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 occurred in August of this year, determining that the SEC’s refusal of Grayscale Investments’ application to transform GBTC into a spot Bitcoin Exchange-Traded Fund (ETF) was incorrect.

This key event ignited the current market trend (as can be seen from the following chart, where CME’s BTC OI started to surge significantly on October 15). During this period, alongside the good news of the Fed’s pause, BTC’s market momentum continued vigorously. With Hashdex, Franklin, and Global X’s application deadlines approaching, the “window period” was postponed again on November 17, serving merely as a reason for market adjustment. Looking at the timeline, the most crucial date is still January 10, for Ark & 21shares’ final decision on this round of applications, as the market’s betting sentiment is strongest for this milestone. As of now, the earliest we could get the results on whether it’s approved is next Wednesday (January 3).

Can a Spot ETF Be Approved Under the Current Circumstances?

According to market expectations for Spot ETFs, Bloomberg ETF analyst James Seyffart believes there is a 90% chance that a Bitcoin spot ETF will be approved before January 10 next year. As someone close to the SEC, his view is widely disseminated in the market.

The head of the BloFin Options Desk&Research Department, Griffin Ardern, published research on potential Authorized Participants (APs) buying seed funds for a spot BTC ETF that might pass in January. Griffin’s research concluded that since October 16, an institution has continuously bought BTC and a small amount of ETH through the same account, transferring $1.649 billion to compliant exchanges like Coinbase and Kraken. An institution capable of a $1.6 billion cash purchase is rare in the crypto market. The use of Tron instead of Ethereum as the transfer channel and the trajectory of the coin transfers suggest that this account likely belongs to a traditional institution based in North America.

There’s technically no limit on the size of a seed fund; it only needs to prove it can provide sufficient liquidity on the day of trading. Traditional seed fund purchases occur 2–4 weeks before the ETF launch to minimize position risks for APs like market makers or ETF issuers, but purchases could start earlier due to the December holidays and delivery impacts. Based on this evidence, there is some rationale to believe that a BTC spot ETF might pass in January, but this cannot be taken as definitive proof.

Regarding the ETF approval process, the maximum duration is 240 days, by which the SEC must issue a final decision. Ark&21 shares, being among the earliest applicants, have a SEC decision deadline of January 10, 2024. If Ark’s application is approved, it is likely that subsequent applications will also be approved. If rejected, Ark would need to resubmit, theoretically starting another 240-day application cycle. However, if any application is approved between March and April 2024 or later, Ark could also be approved earlier.

The SEC’s stance has previously rejected Grayscale’s proposal to convert GBTC into a Spot ETF, mainly due to concerns about cryptocurrency trading on unregulated platforms and market manipulation in the spot market. While the SEC has approved cryptocurrency futures ETFs, these trade on platforms regulated by U.S. financial authorities. Another concern is that many BTC spot ETF investors use pensions or retirement funds, which cannot bear the high volatility and risk of such ETF products, potentially causing investor losses.

However, the SEC hasn’t appealed against Grayscale again, and more active communication with major asset managers applying for ETFs reflects a higher probability of approval. Recently, the SEC’s website disclosed two memorandums showing discussions with Grayscale and BlackRock on proposed rule changes for listing and trading Grayscale Bitcoin Trust ETF and iShares Bitcoin Trust ETF. The memorandums included a two-page PPT from BlackRock, showing two types of ETF redemption methods: In-Kind Redemption Model or In-Cash Redemption Model, with BlackRock seemingly favoring the former (though they have now agreed to In-Cash conditions). As of November 20, the SEC had held 25 meetings with ETF applicants. This indicates the new conditions, including 1) ETFs using cash to create and remove all physical redemptions; 2) SEC’s expectation for applicants to confirm AP information in the next S-1 file update, have been thoroughly discussed. If these conditions are met by January 10, it seems everything is ready, signaling a potential shift in the SEC’s attitude.

The approval of a Spot BTC ETF involves a complex interplay of interests among the Democrat-majority SEC, CFTC, asset management giants like Blackrock, influential industry lobbyists like Coinbase, etc. Coinbase, considered the custodian for most asset management companies, stands to benefit from the approval, though actual custody fees (generally between 0.05%-0.25%) are not significant compared to new international perpetual trade income and the added scale of spot trading. Nevertheless, Coinbase remains one of the biggest beneficiaries if the spot BTC ETF passes, especially after becoming the main government lobbying force in the U.S. crypto industry following the FTX collapse.

