Analysis of the Impact of BTC Spot ETF: Market Conditions, Trading Factors, and Capital Inflows

Written by: @yutsingkuh

Mentors: @CryptoScott_ETH, @HaywarZhu

1. Background

On January 10, 2024, the SEC approved the listing of Bitcoin spot ETFs for the first time. A total of 11 Bitcoin ETFs were approved, with a total scale reaching $27 billion as of January 19 (the vast majority being Grayscale's GBTC shares, converted from its original trust fund). However, this is not the world's first BTC spot ETF. In 2021, the Purpose Bitcoin ETF was listed on the Toronto Stock Exchange. Nevertheless, the U.S. is the largest capital market in the world, and the SEC's approval will have a far greater impact on the market than in Canada.

The listing of the BTC spot ETF is an important milestone in the development of Bitcoin. It will make Bitcoin investment more convenient and further increase Bitcoin's adoption rate. Regular investors can invest in Bitcoin through their securities accounts without needing to open cryptocurrency accounts. The risk control and compliance issues faced when investing in Bitcoin will also be alleviated.

2. Current Market Conditions

The price of BTC has surged significantly over the past three months, rising from $25,889 on September 10 to $46,106 on January 10, an increase of 78%. The market generally believes that the BTC ETF approval is one of the main reasons for the rise in BTC prices. After the BTC ETF approval, the market remained relatively calm, possibly because the market had already priced in this expectation. When the BTC ETF first began trading, BTC briefly spiked to $48,500 but quickly retreated. As of January 17, the BTC price was $42,800, down about 8% from before the BTC ETF approval.

Although BTC price fluctuations have not been particularly dramatic, the BTC ETF has already had a significant impact on the market in just a few days. The trading volume of the BTC ETF was enormous, reaching $4.6 billion on its first day of trading. In comparison, the largest cryptocurrency exchange, Binance, had a spot trading volume of only $4.1 billion that day. This may be due to the more intense competition among market makers in traditional markets.

3. New Trading Factors

Due to the enormous trading volume of the Bitcoin spot ETF, it is likely to have a significant impact on Bitcoin's price movements. In the long run, the Bitcoin spot ETF may become an important channel for incremental funds to enter the market, driving further increases in Bitcoin's price; in the short term, the spot ETF has increased the available information in the market, which may bring new trading factors.

The deep liquidity of the Bitcoin spot ETF and traditional centralized exchanges contains enormous arbitrage opportunities. On one hand, there may be discrepancies between the price of the spot ETF and the BTC spot price, creating arbitrage opportunities; on the other hand, the differences in market structure during U.S. stock market opening and closing hours may also present statistical arbitrage opportunities. These arbitrage opportunities will attract more funds and institutions into the cryptocurrency market.

Trading factors in the U.S. stock market, such as market sentiment, market volatility, and market liquidity, may also affect the cryptocurrency market. The approval of the Bitcoin spot ETF will allow trading factors from traditional markets to more directly influence the cryptocurrency market. For example, investor sentiment in traditional markets may affect the short-term price of the spot ETF, which in turn could impact the BTC spot price. The influence of these factors may lead to new trading strategies.

The cryptocurrency market is highly active and competitive. The inflow of funds into Bitcoin ETFs, as a long-term trend, may not correlate with Bitcoin's short-term price movements. Some publicly available information in the market, such as the inflow of ETF funds on a given day, may have a lag. Investors should be cautious of the volatility risks in the cryptocurrency market and avoid blind trading.

4. Fund Inflows

4.1 Other Forecast Reports

Galaxy estimates that the inflow of funds into the BTC ETF will reach $14.4 billion in the first year, $26.5 billion in the second year, and $38.6 billion in the third year based on the reach of the BTC ETF on asset management platforms.

Glassnode estimates that the BTC ETF will attract $70.5 billion in fund inflows by referencing the scale of existing ETF products.

