Why the bitcoin ETF is more than just hype

As bitcoin continues to level out in a bear market that has been long-pending following the unprecedented bull-run from Q4 2015 to Q4 2017, investors are looking for signs that could trigger the next bull-run. Bitcoins price action since the start of the year hasn’t been reflective of it’s growing fundamentals. The successful implementation of the lightning network, positive regulatory clarity and industry-standard exchanges being built are factors that continue to fuel bitcoins development to become a genuine store of value whilst making a case for a means of exchange. Whilst these factors are worthy of a blog alone, the proposition of a bitcoin ETF is hard to ignore. A bitcoin ETF has the ability to turn this nascent asset into a widely-accepted, and desired, store of value. Let’s look at why, and how.

​An ETF is an investment fund that investors can purchase a holding in. An ETF is traded on exchanges, similarly to how stocks are traded. The notion of a bitcoin ETF is unprecedented, making bitcoin the first cryptocurrency to be listed on a stock exchange through the means of an exchange traded fund. Investors will be able to invest in the ETF which holds solely bitcoin. This isn’t bitcoins first exposure to an institutionally exchanged derivative, as we witnessed BTC futures introduction in 2017. However, there is a clear disparity of impact between the two investment instruments on bitcoins value.

BTC futures vs BTC ETF

As highlighted in my 2018 bitcoin crash blog, the introduction of BTC futures was one of skepticism. The proponents of the futures contract endorsed positions that were cash-settled, this meant that no actual BTC was involved, excavating cries of price suppression from Fundstrat analyst Tom Lee and @super_crypto. Although the introduction of the BTC futures market meliorated the perception institutions had of bitcoin, it also introduced a tool that provided leverage to quell bitcoins value through contracts. A BTC futures contract simply did not, and will not encourage investors to purchase and hold bitcoin, rather, it amplifies the positions that stifle its price action. This is not a criticism of the futures market, as this is part of the game that existed well before bitcoin. This is just to depict the stark differences between the BTC futures hype vs the BTC ETF hype.

Exposure to liquidity

Exchange-traded-funds (ETFs) were successfully launched in 1993. Since then, ETFs have grown to become one of the most popular investment vehicles from retail to institutional investors. As of this year, the ETF market is worth more than $5trn and growing. Ernst & Youngs report on the ETF market in the latter parts of 2017 painted a very bullish picture for future of the ETF market.

“The ETF industry continues to grow in scale and sophistication. In the process, it is breaking new records in terms of global assets under management, which had reached $4.4t by the end of Sept 2017… Our survey respondents predict ETF asset growth of around 15% per annum for the next three to five years. If anything, we think this understates the industry’s growth potential. We believe global ETF assets could reach $7.6trn by the end of 2020 — equivalent to a CAGR of approximately 18%”

This statement isn’t so much speculative, but rather backed up by new fiduciary rules that came partially into play as of June 2017. MiFID II, otherwise known as the revamped version of the Markets in Financial Instruments Directive, has been designed in a way that will enable retirement savers and insurers to raise their exposure to ETFs.

“A boon for people saving for retirement is expected to lift ETFs. The fiduciary rule that took partial effect in June and is designed to improve the quality of investment advice could help more than triple US ETF assets to $10 trillion over the next five years” — Bank of New York Mellon Corp

The hybrid of a bitcoin ETF compensates for some of biggest flaws in the investment infrastructure surrounding bitcoin. Below are some of the key influences that a bitcoin ETF will have on bitcoin:

- Institutional custodianship: The dubious nature of cryptocurrency exchanges have scared away many investors that simply do not trust the sub-standard custodianship that they offer. News of crypto-exchange hacks have become common. ETF investors are typically used to being assured that their investments are safe via an insurance policy. The bitcoin ETF proposed by CBOE and VanEck will provide exactly that. This will open the door to a more risk-averse investor.

- Liquidity: Bitcoin has come far in regards to liquidity, however, it is still prone to erratic swings in price in short spaces of time, this highlights that the bitcoin market has not achieved perfect liquidity. The exposure to vast amounts of new money will help alleviate issues such as manipulation, wash-trading, spoofing etc… This will not only help with the growth of BTCs value, but will also encourage institutions to include BTC in their investment portfolio.

