Part One: A tectonic shift in asset management
Last week, President Biden signed a new directive calling for a thorough examination of the risks and benefits of crypto currencies. This decision, which had been awaited with a great deal of uncertainty by the crypto industry, marks a highly encouraging move along the long road to a fully regulated crypto market in the U.S.
Across the Atlantic, the European Parliament’s Committee on Economic and Monetary Affairs is currently working on a draft of its Markets in Crypto Assets (MiCA) framework, the EU’s regulatory approach to governing digital assets. While we await this proposal, crypto-related products are being created left and right to accommodate growing client demand. For example, in February of this year Grayscale launched an ETF for digital assets. Named the Grayscale “Future of Finance ETF” (GFOF), it pools together stocks that are exposed to digital assets, from Paypal to Robinhood to Coinbase. For many, this single ETF marked the beginning of a new era for Bitcoin.
Since its creation, Bitcoin (BTC) has been the subject of constant discussion regarding its potential impact on financial markets and the seismic shifts it could generate. The latest trend is the creation of ETFs that attempt to replicate the price behavior of BTC and other digital currencies.
At the time of this writing, no direct spot BTC ETF has been approved by the SEC and some market pundits say that Bitcoin will remain highly volatile until that happens. However, we have already seen this market dynamic play out in other countries. The question is, did it fundamentally change how Bitcoin trades?
To answer this, let’s first try to understand the various forces at play. On one hand, demand is clearly building. Asset managers and financial advisors are in a difficult position here, as retail investors are asking to include Bitcoin exposure in their holdings; without products that allow them to do so, those investors will invest directly in crypto as they have been doing up to this point. This translates into lower AUM and lower management fees than asset managers could otherwise earn. On the trading side, proprietary and arbitrage desks see Bitcoin as the ultimate volatile asset and are pushing for more spot and/or derivatives instruments to be created.
On the other hand, regulation is progressing far more slowly than the fast-pace at which digital assets are being created. President Biden’s new executive order brings renewed optimism and a breath of long-awaited fresh air. Will it immediately make the crypto-space a safe world for investors? Of course not. We have all seen the headlines about stolen coins and various other scams, albeit less frequently recently. Still, last month the Wormhole Network used to bridge the Solona blockchain platform with other decentralized finance (DeFi) projects, lost about $320 million in cryptocurrency funds after a novel vulnerability was exploited.
Obviously taking a prudent approach is justified in order to achieve a safe, stable, regulated environment for retail investors who wish to invest in digital assets. The challenge for fund managers is to figure out how best to equip themselves so that they are ready with the proper tools to handle this new asset class for their clients.
A “Reverse IPO”
It starts by understanding Bitcoin as an asset and the process this digital currency is undergoing. Looking at its short 11-year history we see that adoption by various market participants has moved forward in phases.
It behaves a bit like an IPO but in reverse, and in slow motion.
When we review Bitcoin’s progress over the years we are immediately surprised by the uncommon nature of its adoption. It behaves a bit like an IPO but in reverse, and in slow motion. A regular IPO works this way:
1) Regulatory approval
2) Adoption by banks, exchanges and institutional fund managers
3) Retail investor adoption
4) Derivatives (options, structured products, CFDs, ETFs, etc.)
A company preparing an IPO seeks regulatory approval and team up with banks and fund management companies to sell its shares to institutional and retail investors. At a later stage, derivative products are created to address investors’ additional needs, such as the desire for shorting, leverage or exposure management.
In stark comparison, Bitcoin turns this process on its head, looking like an IPO in reverse
1) Retail investor adoption
2) Derivatives trading
3) Institutional adoption
Initially driven by retail investors, a massive number of derivatives products have been created (many are still being developed) and traded on various crypto-focused exchanges or through counterparties. In most cases, this occurred to fill a gap or meet demand from market participants as institutional adoption and regulation of Bitcoin has progressed slowly.
ETFs are one of the ways that Bitcoin is being financialized. It’s been eight years since Cameron and Tyler Winkelvoss first submitted their filing for a Bitcoin ETF. The proposed fund was rejected twice amid concern about the risky nature of the nascent cryptocurrency market. In comparison, more than 30 ETFs applications have been filed in the U.S. over the past 12 months. While some have been approved, none are spot ETFs.
|VanEck Commodities & Bitcoin Strategy ETF||1/18/2022||In Progress|
|VanEck Gold & Bitcoin Strategy ETF||12/17/2021||In Progress|
|Global X Blockchain & Bitcoin Strategy ETF||8/19/2021||Launched|
|Blockfi NB Bitcoin ETF||11/9/2021||In Progress|
|AXS Bitcoin Strategy ETF||10/27/2021||In Progress|
|Grayscale Bitcoin Trust||10/19/2021||In Progress|
|Bitwise Bitcoin ETP Trust||10/14/2021||In Progress|
|BlockFi Bitcoin Strategy ETF||10/8/2021||In Progress|
|Invesco Galaxy Bitcoin ETF||9/21/2021||In Progress|
|Valkyrie XBTO Bitcoin Futures Fund||9/2/2021||In Progress|
|Ark 21Shares Bitcoin Futures Strategy||10/13/2021||In Progress|
|Bitwise Bitcoin Strategy ETF||9/14/2021||In Progress|
|AdvisorShares Managed Bitcoin ETF||8/20/2021||In Progress|
|Galaxy Bitcoin Strategy ETF||8/18/2021||In Progress|
|Valkyrie Bitcoin Strategy ETF||8/11/2021||Launched|
|VanEck Bitcoin Strategy ETF||8/9/2021||Launched|
|ProShares Bitcoin Strategy ETF||8/4/2021||Launched|
|Invesco Bitcoin Strategy ETF||8/4/2021||Rejected|
|Global X Bitcoin Trust||7/21/2021||In Progress|
|ARK 21Shares Bitcoin ETF||6/28/2021||In Progress|
|One River Carbon Neutral Bitcoin Trust||5/24/2021||In Progress|
|Teucrium Bitcoin Futures Fund||5/20/2021||In Progress|
|Galaxy Bitcoin ETF||4/12/2021||In Progress|
|Kryptoin Bitcoin ETF Trust||4/9/2021||Rejected|
|Wise Origin Bitcoin Trust||3/24/2021||Rejected|
|First Trust SkyBridge Bitcoin ETF Trust||3/19/2021||Rejected|
|WisdomTree Bitcoin Trust||3/11/2021||Rejected|
|WisdomTree Bitcoin Trust||12/8/2021||Rejected|
|NYDIG Bitcoin ETF||2/16/2021||In Progress|
|Valkyrie Bitcoin Fund||1/22/2021||Rejected|
|VanEck Bitcoin Trust||12/30/2020||Rejected|
Some say the time is right to launch the first spot Bitcoin ETF, for several reasons:
- It has already been done successfully in other countries, such as Canada, Germany and Switzerland
- SEC Chairman Gary Gensler is much more supportive of crypto currencies than his predecessor
- Bitcoin has come a long way. It currently has a market cap of more $1.1 trillion.
One thing is certain – a spot ETF would allow a new category of funds to “hold” the asset. Numerous derivative instruments would reference a spot ETF, with options likely to be the first. That should bring another major wave of buying, but one could argue that it will change Bitcoin as an asset and make it even more financialized than it is today, taming its volatile nature. Obviously, having access to these instruments would give asset managers more opportunities to exploit market inefficiencies, arbitrage or simply gain exposure to the asset.
In my next post, we will look at the various mutations of Bitcoin over the years and try to understand what type of financial instrument we are dealing with now.