Alaric Securities celebrates at Nasdaq MarketSite
June 26, 2024 | Issue 68

Crypto ETFs: Bridging the Gap to Mainstream Investing

Nikolay Stoykov
Managing Partner at Alaric Securities

On January 10, 2024, the Security Exchange Commission (SEC) approved seven spot bitcoin crypto ETFs. Nearly six months later, these crypto ETFs have proven to be a resounding success, with overall assets reaching almost 65 billion USD or 1MM bitcoins.

Mined bitcoins total around 20MM, meaning ETFs now hold nearly 5% of the overall supply. Considering that not all bitcoins are available for trade, most analysts estimate that crypto ETFs account for closer to 10% of the float (bitcoins available for trade). Since their approval, bitcoin prices have surged by nearly 50%, an impressive gain.

On May 25, 2024, the SEC approved seven spot Ethereum ETFs. Even though they are approved, for regulatory reasons, they are not expected to start trading soon. The earliest estimates are for July 2024, but more realistically, September 2024 listings.

Those are the facts. Here are our interpretations of those facts:

Reducing Volatility: How Crypto ETFs Enhance Investor Access

Bitcoin investors had difficulty getting into the space. To trade the spot, investors typically needed to open a separate crypto account, and they could only use the capital available in that account for crypto trading.

As such, investors had difficulty reacting to favorable crypto price moves, especially when they wanted to buy more.

With the availability of bitcoin ETFs, investors around the globe have access to the bitcoin spot prices through their regular brokerage accounts, so the capital that can support the asset class during volatile times has increased much more.

Moreover, the emergence of 24-hour trading venues like Blue Ocean allows investors to deploy capital quickly at any time. We can reasonably expect similar results for Ethereum ETFs, even though they are not traded yet.

Of course, we will have to wait and see, but most analysts expect that Ethereum ETF will grow to 20% of the daily volume of that cryptocurrency.

Forecasting Future Returns: Insights from the CAPM Model

That interpretation indeed contradicts the narrative most people hear but is quite logical. It arises out of the CAPM model. The CAPM model says that illiquid assets have intrinsically higher expected returns.

The model suggests that to compensate for the lack of liquidity, investors require higher expected returns. Examples here include private equity firms or venture capital firms. The returns those firms need to invest are much higher than the returns offered by publicly listed companies. Some premiums are due to risk differential; small companies are riskier than big companies, but some are due to illiquidity.

Once the investment is made, the opportunity to reduce or sell may not be available. Bitcoin and Ethereum cryptocurrencies are not small, private companies, but the premium for liquidity applies to all securities. So, while most people expect that bitcoin will eventually go up to 1MM USD price, that might take longer than most people expect.

Options Trading on the Horizon: Anticipating High Volume

Unfortunately, as of today, there are no listed options for any of the bitcoin spot ETFs. Sooner or later, however, listed options on those ETFs, bitcoin and Ethereum, will become available.

Given Bitcoin’s average annual return of around 670% and Ethereum’s close to 470%, we anticipate significant interest in trading options on these ETFs. If we look at the history of the first gold ETF, GLD, we can expect many products to market these options to investors.

In particular, investors will likely show interest. For over a decade, bitcoin investors have financed themselves with leverage rates exceeding 10%. With ETFs now accessible and options anticipated to arrive soon, analysts expect the cost of leverage to decrease to levels akin to SOFR, approximately 5.3% per annum.

Disrupting Traditional Models: Challenges for Crypto Exchanges

Many crypto exchanges and lenders are very lightly regulated if regulated. Not to mention that until only a few years ago, practically none of them had ever been audited. With the approval of Bitcoin and Ethereum spot ETFs, one can reasonably expect almost all significant cryptocurrencies to get their spot ETFs.

Transacting in the ETFs, rather than the spot, is several times cheaper and faster. Practically all institutional investors and many retailers will choose to trade the ETFs rather than the traditionally fragmented and unregulated crypto exchanges, especially if there is cross-asset margining. We already see evidence of that.

Grayscale ETF, the oldest bitcoin ETF traded OTC until January 2024, saw assets under management dwindle as investors reallocated towards ETFs with lower management fees.

Greyscale lowered its management fee to only 1.5% from 2% per annum, while most new bitcoin ETFs charged only 0.25% annually. Yes, the new ETFs will make investing in crypto safer, cheaper, and easily accessible for the masses, something most traditional crypto entities could not do. Not to mention that most investors are unlikely to forget the FTX’s bankruptcy soon.

Key Takeaway

The introduction of Bitcoin ETFs is a major milestone in cryptocurrency markets. They will make it easier for investors worldwide to access and stabilize their investments. As these crypto ETFs gain popularity and Ethereum ETFs are on the horizon, we expect less volatility, lower future returns, and more options trading, showing how the market is maturing.

Additionally, the move to ETFs threatens the business models of lightly regulated crypto entities. This could lead to more mainstream adoption and regulatory oversight in cryptocurrency.


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