Standard Chartered Research predicts that the BTC ETF will receive $50 to $100 billion in fund inflows in 2024.

4.2 Asset Allocation-Based Forecasts

Many studies have shown that including Bitcoin in asset allocation helps improve portfolio returns and reduce volatility. This is due to Bitcoin's low correlation with traditional assets. However, for traditional investors, the investment threshold for Bitcoin is relatively high. The approval of the BTC ETF will make it easier for investors to include Bitcoin in their asset allocation. Therefore, we can expect that the approval of the BTC ETF will bring a large inflow of asset allocation funds.

As early as 2019, a study by Aleh Tsyvinski indicated that 4% to 6% of a portfolio should be allocated to cryptocurrencies. As Bitcoin's adoption rate increases, its volatility risk is also diminishing. Wealth advisors typically recommend allocating 1% to 5% to BTC. For a typical investor based on major asset allocation, such as investing in 40% stocks + 25% bonds + 10% gold + 25% cash, including 3% of cryptocurrencies in the asset allocation is quite reasonable. Compared to the current $1.27 trillion in assets under management for the S&P 500 index fund, we expect the BTC ETF's scale to reach $95 billion within two years.

4.3 Product Comparison-Based Forecasts

From an investment perspective, comparing existing products can help estimate market demand for new products. Previously, major products of the same type included the Grayscale Bitcoin Trust, the ProShares Bitcoin Futures ETF, and the Purpose Bitcoin ETF.

The significance of investing in BTC products lies in gaining exposure to BTC positions. Management fees and tracking accuracy are the main considerations when investing in such products. Management fees determine the holding costs for investors, while tracking accuracy determines the risks faced by investors. In actual products, management fees are included in the net asset value. Therefore, such products can be seen as tools that incur a cost of downside risk relative to BTC to gain exposure to BTC. Under unchanged market conditions, this cost determines investor demand.

We assume that, under unchanged market conditions, the market consumption scale of BTC ETP products increases as the cost level decreases.

And the consumption scale is the product of the total position and cost.

Therefore, with reduced holding costs, the total positions held in the market will at least increase inversely with the cost level.

The Grayscale Bitcoin Trust is a trust fund whose shares, GBTC, are held by Grayscale at a 1:1 ratio with BTC, charging an annual management fee of 2%. GBTC shares can be traded on the secondary market but cannot be redeemed. GBTC shares rapidly grew to 650,000 BTC from June 2020 to February 2021, after which growth stopped. For various reasons, GBTC's price has deviated significantly. Before February 2021, GBTC experienced extremely high premiums. Therefore, during this period, the demand for GBTC primarily came from the arbitrage opportunities created by the premiums. After February 2021, GBTC faced severe negative premiums. Due to the inability to redeem, the number of GBTC shares did not decrease significantly. This does not reflect the actual market demand for GBTC. Therefore, GBTC cannot serve as a reference for predicting BTC ETF demand.

The ProShares Bitcoin Futures ETF is a futures ETF whose underlying assets are primarily CME's BTC futures, currently valued at $1.59 billion, making it the largest BTC ETP besides GBTC. Due to management fees and the costs of rolling futures, its net asset value has lagged BTC's increase by about 25% from October 2021 to January 2024. We estimate BITO's annual holding cost to be 13%. In comparison, the newly issued iShares Bitcoin Trust has an annual management fee of 0.25%, which is also the current common management fee level for BTC ETFs. Therefore, BITO's cost level is 52 times that of BTC ETFs. Based on the above assumptions, the expected scale of the BTC ETF is approximately 52 times that of BITO, or $83 billion. Considering that market equilibrium takes time, we expect this to be achieved within two years.

