Wednesday, December 6, 2023

May a spot Bitcoin ETF result in ‘paper’ Bitcoin controlling the market?

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The air is thick with hypothesis. Bitcoin, the flagbearer of the digital forex realm, stands on the precipice of historic transformation.

The sport seems to be altering with monetary titans like BlackRock, Constancy, and Ark Make investments submitting for SEC approval for spot Bitcoin ETFs. However is all of it sunshine and rainbows from right here?

Whereas approval might set off a wave of institutional cash, there are rising issues that it might additionally result in the emergence of “paper Bitcoin,” probably steering the Bitcoin market away from its decentralized essence.

The Rapid Upside: An Onramp for Institutional Cash

Bitcoin’s unstable previous has seen it battle for mainstream acceptance. Nevertheless, submitting spot Bitcoin ETFs by monetary behemoths strongly signifies a extra steady future. There’s an optimistic buzz out there, not simply due to these filings but additionally as a result of these proposals declare to handle the SEC’s issues about fraud and market manipulation.

If the SEC green-lights these ETFs, we’re taking a look at a possible torrent of institutional funding that would elevate Bitcoin to staggering new highs.

By way of market affect, these developments have already set the wheel in movement, with Bitcoin surging over 20%, closing in on the $35,000 mark. With billions in inflows anticipated, there’s chatter about Bitcoin hovering to over $145,000.

The Lengthy-Time period Concern: The Rise of “Paper Bitcoin”

Nevertheless, the creation of spot Bitcoin ETFs additionally brings the danger of giving start to “paper Bitcoin”—a illustration of precise Bitcoin possession with out requiring bodily custody of the digital cash.

This might mark a tectonic shift in how Bitcoin is traded, managed, and understood. Like gold ETFs, usually settled in money and never bodily belongings, spot Bitcoin ETFs might make it simpler for buyers to guess on Bitcoin’s value with out proudly owning the asset.

If paper Bitcoin features floor, a spot between precise provide and demand could kind, probably permitting the ETFs to manage value discovery and disrupting the decentralized ethos that Bitcoin was constructed upon. With extra folks investing in paper Bitcoin relatively than the precise asset, there are fears that Bitcoin’s provide may very well be manipulated to serve the pursuits of bigger monetary entities.

Nevertheless, when reviewing the newest BlackRock submitting for its spot Bitcoin utility, it doesn’t seem to be BlackRock might situation paper Bitcoin with out holding the underlying asset.

The prospectus states that the Belief will retailer precise Bitcoin with a custodian. The bitcoins are held in “chilly” (offline) storage and buying and selling accounts. When new shares are issued, they should be backed by a corresponding quantity of Bitcoin deposited into the Belief’s accounts.

The prospectus states

“No Shares are issued until the Bitcoin Custodian or Prime Dealer has allotted to the Belief’s account the corresponding quantity of bitcoin.”

The worth of the shares tracks the worth of the particular Bitcoin held by the Belief, based mostly on a Bitcoin pricing index. The Belief should pay bills and charges, which implies it must promote a few of its Bitcoin holdings periodically. Nevertheless, the variety of shares stays fixed, decreasing the quantity of Bitcoin backing every Share.

So, based mostly on the outline within the prospectus, it doesn’t appear possible for BlackRock to situation these shares with out holding the underlying Bitcoin belongings to again them. The Shares signify direct possession pursuits within the Belief, which straight owns the bitcoins.

The Liquidity Paradox

Furthermore, whereas Bitcoin ETFs would possibly promise elevated liquidity, let’s not neglect that over 76% of present Bitcoin is held by long-term holders in accounts that haven’t transacted in over 155 days.

bitcoin long term holder supply ytd
Graph exhibiting the provision of Bitcoin held by long-term holders in 2023 (Supply: Glassnode)

The prevalence of “hodling” suggests a sure resilience but additionally factors to present liquidity challenges. An inflow of paper Bitcoin might exaggerate these liquidity points, making the market even much less accessible for brand spanking new entrants and present holders who would possibly wish to promote.

This huge reserve of inactive Bitcoin underscores not simply the long-term confidence of those holders but additionally a sensible liquidity problem already out there.

The phenomenon of “hodling” represents each energy and vulnerability. On the one hand, it alerts agency investor conviction in Bitcoin’s future, probably stabilizing costs and serving as a buffer in opposition to market volatility.

hodler net position change bitcoin 1y
Graph exhibiting the ‘hodler’ web place change from October 2022 to October 2023 (Supply: Glassnode)

Alternatively, it signifies that a good portion of Bitcoin’s provide is off the marketplace for all intents and functions. This creates a good provide surroundings, making it tougher for brand spanking new buyers to enter and present holders to exit with out inflicting important value fluctuations.

