Daniel Malinovski
July 6, 2023
Macro Monday


In this article, we delve into the implications of Bitcoin Exchange-Traded Funds (ETFs) and their potential impact on the next bull run. We explore the fundamentals of ETFs, how they function, the landscape of BTC ETFs, the implications of BTC ETFs, and some of our thoughts.

What are ETFs?

Exchange-Traded Funds (ETFs) are investment vehicles that trade on stock exchanges, mirroring the performance of a specific index, sector, commodity, or asset class. They offer investors a convenient and cost-effective way to access a diversified portfolio of assets.

Here's a simplified explanation of how ETFs work:

• Structure: ETFs are structured as open-ended investment funds. They issue shares, which represent an ownership interest in the fund's underlying assets.

• Creation: ETF shares are created through a process known as creation. Authorized participants (typically large financial institutions) gather a basket of securities that closely mirrors the ETF's target index. They then deliver this basket of securities to the ETF provider in exchange for a specified number of ETF shares.

• Secondary Market Trading: Once created, ETF shares can be bought and sold on stock exchanges, just like individual stocks. The price of ETF shares in the secondary market is determined by supply and demand factors and may deviate slightly from the net asset va lue (NAV) of the underlying assets.

Understanding the Landscape of BTC ETFs: The SEC's Stance

The SEC has taken a cautious approach to BTC spot ETFs having rejected 33 proposals. Notably, rejections include Grayscale's attempt to convert its trust into an ETF. Grayscale had hoped to convert its $13.5 billion trust into an ETF (The Grayscale Bitcoin Trust is a financial vehicle that enables investors to trade shares in trusts holding large pools of Bitcoin. Shares in the fund track the price of Bitcoin, but only roughly.) The SEC stated in its decision that the application failed to answer the SEC's questions about preventing market manipulation, as well as other concerns.

Spot vs. Futures: The Dichotomy in BTC ETFs

Whilst the SEC has rejected countless spot BTC ETFs they have approved two BTC future ETFs. The difference between spot and future ETFs are:

⁃ The bitcoin ETF is backed by real bitcoin, while bitcoin futures ETFs are backed by derivatives of bitcoin (futures contracts).

⁃ The price of bitcoin futures may diverge from the spot price of bitcoin due to the prevailing market sentiment so bitcoin futures ETFs might also occasionally track the price of bitcoin inaccurately. In the case of a bitcoin ETF, there is no risk of price divergence, thanks to the fact that the ETF is backed by real bitcoin.

Blackrock's Entrance: A Game-Changer in the ETF Space

Blackrock, the colossal asset manager known for overseeing roughly $10 trillion in assets, has made a ground-breaking move by filing for a Bitcoin ETF on June 15th. Their offering, known as iShares Bitcoin Trust, has generated significant attention. Interestingly, the filing reveals Coinbase Custody as the chosen custodian for the ETF. Despite the intensified scrutiny from regulators, Blackrock's outstanding track record in obtaining ETF approvals (with a remarkable 99.86% success rate) adds immense weight to their application. It's worth noting that the only time a Blackrock ETF application faced rejection was back in 2014, and that was due to concerns surrounding transparency and manipulation risks specifically related to a silver ETF.

The implications of Blackrock's filing have rippled through the traditional financial world, prompting five other notable entities to follow suit. The likes of Fidelity, Invesco, Wisdom Tree, Valkyrie, and Bitstamp have all filed applications for their own Bitcoin ETFs, acknowledging the potential significance and market demand for such investment vehicles.

Will BlackRock’s ETF application succeed?

While Blackrock's track record may make it seem like destiny for their ETF to be approved, it's important to recognize that the Securities and Exchange Commission (SEC) will take several months to carefully review the filing. The SEC has shown hesitation in the past when it comes to approving Bitcoin ETFs, primarily due to concerns about market manipulation and the potential influence of large-scale Bitcoin holders. However, Blackrock is proactively addressing these concerns by proposing to exclusively use reputable Bitcoin exchanges and by establishing a surveillance-sharing agreement with Nasdaq, a move aimed at ensuring a robust monitoring mechanism.