- Stigma: The notion of bitcoin still splits opinions amongst individuals. Generally, those that are educated on the technology behind bitcoin see it as revolutionary, the skeptics rather perceive bitcoin as this asset that is a bubble. The two factors above should dampen the skepticism, especially as a new demographic of investors start to store part of their wealth in bitcoin. A bitcoin ETF will allow mammoth investment management firms such as Blackrock to offer a bitcoin ETF to their clients. Coincidentally, last month it as announced that Blackrock were ‘exploring’ bitcoin. The opportunities that will be initiated by a bitcoin ETF will see bitcoin being taken more seriously, thus, more capital flowing into the asset.

The impact of a bitcoin ETF on BTCs price

This is the question on every bitcoin investors mind, just what sort of impact will a bitcoin ETF have on bitcoins price? The factors that I have stated above should all contribute to significant positive upside in bitcoins price. However, to get a better understanding of the sort of impact, we should look at an asset that bitcoin is constantly being compared to, gold.

Now “it is widely acknowledged that the launch of gold (exchange-traded products) has had a very significant on the gold market and is now a key part of it” Graham Tuckwell, chairman at ETF securities

2003 witnessed the first ever gold-backed ETF. Prior to the first gold ETF, the gold market was “not at all liquid, transparent or efficient” according to GLD (the largest ETF gold investor). This story is synonymous with bitcoin. Lack of liquidity and transparency are two common pitfalls that have inhibited the exposure of bitcoin to institutional investors. Whilst blockchain technology enables transparency, cryptocurrency exchange are anything but transparent, hence the trepidation towards investing in bitcoin. As the historic price of gold shows, an ETF can alleviate these problems.

Graph depicting the synonymous movements between the increase in gold ETF holdings and the price of gold

The above graph gives us an insight into what sort of relationship ETFs have with the underlying asset. The blue line depicts the price of gold, whereas the orange looks at the volume of gold ETF holdings. If we look closer at the graph, we can see that the volume of gold ETF holdings tend to have a slightly delayed impact on the price of gold. As the volume of gold ETFs increase, the price of gold follows the trajectory of the ETF volume. The increase in gold-backed ETFs puts pressure on the supply of gold with the substantial increase in demand, thus the increase in price.

The introduction of a gold ETF in 2003 has enabled easier accessibility to a commodity that was previously held by opaque custodians. Inevitably, the characteristics of an ETF as a trusted and convenient investment instrument has led to a 380% increase in the price of gold since the first gold ETF.

As stated earlier, bitcoins story is not too dissimilar to gold. Therefore, comparing the impact of an ETF on golds price vs the impact of an ETF on bitcoin price is justified. Just like the gold ETF, a bitcoin ETF will allow investors to gain access to an asset through trusted means. The insurance policy provided by VanEck alleviates any anxiety amongst investors that are conscious of the frivolous infrastructure built around the bitcoin market. This little detail on page 20 of the VanEck/SolidEx proposal will be well noted by sophisticated investors around the world, and the ripple effect will be felt once the bitcoin ETF has launched.

Investing will always be a numbers game, and the numbers in bitcoin paint a bright picture. Speculators online believe that the amount of people that are invested in bitcoin ranges anywhere from 0.4% — 1%. A bitcoin ETF will increase bitcoins exposure to liquidity. This ‘liquidity’ ranges from retail investors that had little idea about how to invest in bitcoin, to large-scale institutional investors that are apprehensive about the custodianship of bitcoin. Most importantly, the ETF move will improve the perception that many have of bitcoin. Bitcoin was taken for a ride by many inexperienced retail investors towards the latter end of 2017, but now, its maturing into an asset that is getting one step closer to becoming a viable store of value. Investors mustn’t forget that although bitcoin is seen as the recent phenomena, ETFs as an investment instrument is also on a similar upwards trajectory. The surging popularity of the two entities will create a hybrid that could see bitcoins value surge significantly, even in the six figures range… yep.

This was part of a wider research project conducted for FutureFuelTech assessing the development of bitcoins investment infrastructure.

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