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It is widely believed that Bitcoin ETF applications were the main driver of Bitcoin’s return to the April 2022 level above $40,000. The thesis is simple: with a new layer of institutional legitimacy, the capital pool for Bitcoin inflow would deepen.
From hedge funds and commodity trading advisors (CTAs) to mutual and retirement funds, institutional investors have easy access to diversify their portfolios. And they would do so because Bitcoin is an anti-depreciation asset.
Not only against constantly depreciating fiat currencies, but also against gold not so capped. In contrast, Bitcoin is not only limited to 21 million, but its digital nature is secured by the most powerful computer network in the world. So far, 13 candidates have jockeyed to serve as institutional Bitcoin gateways.
According to Matthew Sigel, head of digital assets research at VanEck, the SEC approvals will likely bring in “more than $2.4 billion” in the first half of 2024 to boost the price of Bitcoin. Following the SEC’s defeat of Grayscale Investment over its Bitcoin trust-ETF conversion, Bitcoin ETF approvals are now seen as a near certainty.
Most recently, SEC Chairman Gary Gensler met with representatives from Grayscale alongside seven other Bitcoin ETF applicants. Later, in a Interview with CNBCGensler confirmed that the path to Bitcoin ETFs is a matter of ironing out the technical details.
“In the past, we have denied a number of these requests, but the District of Columbia courts have weighed in on this. We are therefore examining the issue in a new light based on these court decisions.
The most telling indicator in this direction is that BlackRock, the world’s largest asset manager, has built-in rules favorable to Wall Street. In this framework, banks could participate as authorized participants (APs) in the Bitcoin ETF exposure. This is also notable given that Gary Gensler himself is a former Goldman Sachs banker.
Given this likely horizon, what would the Bitcoin ETF landscape look like?
The Role and Concerns of Custodians in Bitcoin ETFs
Out of 13 Bitcoin ETF applicants, Coinbase is the BTC custodian for 10. This dominance is not surprising. BlackRock partnered with Coinbase in August 2022 to connect BlackRock’s Aladdin system to Coinbase Prime for institutional investors.
Additionally, Coinbase has established a close relationship with government agencies, from ICE and DHS to the Secret Service, to provide blockchain analysis software. At the same time, the largest US crypto exchange tracks requests for information from law enforcement and agencies in annual transparency reports.
As a preferred choice, Coinbase would serve the dual role of crypto exchange and ETF custodian. This has propelled Coinbase (COIN) shares to new highs this year, preparing to close out 2023 with gains of +357%. On the other hand, the same SEC that regulates Coinbase as a publicly traded company sued Coinbase in June 2023 for operating as an unregistered exchange, broker-dealer, and clearing agency.
According to Mike Belshe, CEO of BitGo, this could cause friction on the path to approval of Bitcoin ETFs. In particular, Belshe sees Coinbase’s merger of merchant and custody services as problematic:
“Building the Coinbase business involves many risks that we do not understand. There is a high probability that the SEC will refuse to approve applications until these services are completely separated. »
Previously, the reasoning often given by the SEC behind the denial of the Bitcoin ETF revolved around market manipulation. For example, as a recipient of BTC flows, Coinbase could initiate the ETF orders just before the ETF orders execute to take advantage of the price difference.
The SEC has insisted on strict trading controls and market surveillance to prevent potential market manipulation. It’s above the existing partnership between Coinbase and Cboe Global Markets for surveillance sharing.
Suffice it to say that it is in the best interests of Coinbase and its COIN shareholders not to erode the integrity of BTC custody. More important is how Bitcoin redemptions will be carried out.
Redemptions in kind or in cash: analysis of options
The Bitcoin ETF concept revolves around exposure to BTC while avoiding the potential pitfalls of self-custody of BTC. After all, it was estimated that up to 20% of Bitcoin supply is lost forever due to forgotten seed phrases, phishing, and other self-guarding weaknesses.
Once this more centralized BTC exposure is achieved, how could investors repurchase their exposure? Besides market surveillance, this has been the focus of the SEC, dividing buyouts into:
- Redemptions in kind: Although existing Grayscale (GTBC) shares are not directly tradable for Bitcoin, instead relying on the secondary market, Bitcoin ETFs would change that. The aforementioned Authorized Participants (APs) could exchange BTC ETF shares for a corresponding BTC amount.
This is the preferred approach for most Bitcoin ETF applicants, given its common use in Traditional Stock/Bond ETFs. This approach would also benefit the market, as it minimizes the risk of price manipulation by avoiding the need for large-scale BTC sales. Instead, APs can gradually sell their bitcoins without flooding the market to artificially suppress the price.
- Cash redemptions: By default, this approach is reductionist, providing a more direct BTC-to-fiat pipeline when APs trade ETF shares for cash.
Since the SEC is part of the U.S. government’s fiduciary system, the supervisory agency prefers it. Cash buybacks would close the loop on the buyback lifecycle by retaining capital in TradFi instead of exploring BTC custody.
From November 28 memorandum between the SEC and BlackRock, it is clear that the approach is not yet settled. BlackRock has revised its in-kind repurchase model, following SEC concerns about market maker (MM) risk. In the new model, there would be an additional step between the MM and the market maker’s registered broker-dealer (MM-BD).
Compared to the cash model, the revised in-kind model would remove the need to pre-finance sales transactions. This means that ETF issuers do not need to sell assets/raise cash to meet AP redemption requests. Despite the complexity, this would have no impact Unlevered Free Cash Flow.
Additionally, market makers would bear the repurchase execution risk instead of this risk falling to APs. With lower transaction costs and better protection against market manipulation, BlackRock’s preferred in-kind buyouts appear to be gaining traction.
Another large asset manager, Fidelity Investments, also prefers an in-kind model, as noted in the Dec. 7 report. memorandum.
It will then be up to the SEC to define the post-Bitcoin ETF landscape.
Market Implications and Investor Perspectives
In the short term, following the Bitcoin ETF approvals, the VanEck analyst estimates an inflow of $2.4 billion. VanEck projects a larger capital pool of $40.4 billion in the first two years.
First year, a Galaxy researcher Alex Thorn sees over $14 billion in capital accumulation, which could push the BTC price to $47,000.
However, some analysts are more optimistic. THE Bitwise The research team predicts that Bitcoin ETFs will not only be “the most successful ETF launch ever,” but that Bitcoin will trade above the new all-time high of $80,000 in 2024.
If the SEC continues its anti-crypto tradition, it could cherry-pick certain details that would have a deterrent effect. For example, a high redemption threshold would discourage APs from creating BTC ETF shares because the upfront cost of purchasing a large amount of bitcoin would be perceived as too expensive and risky.
For example, redemptions of existing gold ETFs, treated as ordinary income, result in a 20% discount over the long term capital gains tax. On the other hand, cash redemptions would not trigger a taxable event until Bitcoin is sold.
If the SEC approves cash models for some applicants, investors would have a greater incentive to redeem ETF shares for cash. In turn, this could lead to greater potential for price manipulation.
Overall, the SEC has ample room to exert significant downward pressure on the price of Bitcoin, despite its stated goal of protecting investors.
Conclusion
2024 is poised to be the triumphant year for Bitcoin. With Bitcoin ETF inflows, the market is also expecting the fourth Bitcoin halving and the Fed’s entry into rate cuts. In the meantime, the dollar will continue to erode, even under a best-case scenario of a 2% annual inflation rate.
These last two factors could even eclipse Bitcoin ETFs, whether the SEC opts for in-kind or cash redemptions, at a lower rate. Either way, Bitcoin is poised to take the next step in legitimacy. This in itself will definitely please Bitcoin holders for years to come.
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