The outcome of the SEC's review remains uncertain, but the entry of a heavyweight player like Blackrock into the Bitcoin ETF arena certainly adds a new level of anticipation and potential validation to the market. As the regulatory landscape continues to evolve, the decision on Blackrock's ETF could have a profound impact on the mainstream adoption of cryptocurrencies and shape the future of digital asset investments.

*Side Note: Members of the SEC have commented on the BTC ETF filing from Blackrock stating that it was inadequate, but this is not an official decision or official statement released by the SEC.

TradFi taking over BTC?

Following the filing of the ETF by Blackrock, there has been a significant surge of interest in the cryptocurrency market from the traditional finance sector (TradFi). Five other ETF applications have emerged, indicating a growing recognition of the potential of digital assets. Moreover, last week witnessed the announcement of a new exchange backed by prominent institutions such as Fidelity International, Charles Schwab, and Citadel Securities. This exchange facilitates the trading of various digital assets, including Bitcoin, Ethereum, Litecoin, and Bitcoin Cash. Despite the challenges faced during the recent downturn following the Luna and FTX crashes, TradFi has demonstrated an unwavering commitment to the digital asset space.

According to Saxo Bank, the filing of the Blackrock ETF application has reignited institutional investor interest and demand. As institutional demand continues to grow, it is reasonable to expect a subsequent clarification of policies and regulations, thereby fostering a spiralling effect where demand for digital assets further increases. This development holds promising prospects for Bitcoin investors, as the potential approval of the Bitcoin ETF could pave the way for institutional and first-time investors to gain exposure to BTC. Consequently, the market would experience an influx of capital. Over time, Bitcoin investments could even transition into the realm of mainstream investment opportunities.

However, it is important to acknowledge that the embrace of centralization and regulation, which facilitates wider adoption, may not fully align with the philosophical views held by many DeFi/BTC maximalists. Bitcoin was originally conceived as a means to liberate financial systems from traditional constraints. Yet, the current trend suggests that Bitcoin is gradually assimilating into the existing financial landscape, which poses a challenge for those who adhere to a more decentralized vision.

Blockchain Sensei Thoughts

Decentralized self-custody is a core principle in crypto, however, ETFs deviate from this concept, lacking direct ownership visibility for holders – this raises concerns about Grayscale's value and the potential for increased insider trading with higher on-chain transactions. Moreover, a tangential point, ETFs introduce more volatility to an already volatile asset class, allowing certain institutions to profit way more: Coinbase could earn an extra $500 million in revenue if Blackrock generates $100 billion in trading volume using others' funds.

USD Coin (USDC) conversions, partly owned by Coinbase, contribute to its profitability and appeal to investors. It’s interesting that Blackrock emerges as a notable Coinbase shareholder, potentially earning more than meets the eye. This milestone signifies a turning point for Bitcoin and crypto and aligns with Ark Invest's $1 million Bitcoin price thesis, offering exposure and diversification through trusted industry players.

On top of this, geopolitical risks arise from this ETF structure. With a high statistical likelihood (99.86%) of Blackrock and the US adopting it, the implications are significant. The ETF and crypto market situation has its comical aspects, with speculation of pre-rehearsed FUD dances. Nevertheless, ETFs reshape the industry, paving the way for institutional involvement.

Simplicity Group Thoughts

The United States has faced criticism for potentially stifling innovation within its borders, particularly considering recent lawsuits filed by the SEC against prominent cryptocurrency exchanges like Binance and Coinbase. Initially, there were speculations that these actions could trigger a shift in the leadership of the next Bull Run towards the East, with considerations of Coinbase potentially relocating to countries like England or Dubai. However, the filing of the ETF by Blackrock and the significant influence of lobbying within the United States have bolstered my belief that the nation will maintain its prominent position as a leader in the Web 3 industry.

The power of lobbying becomes evident when we examine the case of Sam Bankman Fried, who has successfully navigated legal challenges so far. Taking into account the substantial lobbying capabilities of Blackrock, the largest asset manager, advocating for Coinbase - which plays a crucial role in the custodial aspects of the ETF - it becomes apparent to me that Coinbase is likely to receive regulatory support and clarity within the United States. Overall, these ETF filings represent much more than TradFi entering the crypto space; they signal the continued mainstream presence of the United States in the world of cryptocurrencies.

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