Is it finally going to happen? A US’ spot’ Bitcoin ETF that invests in ‘physical’ Bitcoins rather than via a derivative, like a future? BlackRock, the largest ETF manager in the world, thinks so and has filed an application at a surprising moment with the US stock market watchdog, the SEC. Does BlackRock know something we don’t?
In response to BlackRock’s announcement, many providers, such as Investco, Valkyrie, and Wisdomtree, have also applied with the SEC. Nobody wants to be left behind, should the approval of a physical Bitcoin ETF succeed this time around.
An almost perfect track record
Since BlackRock’s announcement, the price of Bitcoin has risen by more than 10%. This must have a lot to do with BlackRock’s track record. The last time the SEC rejected a product offering from the ‘inventor’ of iShares was in 2014. In total, BlackRock has a score of 575 for and one against. That is a hit ratio of 99.8%. If you disregard for a moment that this is about Bitcoin, you would have to estimate the odds of this ETF being approved as high, based on BlackRock’s historical approval performance.
Some more facts. BlackRock alone controls 33% of the global ETF market (which apparently is not an issue for the SEC), with assets under management of USD 10 trillion. For comparison, the total market value of gold is about USD 13 trillion.
Incidentally, about USD 80 billion is invested in physical gold ETFs, the equivalent of a ‘physical’ Bitcoin ETF. For those who have been paying attention, one of my favorite valuation methodologies regarding Bitcoin is to estimate what share Bitcoin can gain in the total ‘premium’ investors are willing to pay to insure themselves against unpleasant developments. Those unpleasant developments, of course, are different for everyone. It could be fear of inflation, protection against declining (stock) markets, or predictions that the end of the dollar is near. In any case, if physical Bitcoin ETFs also raise USD 80 billion, that will reflect more than 13% of Bitcoin’s total market value.
Where does that USD 80 billion come from? For instance, from financial advisors. They together sit on a pool of assets worth USD 23 trillion(!). USD 80 billion represents just 0.3% of that, which is peanuts. The idea is that all those advisors have done their homework and understand that if you want to invest in Bitcoin, just like with gold, you have to opt for the ‘real deal.’ Physical Bitcoin, that is. You understand what I mean by physical here.
So much for the staggering facts explaining the recent price increase in Bitcoin. But that does not mean that this physical ETF will be released. The SEC has so far rejected 33 applications, and always for the same reason. Most Bitcoin/Crypto exchanges are not regulated, so price manipulation remains possible. In other words, a physical Bitcoin ETF cannot guarantee that you enter (or exit) at the ‘true’ price. With futures contracts, which are, for example, traded on CME, where many other regular futures also trade, you do not have this problem, or at least less so. Little has changed in this situation. In fact, the collapse of FTX is likely to have made the SEC even more cautious. If you listen closely to SEC boss Gensler, this is indeed the case.
But to tackle the manipulation issue, BlackRock has entered a ‘surveillance-sharing’ agreement with Nasdaq. This means Nasdaq will share data on customer identities and trading activity, reducing the odds of market’ manipulation.’ It is the first time such a surveillance-sharing agreement has been made part of a spot Bitcoin ETF filing.
Investors probably also have several questions. Just as some investors choose to keep their gold at home or with a custodian in a safe, there will also be Bitcoin investors who prefer to stick with their Ledger or Trezor or with a custodian who keeps the keys hidden in a mountain in Chile. An issue is also what happens in the case of a ‘hard fork.’ The Bitcoin blockchain splits, and it has to be determined which is the only real Bitcoin. In BlackRock’s proposal, this decision lies entirely with BlackRock. So, there is no such thing as a consensus mechanism.
Finally, it is pretty remarkable that BlackRock comes with its ETF filing while the SEC is chasing (and suing) Binance and Coinbase. Interestingly, the latter has been chosen as BlackRock’s custodian. You may expect that BlackRock has done a thorough due diligence on how things work at Coinbase. But I also think this reduces the chance of approval.
Story continues below.
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A little bit of perspective. There are already numerous physical Bitcoin ETFs active in Europe. That doesn’t do much for Americans, but should BlackRock receive approval from the SEC, it is not new. The positive thing is that US financial markets are much more liquid than the fragmented markets in Europe or Asia. The better the liquidity, the lower the volatility. In addition, approval will lead to significantly lower costs simply because it matches BlackRock’s strategy, to outcompete competitors with low prices. This is also advantageous if you trade Bitcoin and then store it yourself.
Intermezzo: Bitcoin as an insurance premium
One of the ways to value Bitcoin is to view it as an insurance premium. From this perspective, a comparison with gold is meaningful. Gold is 17 times as scarce as silver, yet it trades at a price more than 80 times higher than silver. This is because gold reflects an insurance premium that protects investors from unfavorable market conditions. Note, these conditions vary greatly. For some investors, it is a hedge against declining stock markets or high (expected) inflation, while for others, it is protection against the end of the dollar. Whatever the reason, gold has proven for millennia that it serves as insurance against adverse market conditions.
Given the underlying philosophy behind Bitcoin and the investors interested in this asset class, Bitcoin can (theoretically) also serve as an insurance premium. Of course, one with a significantly shorter history and track record than gold. The question remains whether Bitcoin can fulfill the function of insurance premium over the long term, not only because of the persistently high volatility.
The table below contains a scenario analysis of Bitcoin as an insurance premium. The first column lists hypothetical assumptions of the share that Bitcoin represents of the total gold-related insurance premium, which we estimate at 10,200 billion US dollars. We vary the share from only 1% to as much as 40% to get an idea of what this means for the price of Bitcoin. We also vary the time it takes for Bitcoin to reach the corresponding share of the insurance premium from three to eight years. By the way, for this analysis, we leave the estimated insurance premium of USD 10,200 billion constant, but given the debt spiral many economies find themselves in, we could opt to let the premium rise over time.
The table shows that Bitcoin needs to garner a share of more than 5% of the gold-related insurance premium for there to be upside in the price. The fact that Bitcoin is by far the smallest investment category in our universe does not change the fact that with a current market cap of USD 590 billion, Bitcoin already represents 6% of the gold-related insurance premium.
It should be noted here that this is just one method to determine the value of Bitcoin. Factors such as network value and production costs (mining) are not included. The table shows that there is certainly value in Bitcoin if it starts to represent a larger portion of the total insurance premium, as can be derived from the gold price. Still, the poorly substantiated assumption that Bitcoin is going to USD 1 million should be taken with a hefty grain of salt. This implies that Bitcoin would have a market cap of over USD 20,000 billion, twice the insurance premium that gold currently reflects.
Our main conclusion is that Bitcoin is far from ‘dead.’ The downfall of FTX has pushed many people in another direction. Unfortunately, often towards Meme stocks or Tesla options. And the SEC’s attack on other Bitcoin/Crypto entities like Binance certainly did not help. By the way, the SEC’s action in this regard is not bad news; you want to get rid of those shady unregulated exchanges to get a better sight of Bitcoin’s potential. Second, if approval takes place, the costs of investing in Bitcoin will drop significantly. And finally, a physical ETF, which already exists here in Europe, allows investors to further diversify their investments that serve as insurance. And even when you include elements in your portfolio that are meant to protect you, for whatever reason, it’s good not to put all your eggs in one basket. With this cliché, we will wrap up today’s Daily Insight.