end of this week, so you buy a call option with a strike price of $125. This option is OTM because the current ETF price is 25% lower than the current strike price. The volatility is high but not extremely high, so the option premium is relatively low, only $1. You can only lose $1 at most, and if the option quickly becomes profitable (above $125), the money you earn from the change in the option premium will far exceed the 25% you would earn from trading the ETF shares themselves. This is a very rough way to explain asset-liability ratios.

The degenerates in the U.S. capital markets are a serious bunch. With these new high-leverage ETF options products, they will mess up some things regarding Bitcoin's implied volatility and forward structure.

Forward Arbitrage

Call-Put = Long Forward

As the prices of ETF options are driven up by lottery ticket buyers, the at-the-money (ATM) forward prices will also rise. This creates an opportunity for arbitrage between the ATM forward options derived from Bitcoin/USD options and ETF options on exchanges like BitMEX.

Futures Basis = Futures Price - Spot Price

I expect the trading price of the ETF ATM forward basis to be higher than the BitMEX futures basis. Here’s how to trade it.

Sell ATM call options, buy ATM put options, and short ETF ATM forward options.

Go long on BitMEX Bitcoin/USD fixed expiration futures contracts (with similar expiration dates).

Wait for prices to converge as expiration approaches. This will not be a perfect arbitrage because BitMEX and the ETF use different exchange prices to construct the Bitcoin spot index price.

Volatility Arbitrage

To a large extent, when you trade options, you are trading volatility. The types of ETF options traders and their preferences for expiration dates and strike prices differ from those trading Bitcoin options on non-U.S. exchanges. I predict that ETF options trading volume will dominate the global liquidity of Bitcoin options. Because domestic and non-domestic traders cannot interact on the same exchange, arbitrage opportunities will arise.

When options with the same expiration date and strike price trade at different prices, direct arbitrage opportunities arise. When the implied volatility surface of ETF options significantly differs from the implied volatility surface of Bitcoin options outside the U.S., more general volatility arbitrage opportunities will also arise. Discovering and exploiting these opportunities will require more trading skills, but I know many French people will be licking their lips, eager to make big money from these markets.

MOC Flow

As the ETF will lead to a surge in trading volume for ETF derivatives listed in the U.S., the CF benchmark index at 4 PM will become very important. The value of derivatives comes from the underlying asset. Since the nominal value of options and futures expiring daily can differ by billions of dollars from the ETF's closing trading price, it is crucial to match it with the NAV.

This will create statistically significant trading behavior around 4 PM EST and other time periods throughout the trading day. Those who are good at leveraging datasets and have excellent trading bots will earn huge profits by arbitraging these market inefficiencies.

ETF Financing (Creation Lending)

Centralized lending platforms like BlockFi, Celsius, and Genesis are popular among Bitcoin players who want to borrow against their Bitcoin collateral. Unfortunately, the dream of an end-to-end Bitcoin economy has not yet been realized. Believers still need to use dirty fiat currency to pay for necessities.

All the centralized lending institutions I just mentioned, along with many others, have collapsed. Borrowing against Bitcoin collateral has become more difficult and costly. TradFi is very accustomed to lending against liquid ETFs as collateral. Now, as long as you pledge Bitcoin ETF shares, you can obtain competitively priced large fiat loans. For those who believe in financial freedom, the question is how to maintain control over their Bitcoin while utilizing this cheaper capital.

The solution to this problem is to exchange Bitcoin for ETFs. Here’s how it works.

APs that can borrow in the interbank market will create ETF shares to hedge Bitcoin/USD price risk. This is the "creation-lending" business. In Delta-one terms, it is the repurchase value of ETF shares.

The specific process is as follows:

Borrow USD in the interbank market and cash out the created ETF shares.

Sell ATM call options on the ETF, buy ATM put options to create a short synthetic forward.

Since the forward basis > interbank USD exchange rate, the act of creating ETF units will generate a positive spread.

Lend out ETF shares in exchange for Bitcoin collateral.

Let’s have Chad talk about how he needs to handle his Bitcoin.

Chad is a person with 10 BTC who needs to pay his AMEX bill in USD. The bubbly wine at the club is outrageously expensive. Chad turns to his friend Jerome, a crafty Frenchman working at SocGen, who used to be a puppet in a major financial middle office and served time for aggressive futures trading but later got his job back (you can’t fire anyone in France), and is now managing a cryptocurrency trading platform. Chad asks Jerome for a swap between BTC and ETF over 30 days. Jerome quotes him -0.1%. This means Chad will exchange 10 BTC for 10,000 ETF shares, assuming each share is worth 0.001 BTC, and after 30 days, Chad will get back 9.99 BTC.

During these 30 days, while Chad holds 10,000 ETF shares instead of 10 BTC, he will pledge the ETF shares to borrow USD from TradFi brokers at a very low rate.

Everyone is happy. Chad can continue to be a star at the club without selling his Bitcoin. Jerome earns the financing spread.

ETF financing will become extremely important and will impact Bitcoin's interest rates. As the market develops, I will focus on attractive ETF, physical Bitcoin, and Bitcoin derivatives financing trades.

Your size is my size

For these trading opportunities to last a long time and for arbitrageurs to have enough scale to execute, the Bitcoin spot ETF complex must trade shares worth billions of dollars daily. On Friday, January 12, the total daily trading volume reached $3.1 billion. This is very encouraging, and as various fund management companies begin to activate their vast global distribution networks, trading volume will only increase. With a way to trade financial Bitcoin within the TradFi system, fund managers can escape the poor returns from bonds in a global inflationary environment.

We are in the early stages of transitioning to sustained global inflation. While there is a lot of noise now, over time, managers who manage the correlation between stocks and bonds will realize that the situation has changed. With interest rates at zero, bonds no longer serve a purpose in portfolios, and this is even more true when sustained inflation occurs. The market will slowly come to this realization, and the rapid exit from the $100 trillion bond market will devastate countries around the world. At that point, these managers must find another asset class that is uncorrelated with stocks or any TradFi asset class. Bitcoin can do that.