BlackRock has already launched a crypto-related stock fund, the iShares Blockchain and Tech ETF (IBLC). Despite being on the market for over a year, its assets are under $10 million. BlackRock has enough motivation to push for the approval of a spot BTC ETF.

Furthermore, traditional asset management giants like BlackRock, Fidelity, and Invesco play a unique role in government regulation. As the world’s largest asset manager with about $9 trillion in assets, BlackRock maintains close ties with the U.S. government and the Federal Reserve. U.S. investors eagerly await the legal ownership of crypto assets like Bitcoin to hedge against fiat inflation, and institutions like BlackRock recognize this, leveraging their political influence on the SEC.

In the political context of the 2024 elections, cryptocurrencies and AI have become hot issues. Inside the Democratic Party, President Biden, the White House, and the current regulatory bodies appointed by the president (SEC, FDIC, Fed) seem largely opposed to cryptocurrencies. However, many young Democratic congress members support cryptocurrencies, as do many of their voters. Thus, a shift in stance is possible.

Republican presidential candidates are more likely to support crypto innovation. Ron DeSantis, a Republican leader, has expressed support for banning CBDCs and promoting Bitcoin and crypto-technology innovation. As governor, DeSantis has made Florida one of the most crypto-friendly regions in the U.S.

Despite former President Trump’s past negative comments on Bitcoin, he launched an NFT project last year. His main supporter states, Florida and Texas, largely support the crypto industry.

The biggest uncertainty comes from Gary Gensler, the Democratic SEC chair. Gensler believes most token trades on Coinbase are illegal, except for Bitcoin. The SEC under Gensler has taken a tough stance on crypto. Coinbase is undergoing an SEC lawsuit regarding its core business practices. Binance faces a similar lawsuit and is defending itself in court. According to Berenberg Capital Markets analyst Mark Palmer, the worst-case scenario could see Coinbase losing over a third of its revenue. “There is almost no hope of changing the majority stance of the SEC in the short term.”

Coinbase and other companies are not waiting for a court ruling but hope Congress will exempt crypto from securities rules. Coinbase executives are pushing for bills that limit the SEC’s regulatory power over tokens and establish rules for “stablecoins” (like USDC, in which Coinbase holds shares).

Crypto companies are also lobbying against bills that require compliance with anti-money laundering regulations, which they claim are costly or impossible to adhere to in a decentralized blockchain-based world. However, the task becomes more challenging with each ransomware attack or terrorist act funded partially by tokens.

Some bills are making progress. For example, the House Financial Services Committee passed a bill on crypto market structure and stablecoins, supported by Coinbase, paving the way for a full House vote. However, there’s no indication that Senate Democrats will propose this bill, or if President Joe Biden will sign a crypto bill.

Since this year’s spending bill might be Congress’s main priority and Congress will enter election mode in 2024, controversial crypto bills may struggle to progress for a while.

“The collapse of FTX is a setback, but some in Congress recognize that crypto is inevitable,” says Kristin Smith, CEO of the Blockchain Association. For now, the industry might have to settle for Bitcoin Exchange Traded Funds, while lobbyists continue to push for bills that will reach the finish line next year.

According to a recent Grayscale study, 52% of Americans (including 59% of Democrats and 51% of Republicans) agree that cryptocurrency is the future of finance; 44% of respondents said they hope to invest in crypto assets in the future.

For the SEC, the main reason for opposition and contradiction with cryptocurrencies remains BTC’s inherent manipulability, which cannot be fundamentally resolved. However, we will soon find out whether the SEC will approve the BTC spot ETF under pressure from various stakeholders.

Spot BTC ETF & BTC Price Impact Sensitivity Analysis

Despite the lack of a direct Spot Bitcoin ETF in the United States, investors have already participated in the Bitcoin market through existing product structures. The total assets under management (AUM) of these products have exceeded 30 billion US dollars, approximately 95% of which are invested in products related to spot Bitcoin.

