The trading of Hong Kong virtual asset spot ETFs is not going well. Is it due to "insufficient innovation" or "being out of time"?

Author: Jason Jiang, Researcher at OKLink Research Institute

Since April 30, six virtual asset spot ETFs have been listed and traded in Hong Kong for half a month. How has the market performed? Has the much-anticipated physical creation and redemption, along with the earlier launch of the Ethereum spot ETF in the U.S., brought new increments to the Hong Kong market? What stories are worth looking forward to in the future? With these questions in mind, the OKLink Research Institute reviewed the development of the Hong Kong virtual asset ETF market over the past half month based on data.

1. Market Performance of Hong Kong Virtual Asset ETFs in the Past Half Month

On the first day of issuance on April 30, the three Bitcoin spot ETFs in Hong Kong reached a total issuance scale of $248 million, far exceeding the approximately $125 million initial scale of the U.S. Bitcoin spot ETF on January 10 (excluding Grayscale). However, the subsequent market performance has not been as optimistic as expected: according to incomplete statistics from the OKLink Research Institute, as of May 15, 2024, the total asset management scale of the six Hong Kong virtual asset spot ETFs exceeded HKD 2 billion (approximately $264 million), with the Huaxia Bitcoin asset management scale reaching HKD 816 million, close to 40% of the total. Although this pales in comparison to the scale of the U.S. Bitcoin spot ETF (approximately $51.4 billion), considering the comparison of ETF market sizes between Hong Kong (USD 50 billion) and the U.S. (USD 8.5 trillion), the $264 million virtual asset spot ETF has a significant impact on the local financial market in Hong Kong.

In terms of trading, the total trading volume of Hong Kong virtual asset spot ETFs has exceeded HKD 520 million in the half month since their listing, but the daily trading volume has recently shown a declining trend, falling below HKD 40 million for several consecutive trading days (as of May 14).

However, trading volume does not reflect the direct impact of spot ETFs on the crypto market; only the actual inflow of funds into the market can influence market trends. Unfortunately, the fund inflow situation for Hong Kong ETF products is also not optimistic: the three Bitcoin spot ETFs have experienced net outflows for four consecutive days, and the Ethereum spot ETF has also seen net outflows for several days. In fact, the overall demand for virtual asset spot ETFs in the global market seems to be weakening. Since the halving, U.S. Bitcoin ETFs have also generally experienced fund outflows: in the past month, there have been 14 trading days with net outflows totaling $783 million.

2. Why Didn't the Ethereum ETF Bring "Surprises"?

Compared to the U.S., the main advantage of Hong Kong's Bitcoin spot ETFs lies in supporting physical creation and redemption. Although the specific shares of physical and cash subscriptions have not yet been disclosed, previous reports indicated that the share of physical subscriptions in the initial issuance scale might exceed 50%, but it seems that this has not brought sustained increments to the Hong Kong spot ETF market.

Theoretically, physical creation and redemption are more attractive to native crypto investors, and Bitcoin miners are expected to be the main group interested in Hong Kong's Bitcoin spot ETFs. However, on-chain data shows that miners seem to prefer to "wait and see" under the current market conditions rather than putting Bitcoin into the ETF market through physical subscriptions. From the miners' wallet balances, the outflow volume has dropped to the lowest point in six months. Additionally, since Hong Kong does not have an advantage in fees, the likelihood of miners changing their minds in the short term to inject increments into the Hong Kong ETF market is low.

Moreover, observing the recent overall changes in on-chain data in the Bitcoin market, we find that Bitcoin trading volume and market liquidity are declining. This is partly due to the influence of U.S. macro expectations, leading investment elites, led by Wall Street, to be reluctant to easily release liquidity at this stage. On the other hand, the recent weak performance of the Bitcoin ecosystem has resulted in Bitcoin holders lacking sufficient enthusiasm to participate in trading within the current price range, leading to a decrease in demand for ETF products.

(Note: Velocity is an indicator that measures the speed at which units circulate in the network; the higher the value, the faster the circulation speed of Bitcoin on-chain, and the higher the trading activity.)

The highly anticipated Ethereum spot ETF has also not brought surprises in the short term. Currently, the Ethereum spot ETF accounts for only 15.11% of the Hong Kong virtual asset spot ETF market, with an asset management scale of approximately HKD 327 million—lower than its initial scale. This is partly due to the recent weak performance of Ethereum; the previous Cancun upgrade did not lead to a collective explosion of Layer 2 projects. Although gas fees dropped to historical lows, it did not improve on-chain activity; instead, the adjustment of the transaction fee structure due to the Cancun upgrade has kept Ethereum in an inflationary state for over a month, which has somewhat negatively affected market expectations for Ethereum.

On the other hand, the current lack of support for staking in Hong Kong's Ethereum spot ETF may be one of the factors affecting its ability to attract more investors. We believe that whether or not staking is supported may be key to determining the scale of Ethereum spot ETF products. Currently, the yield from staking Ethereum is about 3.7%. From both a narrative and economic perspective, the additional income from staking is likely to be an important factor attracting investors, especially traditional financial investors, and is a major feature distinguishing Bitcoin from Ethereum. Existing Ethereum holders may be unwilling to participate in the ETF because it cannot be staked, as subscribing to the ETF means they have to give up staking rewards; new investors, unless particularly optimistic about the Ethereum ecosystem, will also tend to prefer Bitcoin ETFs over Ethereum ETFs.

3. What Should We Expect from the Future of Hong Kong Virtual Asset ETFs?

As the industry generally believes that the U.S. SEC is unlikely to approve the Ethereum spot ETF application this month, it means that Hong Kong's current Ethereum ETF products will continue to have a first-mover advantage for some time. If the Ethereum ecosystem can turn around, we believe Hong Kong still has the opportunity to attract more incremental funds interested in Ethereum into the ETF market.

In addition, there are more aspects worth looking forward to in the future of Hong Kong virtual asset spot ETFs:

First, considering that Hong Kong has approved the application for a spot ETF based on the PoS mechanism for Ethereum, it is possible that more mainstream public chain tokens, such as Solana, which also supports the PoS mechanism, could enter the mainstream financial market through the issuance of ETFs. This would greatly increase Hong Kong's attractiveness to various Web3 projects and enhance the future imagination of Hong Kong virtual asset ETFs.

Moreover, virtual asset spot ETFs are essentially similar to token securitization, which transforms relatively niche virtual assets into securities that are more accepted by the mainstream market through a series of compliance processes. Once virtual assets like Bitcoin complete their "identity transformation," financial institutions can leverage ETF products to launch more derivative products such as leverage, lending, and asset management, achieving financial innovations that were previously difficult to implement directly with physical Bitcoin assets, thus meeting the needs of various investors to allocate virtual assets.

Guotai Junan International has currently launched structured products based on virtual asset spot ETFs in Hong Kong, and Harvest International and Huaxia Fund are also advancing the collateralization of ETF products. We believe that virtual asset spot ETFs, as frictionless trading tools, will stimulate more financial innovations, and various structured products and derivatives based on spot ETFs will bring more possibilities to the Hong Kong market, accelerating the connection between Hong Kong's financial system and the virtual asset market.

More importantly, the OKLink Research Institute has stated in interviews with media such as the South China Morning Post that the significance of issuing virtual asset spot ETFs in Hong Kong does not lie in bringing significant changes to the market in the short term, but in marking that Hong Kong financial institutions will accelerate their embrace of virtual assets. Perhaps we will see more financial institutions participating in the Bitcoin and Ethereum spot ETF markets in Hong Kong in the near future or accelerating their virtual asset business layout in other ways, providing virtual asset products and services to a broader user base.