Approaching the launch of spot Bitcoin ETFs: Strategies for redemption and market impact
It is widely believed that Bitcoin ETF applications have played a major role in driving Bitcoin’s price back above $40k to its April 2022 level. The idea is simple: with institutional legitimacy, the capital pool for Bitcoin investment would expand, attracting institutional investors such as hedge funds, commodity trading advisors (CTAs), and mutual and retirement funds who are looking to diversify their portfolios. Bitcoin is seen as an asset that can protect against depreciation, not only against fiat currencies but also against gold, which does not have a capped supply like Bitcoin. Currently, there are 13 applicants vying to become institutional gateways for Bitcoin.
According to Matthew Sigel, VanEck’s Head of Digital Asset Research, the approval of Bitcoin ETFs by the SEC could bring more than $2.4 billion in investments in the first half of 2024, which would have a positive impact on Bitcoin’s price. SEC Chair Gary Gensler recently met with representatives from Grayscale and seven other Bitcoin ETF applicants, confirming in a CNBC interview that the path to Bitcoin ETFs is being sorted out.
One important aspect to consider is the role of custodians in Bitcoin ETFs. Coinbase, one of the dominant players in the cryptocurrency industry, serves as the custodian for 10 of the 13 Bitcoin ETF applicants. Coinbase has established strong relationships with government agencies and has partnered with BlackRock to provide institutional investors with access to Bitcoin. However, Coinbase has faced regulatory challenges, including a lawsuit from the SEC for operating as an unregistered exchange, broker, and clearing agency.
Mike Belshe, CEO of BitGo, believes that Coinbase’s fusion of merchant and custodial services could be problematic and may cause friction on the path to Bitcoin ETF approvals. The SEC has expressed concerns about market manipulation and has insisted on strict trading controls and market surveillance to prevent it.
When it comes to redemptions, there are two options being considered: in-kind redemptions and in-cash redemptions. In-kind redemptions would allow authorized participants (APs) to exchange Bitcoin ETF shares for the corresponding amount of Bitcoin. This approach is preferred by most Bitcoin ETF applicants as it minimizes the risk of price manipulation. In-cash redemptions, on the other hand, would allow APs to exchange ETF shares for cash, keeping the capital in the traditional financial system. BlackRock and Fidelity Investments both prefer the in-kind redemption model.
The SEC has not yet settled on a specific approach and is working with BlackRock to address concerns related to market maker risk. The revised in-kind redemption model would remove the need for pre-funding sell trades, while still ensuring the integrity of BTC custody. Market makers would bear the risk of redemption execution, reducing transaction costs and preventing market manipulation.
The market implications of Bitcoin ETF approvals are significant. In the short run, it is estimated that there would be a $2.4 billion influx of capital, with the potential for a $40.4 billion capital pool within the first two years. Some analysts are even more optimistic, predicting that Bitcoin ETFs will be the most successful ETF launch of all time and that Bitcoin will trade above $80k in 2024.
However, the SEC could potentially impose certain details that would deter APs from creating Bitcoin ETF shares, such as a high redemption threshold. This could have a downward pressure on the price of Bitcoin. Additionally, if the SEC approves in-cash redemptions, investors may be more incentivized to redeem ETF shares in cash, which could increase the potential for price manipulation.
Overall, 2024 is expected to be a significant year for Bitcoin, with the launch of Bitcoin ETFs, the 4th Bitcoin halving, and potential rate cuts by the Federal Reserve. The impact of these factors, along with the erosion of the dollar due to inflation, will shape the future of Bitcoin