The Purpose Bitcoin ETF is a BTC spot ETF listed on the Toronto Stock Exchange in Canada and was once the largest BTC spot ETF. It was established in February 2021 and currently has a management scale of $1.5 billion. Considering that the total wealth management market in Canada was $1,933 billion in 2023, while the total wealth management market in the U.S. was $58,446 billion. If the BTC spot ETF has the same participation rate in the U.S. market as in the Canadian market, it is expected to reach $45 billion. Additionally, Statista predicts that the U.S. wealth management market will grow by 10% in 2024, reaching $64,700 billion, which would mean that by the end of 2024, the BTC spot ETF's scale will reach $50 billion.

4.4 Comparison of Gold ETFs and Bitcoin ETFs

Gold ETFs are the earliest commodity ETFs and one of the most successful ETFs. Their scale has exceeded 10% of the gold market. Bitcoin is often referred to as digital gold. Its anti-inflation value and store of value function are similar to those of gold. The successful experience of gold ETFs provides some reference value for predicting the scale of Bitcoin ETFs, which are also commodity ETFs.

The first gold ETF in the U.S., SPDR GLD, was listed in November 2004 and remains the largest gold ETF to this day. After 1, 2, and 3 years of listing, its management scale reached $3.2 billion, $8.3 billion, $15 billion. Today, the total scale of gold ETFs in the global market is approximately $235 billion. Considering that the market's acceptance of ETF products is much higher than it was in 2004, we expect the BTC ETF to reach its mature scale even sooner. Currently, the total market value of gold is about $12 trillion, and the scale of gold ETFs accounts for 2% of the total market value. The total market value of Bitcoin is approximately $840 billion. If Bitcoin ETFs occupy the same market value proportion, their scale would reach $17 billion.

Considering that gold has other uses beyond its financial attributes, we will make another comparison from the perspective of financial transactions. The current trading volume of gold spot is approximately $130 billion/day, while the trading volume of Bitcoin spot is about $30 billion/day. Assuming the scale of Bitcoin ETFs is related to spot trading volume in the same way as gold ETFs, we estimate that the mature scale of Bitcoin ETFs will be approximately $54 billion.

We assume that the above predictions will be reached in two years.

4.5 Growth in Bitcoin Adoption Rate

The approval of the Bitcoin spot ETF is a significant market event. However, from the perspective of Bitcoin's long-term development, this is just a small step towards large-scale adoption. Many viewpoints suggest that BTC's adoption follows the theory of innovation diffusion, and BTC is still in the early stages of its development, at the head of the S-curve. In recent years, many studies have used similar models to predict the growth of BTC's adoption rate, and these predictions have been validated. The approval of the Bitcoin ETF is an essential step for the growth of Bitcoin adoption and reaching more people. It significantly lowers the entry barrier for investing in Bitcoin and is expected to become one of the main channels for Bitcoin investment in the coming years, as well as an important driving force for the growth of Bitcoin's adoption rate.

4.6 Possible Shrinkage of GBTC

GBTC is currently the largest BTC spot ETF, converted from a previous trust fund. Between 2022 and 2023, GBTC experienced a significant negative premium, attracting a large number of arbitrageurs, and this portion of funds is expected to flow out after the listing of the BTC ETF. Considering that GBTC's negative premium once approached 50%, nearly half of the funds may flow out. This portion of funds may flow into other Bitcoin ETFs, but it may also not. However, estimating the impact of this on the growth of Bitcoin ETF scale is quite difficult.

5. Comprehensive Analysis

Based on the current market conditions, we have made predictions about the scale of the Bitcoin spot ETF from multiple independent perspectives. Combining existing market forecasts, the timing and scale of all predictions are shown in the figure below. Assuming that the inflow of funds into the Bitcoin spot ETF follows a log-normal distribution. Kernel density estimation of known data points yields the comprehensive results shown in the figure. The median and quartiles in the predictions represent optimistic, neutral, and conservative estimates. The final results are shown in the table below, with an expectation that within three years, in an optimistic scenario, the Bitcoin spot ETF will bring in $85 billion in fund inflows, in a neutral scenario, $50 billion, and in a pessimistic scenario, $30 billion.