What investment opportunities does the approval of the Bitcoin spot ETF bring?

On Wednesday EST, the US Securities and Exchange Commission (SEC) approved the first-ever Bitcoin ETF for spot trading. 11 ETFs were authorized to begin trading on Thursday. This is a milestone step in the history of Bitcoin and the entire cryptocurrency market.

Digital currencies have full currency attributes, but the source of their value has always been in doubt. That is, after an item has currency attributes, whether it can continue to be a currency depends on "consensus". When more and more people recognize that a certain item can be used as a "currency", its value will increase sharply from "item" attributes to resist the dilution of "currency" (trading medium) issued arbitrarily by fiat currency. This is what the digital currency market has always referred to as "consensus".

Therefore, when authoritative regulatory agencies recognize that digital currencies can be issued ETFs, their value will increase sharply with the increase of "consensus". So, what is this digital currency issuance? What specific impact does it have? We will delve into the operating mechanism of digital currencies to provide a more in-depth explanation.

1. Digital Currency ETF Issuance

A Bitcoin spot ETF is an exchange-traded fund based on Bitcoin as an underlying asset and is an index fund. A Bitcoin ETF allows investors in traditional stock markets to gain ownership of Bitcoin and related assets without researching, purchasing, or storing actual cryptocurrencies (or derivative assets). In other words, after buying an ETF, investors indirectly hold a certain proportion of digital currencies. In fact, there were already some Bitcoin futures ETFs listed in the US before the approval of the Bitcoin spot ETF.

The digital currency ETFs issued in the past were "futures ETFs", while this one is a "spot ETF", meaning that the underlying assets of the ETF are different. From the perspective of price fluctuations, spot ETFs and futures ETFs are very similar, both aiming to accurately track the price of BTC and help investors obtain exposure to BTC. However, compared to futures ETFs, the underlying assets of which are Bitcoin futures contracts, the operation of spot ETFs is less complex and the fees are lower.

Simply put, futures ETFs with "futures" as underlying assets face long-term losses from rolling over contracts (different futures contracts of different months have expected price differences, resulting in the futures price not being continuous with spot price value. Each time the futures contract is adjusted, there will be a loss caused by price differences). How big is this loss in extreme cases? The massive default of "crude oil treasure" a few years ago was the most extreme case in recent years. At that time, affected by the epidemic, global demand for crude oil declined, leading to a sharp drop in crude oil futures prices, and the May WTI crude oil futures price once fell to a historical low of -40 US dollars per barrel.

Similarly, the difference between investing in futures digital currency ETFs and spot digital currency ETFs is that the latter can better track digital currency fluctuations. Therefore, the market has been looking forward to the SEC approving Bitcoin spot ETF as soon as possible. This time, it is finally out. For digital currency investors, it is obviously a safer trading tool.

2. What is the impact of spot ETF approval on the Bitcoin market?

Obviously, the immediate increase in market consensus is a positive factor for Bitcoin's incremental funds, and it will significantly increase Bitcoin's trading volume and liquidity. According to data from Coinglass as of January 10, the Bitcoin balance in the wallets of the top 20 mainstream cryptocurrency exchanges is 1.89 million, with a total value of about US$86.9 billion at a price of US$46,000.

Graph: Bitcoin price and position weighting

According to GalaxyDigital's calculations, based on the overall size of the US wealth management market, if it is assumed that Bitcoin accounts for 10% of the total available assets in each wealth channel (brokerage, bank, investment advisor), and the average allocation ratio is 1%, then in the first year after Bitcoin ETF is released, an estimated $14 billion will flow into it.

Graph: Estimated Bitcoin spot market sizing & inflows

In the short term, speculation based on Bitcoin spot trading may push up the market and cause market fluctuations, but a large influx of new funds takes time, so the impact of ETF on the price in the short term is limited. However, this flow is medium and long-term, and as more funds flow into the Bitcoin market, it will have a positive impact on Bitcoin prices and may provide possibilities for the launch of other related derivatives in the future.

However, there are negative factors for institutions, such as digital currency exchanges. The issuance of ETFs is a typical competition for liquidity between traditional exchanges and emerging exchanges, which undoubtedly has a short-term negative impact on emerging exchanges, but a long-term positive impact.

Returning to investment, as the "consensus" of digital currencies strengthens and the entire market grows, it is good news for the entire industry chain:

(1) Short-term speculative trends will bring investment opportunities for Bitcoin-related concept sectors (except exchanges).

(2) From a long-term perspective, there are currently four main types of related listed companies:

1.      Mining power stocks: Conducting Bitcoin mining business by holding/custodying computing power, which is positive;

2.      Mining machine manufacturers: Developing, producing, and selling Bitcoin mining machines, which is positive;

3.      Cryptocurrency exchanges: Providing trading, custody, and wealth management services for cryptocurrencies, which is negative in the short term and positive in the long term.

Graph: Digital currency concept sector trend chart

Although digital currencies cannot generate continuous free cash flow returns like traditional assets, their special trading attributes enable them to act as a "trading medium", that is, as a "currency". We can compare this to a large "gold mining" activity, and investment opportunities are dug around the "gold mine" investment.