For years, bitcoin exchange traded funds (ETFs) have been struggling to get off the ground and receive approval from the U.S. Securities and Exchange Commission (SEC). Passive fund providers are now arguing there is sufficient market liquidity for a bitcoin ETF to be launched in 2019.
ETFs to Top $9 Trillion by 2022
ETFs are becoming a large part of the investment landscape. Research firm ETFGI predicts that in 2020, ETFs and ETPs listed in Europe will reach $1.1 trillion. Morgan Stanley forecasts global ETF assets to top $9 trillion by 2022. As interest in these products grows, regulators have been addressing structural vulnerabilities. Research conducted by broker and asset manager Charles Schwab shows the millennial generation is increasingly choosing to invest in ETFs accessed by apps. It could be a game-changer when – or if – the SEC approves a bitcoin ETF.
There have been a number of applications submitted over the years. The most recent ones include Proshares, which had two proposals for a bitcoin ETF, both based on bitcoin futures contracts. There was also the Vaneck-Solidx proposal which is based on a physical-backed bitcoin ETF. Before an ETF is approved to trade on one of the U.S.’s major exchanges, there is a number of factors which need to be considered.
Bitcoin Market Cap Stands at $72 Billion
Last year, Blockforce Capital launched blockchain ETFs in the form of BLCN and the world’s first Chinese blockchain ETF, BCNA. Eric Ervin, CEO of Blockforce Capital, told news.Bitcoin.com the current market environment has the ability to support an ETF for two primary reasons.
“First, [BTC] has a market cap of $72 billion,” he explained. “While this is small in comparison to many blue-chip stocks, there are a number of ETFs currently on the market that are focused on esoteric assets. For example, iShares’ IWC ETF focuses on micro-cap stocks, and has almost $900 million in assets. Collectively, the underlying stocks have a market cap of about $450 billion. That number dwarfs bitcoin’s market cap, but when looking at the underlying assets’ liquidity, there are significant volume constraints.”
Ervin explained that 40 percent of the IWC fund comprises holdings that are greater than 50 percent of the average 30-day volume. This is because most are micro-caps, and are also only listed on U.S. exchanges. Ervin highlights that in comparison, BTC’s 24-hour trading volume is about $5.3 billion, and trades on multiple exchanges around the world, allowing global investors to add liquidity to the marketplace.
Exchange Arbitrage Is a Growing Business
As the market develops, participants are becoming more sophisticated and exchange arbitrage is a growing business.
Ervin said: “Exchange arbitrage – buying bitcoin on exchange A and selling on exchange B to take advantage of small price inefficiencies – is a growing business as many traditional market players enter the space because returns from arbitrage are considered ‘risk free’ as the strategy has no directional exposure.”
When the Blockforce Capital team started arbitraging prices at the beginning of summer 2018, they were averaging around 75 bps profit per trade. “That number has dwindled and the number of opportunities have gone down considerably, due to increased competition. These market participants add liquidity to the marketplace because if an exchange’s price of [BTC] deviates from the global mean, market participants will arbitrage the price back in line with the global average,” explained Ervin.
He concludes that this factor, coupled with an expanding derivative, futures, and swap market, adds liquidity and makes it much more difficult for the price of a globally traded asset to be manipulated, adding:
We could make the case that an ETF holding a substantial amount of a micro-cap stock’s daily volume would have a higher impact on the price than a globally traded asset.
Scandinavia Leads Market With Bitcoin ETNs
As the SEC continues to agonize over whether to approve a bitcoin ETF, it is worth taking a look at other crypto financial products such as Sweden’s bitcoin exchange-traded note (ETN). In May 2015, XBT Provider AB announced the authorization of Bitcoin Tracker One, the first bitcoin-based security available on a regulated exchange.
Laurent Kssis, the CEO of XBT Provider, a Coinshares company, said that to put things in perspective, a so-called ‘physical’ bitcoin ETF simply asks for money upfront to buy the underlying asset physically.
“In this way, a bitcoin ETF provides quick exposure to the underlying asset, but this also means the market needs to be liquid enough to support any new demand for the underlying asset – in this case, bitcoin. There is a key operational question that regulators and investors alike need answered before approval of a bitcoin ETF,” explained Kssis.
The good news is there are prior proxies in the market to study. Kssis said in his experience of operating the BTC and ETH trackers on Nasdaq Stockholm – notes which are hedged by buying the underlying asset (BTC 1:1) – he has so far been able to keep up with demand while maintaining an accurate price over the last three and a half years without any liquidity issues and being the sole liquidity provider.
“Put differently, even during the height of 2017, the underlying bitcoin market remained liquid enough to absorb new demand as we bought bitcoin to physically hedge the bitcoin trackers,” added Kssis.
According to XBT Provider, during 2017, when BTC traded at $20,000, the group was able to source ample liquidity. “My takeaway from 2017: even with substantial demand driving AUM well above $1 billion, the market demonstrated that delta-one security desks were able to source ample liquidity in the market to operate similar products to a proposed bitcoin 1:1 physical bitcoin ETF. A futures market will simply enhance that liquidity that is already available,” said Kssis.
If Crypto Trading Picks up Expect More Launches
Other products available in the market include Greyscale Bitcoin Investment Trust (OTC:GBTC) which trades over the counter and the Amun Crypto Basket Index (SIX:HODL) which launched in November 2018 on Switzerland’s Zurich-based SIX Exchange.
According to Lars Seier Christensen, chairman of Concordium and founder of Saxo Bank, if trading picks up we can expect more launches. He said: “If the primary cryptocurrency exchange market continues to be in trouble, there will be little appetite for launching new trading vehicles. On the other hand, if trading picks back up, it is quite likely that we will see a slew of new initiatives being launched — perhaps even some that have already been planned and gone through due diligence but where the offering party have been waiting for a better time to launch.”