Introduce “paper Bitcoin” into this equation, and the liquidity dynamics may very well be much more complicated. If a big phase of market participation shifts in direction of buying and selling paper Bitcoin by way of ETFs, we would discover ourselves in a paradoxical scenario.

Whereas these ETFs might supply the attract of enhanced liquidity on the floor, they might concurrently exacerbate the prevailing liquidity challenges within the precise Bitcoin market.


As a result of paper Bitcoin doesn’t instantly necessitate the acquisition of actual Bitcoin, probably inflicting a disconnect between provide and demand metrics. This might create a bifurcated market—liquid on paper however more and more illiquid in actuality—posing challenges for each new entrants in search of to purchase and present holders seeking to promote.

May BlackRock situation ‘paper’ Bitcoin with out holding the underlying asset?

Within the BlackRock prospectus, I couldn’t determine specifics on the timing lag between share purchases and Bitcoin acquisitions. Nevertheless, it does counsel that Bitcoin is acquired earlier than shares are issued:

“The Belief points and redeems Shares solely in blocks known as “Baskets.”

Solely “Licensed Contributors” could buy or redeem Baskets. To create a Basket, an Licensed Participant deposits the corresponding Bitcoin with the Belief in trade for shares.

This means BlackRock would wish to have custody of adequate Bitcoin earlier than issuing new shares to an Licensed Participant. The prospectus doesn’t seem to explain a mechanism for issuing shares earlier than buying Bitcoin.

Nevertheless, the prospectus doesn’t present all operational particulars. So, whereas it suggests shares are solely issued after getting Bitcoin, it’s attainable there may very well be some brief lag in apply.

Thus, whereas Bitcoin ETFs maintain the promise of elevated liquidity, the prevailing pattern of “hodling” and the potential inflow of paper Bitcoin create a nuanced panorama. It might result in a market that seems liquid however is fraught with underlying challenges, making it each compelling and treacherous for buyers.

Classes from the Gold ETF surge

After we contemplate the way forward for Bitcoin ETFs, the trajectory of gold ETFs gives an illuminating case research. Launched in 2003, gold ETFs revolutionized how buyers might entry this conventional retailer of worth. They ushered in a plethora of benefits, reminiscent of price effectivity, elevated transparency, and enhanced liquidity, successfully democratizing gold funding.

Let’s take a look at the numbers to know the affect higher. The typical every day buying and selling quantity for gold in 2023 stands at $139 billion, making it probably the most liquid belongings globally, partly due to the liquidity and accessibility supplied by gold ETFs.

Furthermore, gold costs displayed resilience, falling solely 3.7% in Q3 2022 however remaining up by 11% over the earlier yr. These dynamics counsel that ETFs can appeal to important funding even when the underlying asset faces market headwinds.

So what might this imply for Bitcoin? If Bitcoin ETFs are accredited and handle to copy even a fraction of gold ETFs’ success, we might witness an influx of institutional and retail funding on a scale not seen earlier than within the crypto market. On condition that gold ETFs have enabled every day buying and selling volumes within the lots of of billions and Bitcoin presently trades round $23 billion per day, Bitcoin ETFs might equally develop into a catalyst for large quantity and capital influx.

Nevertheless, the important thing distinction right here lies out there cap and present liquidity. Gold has been traded for hundreds of years and has a market cap within the trillions, whereas Bitcoin, with its $669.7 billion market cap, remains to be in its adolescent stage. But, this additionally signifies extra room for exponential development.

Thus, the transformative impact of gold ETFs on their underlying asset affords a tantalizing preview of what may very well be in retailer for Bitcoin. Whereas one should train warning given the inherent variations and dangers between the 2 belongings, the profitable path paved by gold ETFs means that Bitcoin may very well be on the cusp of a brand new period of funding, liquidity, and valuation.

The Halving X-Issue

Including a layer of complexity is Bitcoin’s impending halving occasion. With the provision of latest Bitcoin set to lower, an ETF-induced demand surge might ship costs skyrocketing. But when that demand is principally for paper Bitcoin, then the implications for the precise, bodily Bitcoin market may very well be unprecedented and unpredictable.

Whereas the potential approval of spot Bitcoin ETFs opens the door for transformative institutional funding, it additionally raises official issues.

The rise of “paper Bitcoin” might shift management of the Bitcoin market away from particular person, decentralized actors to extra centralized monetary entities.

As we stand at this important juncture, one factor is certain: the choices made in the present day may have a far-reaching affect on the Bitcoin panorama of tomorrow.

Subsequently, whereas we could revel within the short-term features, we should be cautious of the long-term implications. In spite of everything, within the quest for legitimacy and acceptance, Bitcoin should not lose its soul.

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