Before the emergence of a Spot BTC ETF in the US, Bitcoin investment methods and product structures included trusts (like Grayscale Bitcoin Trust GBTC), BTC futures ETFs, Spot ETFs already launched in regions outside the US (such as in Europe and Canada), and private funds configured with BTC. GBTC alone has an AUM of 23.4 billion US dollars, the largest BTC futures ETF BITO has an AUM of 1.37 billion US dollars, and Canada’s largest spot BTC ETF BTCC has an AUM of 320 million US dollars. The configuration of BTC in other private funds is not transparent, and the actual total may be far greater than 30 billion US dollars.

Spot ETFs vs. Spot ETFs Compared to Existing Alternatives

Compared to the investment product structures like trusts/closed-end funds (CEF), Spot ETFs have a lower tracking error (with the returns of BITO, BTF, and XBTF lagging behind the spot price of Bitcoin by 7%-10% annually), better liquidity than private funds, and potentially lower management cost advantages (compared to GBTC), such as Ark setting its fee rate at 0.9% in its application file.

Potential Capital Inflows:

Existing Demand

It is foreseeable that, without a better change in the GBTC fee structure, a significant outflow of GBTC’s AUM (Assets Under Management) will occur. However, this will be compensated by the demand for new ETFs. Assuming that 1% of the current 58,440 billion in wealth management AUM flows into BTC, and 5% of that in the first year, this would result in an inflow of 29 billion USD (58,440 billion 1% 5%). Assuming that 10% of the funds enter on the first day, this would create a buying pressure of 2.9 billion USD (10% of 29 billion USD). These funds, combined with the pressure points of BTC’s rise, and considering the BTC market value of 557 billion USD on October 13 (BTC price = 26,500 USD), would set a target price of 53,000 USD for BTC from October 13 onwards, taking into account the capital inflow from the spot ETF and disregarding other factors (mainly considering the pressure points of the rise and the effect of capital inflow on price changes, which is difficult to predict due to dynamic changes in market trading volume). However, due to the complexity of market sentiment, a spike followed by a downturn is quite possible.

Comparing this with the Gold ETF’s 209 billion AUM, and considering BTC’s total market value is 1/10th of gold, if we assume the BTC spot ETF AUM could reach 10% of the Gold ETF’s 209 million AUM, i.e., 20.9 billion, then assuming 1/10th of 20.9 billion flows in the first year (as Gold ETF retained about 1/10th of the total AUM in the first year after approval, with AUM gradually accumulating, and 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 starts to decrease), this would result in a net inflow of 2.1 billion USD in the first year.

Therefore, if we make a comparison with SPDR Gold (an ETF issued by State Street Global Advisors, which is the largest and most popular), we see that SPDR’s AUM is 57 billion. Assuming BTC spot ETF AUM could reach 10% - 100% of SPDR’s 57 billion AUM, i.e., 5.7 billion - 57 billion (assuming 1/10th of 5.4 billion = 540 million - 5.4 billion flows in the first year, as Gold ETF retained about 1/10th of the total AUM in the first year after approval), a very conservative estimate of the inflow for BTC in the first year is between 5.4 and 54 billion USD.

Using a very conservative analogy with gold and estimating using 1% of the 58,440 billion in wealth management AUM flowing into BTC, the expected inflow of funds in the first year after the approval of the BTC spot ETF is estimated to be between 54 billion and 290 billion USD.

New Demand

Considering the new adoption from the retail end, the percentage of BTC holdings in the U.S. for the years 2019-2023 were 5%, 7%, 8%, 15%, and 16%, ranking 21st among all countries. The approval of the spot BTC ETF is very likely to continue to increase this percentage. Assuming the percentage increases to 20%, adding 13.2 million retail customers, and calculating with an average household income of 120k USD, assuming an average holding of 1,000 USD in BTC per person, this would generate a new demand of 13 billion USD.

Conclusion

As more and more investors start to appreciate the benefits of Bitcoin as a value storage asset or digital gold, combined with the increasing certainty of ETF launches, the approaching halving, and the Federal Reserve’s halt to interest rate hikes, it is highly likely that BTC’s price will be pushed to the 53,000 USD mark in the first half of next year.

However, the approval of the Ethereum spot ETF, combined with the 240-day application process for the BTC spot ETF, and the security qualification controversy surrounding Ethereum compared to BTC, means that the Ethereum ETF is likely to be approved much later than the BTC spot ETF. Therefore, Ethereum may only see its ETF market when Gensler is replaced by a more crypto-friendly leader.

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