- What is an ETF?
- How spot ETFs Work
- Status of ETF Listing Applications in the U.S.
- What is the big fuss about having a Bitcoin ETF?
- End: Reference Articles
On January 10, 2024, the SEC (U.S. Securities and Exchange Commission) finally approved the listing applications of 11 spotBitcoin ETFs! These ETFs now can be traded in the US on the NYSE, Cboe, and Nasdaq. In the EU, the first spot Bitcoin ETF was listed in Amsterdam in the summer of 2023 (source: Coindesk)
Note: The following public statement from the SEC says that it has approved "Exchange Traded Products”. The S-1 (application form) of each company states that it is not registered under the Investment Company Act, and for this reason, the SEC may officially use the term "ETP" instead of "ETF". In this article, the term "ETF" will be used.
This topic has been widely covered by crypto pundits in recent months. Many cited the imminent approval of a Bitcoin ETF by the SEC as one of the primary drivers of the price increases we saw in 2023. This article will explain what Bitcoin ETFs are, how they work, and why they will have a huge impact on our industry.
What is an ETF?
ETFs are investment products listed and traded on stock exchanges, and include mutual funds that aim to be linked to indices such as stock price indices (index-based ETFs) and actively managed mutual funds that are not linked to any index (actively managed ETFs). The acronym ETF stands for "Exchange Traded Fund". ETFs can be traded by anyone who has an account at a securities brokerage, just like listed stocks.
A typical example of an ETF product is an ETF linked to a major index such as the Standard and Poor's 500 (“S&P 500”). S&P 500 is a stock market index calculated using the shares price of 500 leading publicly traded companies in the U.S.ETFs linked to the S&P 500 are managed so that their price movements are almost the same as those of the underlying index. In other words, investing in this ETF will have almost the same effect as investing in the entire underlying index. In addition to ETFs linked to equity indices, there are also ETFs linked to real estate, bonds, commodity prices, etc.
So, the creation of a Bitcoin ETF means that we will have a product listed on stock exchanges that is linked to the price movement of Bitcoin. A Bitcoin ETF also allows traders to easily get a price exposure to the Bitcoin via traditional brokerage accounts and stock markets, without having an account on a crypto exchange.
How Spot ETFs Work
There are three types of models for spot ETFs based on the method used for its creation and options available for its redemption:1. In-kind creation / redemption model2. Cash creation / in-kind redemption model3. Cash creation / redemption methodFor this Bitcoin ETF, there was some discussion around whether to use the 1. In-kind creation / redemption model or the 3. Cash creation / redemption model. Let’s examine these models. In the case of equity ETFs, under the in-kind model, investors who wish to create an ETF will prepare a basket of shares for ETF creation from their original holdings or from the stock market or lending market. The ETF is established by contributing this basket of shares to the ETF through an “authorized participant”. In the case of redemption, the opposite is true: the physical basket is returned to investors from the ETF via the authorized participant. The base price of an ETF is the price used by the authorized participant in the issuing market to establish or redeem the ETF. In the case of equity ETFs, it is calculated once a day using the most recent closing price of the securities held by the ETF.If there is a difference between the ETF's NAV and the ETF's market trading price, the authorized participant may arbitrage, so that the two prices are less likely to diverge.
In the cash creation and redemption model, the ETF is created using cash, the ETF manager purchases the underlying shares, and at the time of redemption, the ETF manager converts the shares held by the ETF into cash for redemption. In this case, compared to the in-kind model, the divergence between the cash price and the ETF's market price may be more likely to occur.
Originally, Blackrock and others had applied for an in-kind model ETF, but over the course of communication with the SEC, they decided to switch to a cash model. It is suspected that this is because brokers, which serve as the ETF’s authorized participants, have difficulties buying, selling, and storing physical bitcoins.
Status of ETF Listing Applications in the U.S.
Since October 2023, there have been a series of revisions to the S-1s (application documents), presumably in response to the SEC's comments, and it was thought that discussions were progressing toward approval. In order to set up a Bitcoin ETF, Blackrock and other investment management companies will need to buy Bitcoin, and there were multiple topics discussed in this regard such as: where the custodian for the purchased Bitcoin will be be located, what price will the ETF's value be based on, how the price will be determined, whether or not it could be manipulated, if there is sufficient risk disclosure to investors, and so on. An S-1 amendment was made at the end of 2023 to designate Jane Street and JP Morgan as the designated participants for Blackrock's ETF (iShares Bitcoin), with Macquarie Capital (USA) Inc. and Virtu Americas further added at the beginning of the year This was one of the last amendments before approval. The CBOE has announced that trading will begin on January 11 (U.S. time).
Spot Bitcoin ETF Issues Approved Source: Bloomberg
What is the big fuss about having a Bitcoin ETF?
Bitcoin ETFs may be the catalyst for institutional investors around the world to start including Bitcoin in their portfolios. For example, according to a survey released by Laser Digital (part of Nomura Group) in June 2023, 96% of institutional investors responding to the survey believe that digital assets such as Bitcoin are a diversification opportunity alongside traditional asset classes such as bonds, cash, stocks, and commodities. As for the maximum allocation to digital assets, 80% of respondents said they expect to have about 3-5% of their portfolio in digital assets.
In this survey, approximately 90% of respondents indicated that it is important to have the backing of a large traditional financial institution before considering putting money into a digital asset fund or investment vehicle.(Source: Laser Digital Investor Survey on Digital Assets, June 19, 2023)Sometimes institutional investors have some limitations around what they can invest in, and often cannot directly invest in "crypto assets". ETFs established by large financial institutions, on the other hand, are eligible for investment. It is believed that the creation of Bitcoin ETFs will help remove hurdles for institutional investors to invest in Bitcoin.
While the total market capitalization of bitcoin is currently around 925 billion USD (843 billion EUR)and the overall market capitalization of all crypto assets is around 1.8 trillion USD (1.64 trillion EUR) (as of January 11, 2024, source: Coinmarketcap), institutional money invested in stocks and bonds totaled 131 trillion USD in the top 500 companies as of October 2022 ( Source: Willis Towers Watson), of which 3% - 5% would be around 3.9- 6.6 trillion USD. It is believed that some of this large sum of money will go to buy Bitcoin, as managers need to purchase spot Bitcoin in order to offer institutional investors Bitcoin ETFs. It’s worth noting that spot ETFs for gold, a commodity, were approved in September 2004, and the price of gold has risen considerably since then.
On the other hand, it is unlikely that institutional money will flow into the market all at once, since institutional investors need to go through a certain amount of screening and consultation with decision-making bodies before they can expand their investment targets. Also, there may be some institutional investors who decide not to invest in digital assets. The impact of Bitcoin ETF approval on the Bitcoin price needs to be carefully considered under these circumstances.
End: Reference Articles
The approval of the listing of the physical Bitcoin ETF in the U.S. is, in our opinion, a major milestone in Bitcoin's history. We look forward to watching how the investor base will grow and what impact it will have on the price and price movements.
This article was originally published on bitFlyer blog in Japan (https://blog-jp.bitflyer.com/n/n7ca5bd410db1), and was adjusted for the English version.