ETC Group Crypto Minutes Week #42

First US Bitcoin ETF approved: markets boom

The United States has been waiting for years to see its first Bitcoin ETF. It’s not quite what retail or institutional investors wanted, but it is here. The Proshares Bitcoin Strategy ETF (BITO) debuted on the New York Stock Exchange on 19 October 2021.

Four days earlier, Bitcoin crossed the $60,000 threshold for the first time since April as investors bought the rumour and sent markets into overdrive.

Of course this ETF is important for Bitcoin adoption, since there are so many institutional capital pools that are not allowed to invest directly in Bitcoin or other cryptocurrencies but need regulator-approved structures by agencies such as the SEC. There is a huge pile of capital waiting to gain Bitcoin exposure by means of those products. Sebastian Markowsky, Chief Strategy Officer, Coinsource

Anticipating that incoming “huge pile of capital” were existing investors, who helped drive crypto market prices ever northwards and on to the edge of their all time highs.

Both Bitcoin and Ethereum are up by more than 100% in the last three months, compared to 67% for Litecoin, and 47% for Bitcoin Cash.

Competition for the first US Bitcoin ETF has been raging for years. The SEC has turned down scores of applications from the largest asset managers in the world, citing standard investor protections. The Winklevoss twins — the operators behind the Gemini exchange — filed for their first Bitcoin ETF in 2013. Journalists at the time were intrigued, if not hugely enthusiastic.

[Critics] also laughed at the first gold exchange-traded funds, saying funds backed by hard assets were a gimmick; today gold ETFs combined are the world’s fourth largest holder of gold, behind only the United States, Germany and the International Monetary Fund. Chuck Jaffe, Marketwatch

By 2018 no Bitcoin ETFs had appeared. The Winklevoss brothers had, a year before, seen the SEC turn down their application yet again. And with Bitcoin priced at just under $8,000 the SEC denied them their second application for a Bitcoin ETF.

On a single day in August 2018, the US securities regulator slapped down eight ETF proposals: the first was Proshares’ Bitcoin futures ETF proposal, alongside one from GraniteShares and five inverse and leveraged options from Direxion.

Bitwise has been pursuing the issue since 2019, with all attempts for a pure Bitcoin ETF knocked back, delayed or outright turned down. Seeing ProShares win the race has spurred Bitwise back into action this week, as it applied for an “actual” Bitcoin ETF with NYSE Arca.

Bitcoin futures ETFs are by their nature a more speculative tool than ETPs that accurately track the price of Bitcoin directly, allow redemption in BTC and are centrally cleared, such as ETP Group’s BTCE — now the most-traded and largest of its kind globally with $1.3bn AUM.

US retail investors, specifically, are attracted to products with an ETF structure because they are eligible to be traded through tax-exempt 401(k) plans, offering direct bitcoin exposure through pension savings.

Currently the largest Bitcoin investment vehicle of its kind is the Grayscale Bitcoin Trust which launched in 2013 and to date holds around 3.5% of all Bitcoin in circulation, but this product comes with significant downsides. Its structure comes with significant lock-up periods and does not offer active redemption, which has produced catastrophic divergence between its share price and the NAV (net asset value) of GBTC.

As noted above, the spot price of Bitcoin is up more than 100% since July, but the GBTC price is more than 35% below that figure. On 19 October Grayscale filed with the SEC to convert GBTC into an ETF.

The structure of the ProShares Bitcoin Strategy ETF is likely to incur unwanted costs for investors, experts agree. As one analyst told Reuters:

There is no free lunch. An ETF based on futures is not ideal as there is a cost to rolling into the futures contracts, given contango...translating into underperformance versus the underlying asset. Martha Reyes, head of research, Bequant

The final quarter of the year is likely to see more US Bitcoin ETFs approved, with decisions due from the SEC on four products from Global X, Kryptoin, Valkyrie and WisdomTree.

China Bitcoin mining drops to zero: US takes over

China has systematically destroyed its vast Bitcoin mining industry over the past year, and now there exist the statistics to prove it.

Updated data to August 2021 from the Cambridge Center for Alternative Finance, released on 13 October 2021 shows that China’s share of Bitcoin mining has fallen to zero.

The United States has nearly tripled its share to more than 35% of global Bitcoin hashrate since the last CCAF statistics were published in April 2020. With Canada’s boom to 9.55%, it means that North American mining operations now control nearly half the global Bitcoin hashrate. At its peak, China controlled approximately three-quarters of Bitcoin hashrate.

The reaction to one of the biggest sources of Bitcoin hashrate dropping off the map entirely was not the bloodbath one might have expected: Chinese miners have fled their home country in droves, instead pitching up in the US, in Texas, Maryland and Georgia, or moving their operations to locations with cheap electricity sources; namely Russia and Kazakhstan.

Hashrate is a measurement of the amount of computing power that miners expend for securing the Bitcoin network, processing transactions and minting new BTC. The higher the hashrate of a Proof of Work blockchain, the more resistant it is to attack.

Since its series of anti-crypto actions started coming into force in May 2021, Bitcoin hashrate dropped from an all-time high of 180.66TH/s to a low of 89.03TH/s. However the recovery since then has been markedly strong, with hashrate climbing back to more than 140TH/s.

Market analysts have largely welcomed China’s pullback from the global Bitcoin stage.

The effect of the Chinese crackdown is an increased geographic distribution of hashrate across the world, which can be considered a positive development for the decentralised principles of Bitcoin. Michel Rauchs, digital assets lead, Cambridge Center for Alternative Finance

China’s domination of the Bitcoin mining machine market may also be coming to a close.

In a 15 October tweet thread, Square and Twitter CEO Jack Dorsey outlined his plans to start producing ASIC chips: the computationally-heavy tools required to run through billions of calculations per second to solve Bitcoin’s Proof of Work equations. Beijing-founded Bitmain has had a near-monopoly since 2013 by bringing ASIC chips to the mass market.

Crypto regulation “urgent”, says Bank of England deputy governor

The UK has not legislated on cryptocurrency at a national level: while its law taskforce was well ahead of the curve, concluding as early as 2019 that smart contracts are legally binding, for example, the government has summarily failed to offer businesses the kind of certainty they are clamouring for, beyond support through the Financial Conduct Authority’s regulatory sandbox and the odd warning to retail investors about speculation, usually rather ironically from high net-worth brokers and bankers.

That is not good enough, says the Bank of England deputy governor for financial stability Sir Jon Cunliffe, in comments to the global financial conference SIBOS on 13 October.

Bitcoin and cryptocurrencies are becoming tightly integrated with traditional finance, and so pose potential systemic risk, he notes.

Interconnectedness is one thing, but leverage is entirely another. While exchanges like Binance and FTX have dialled back their 125x leverage for retail investors, it is still entirely possible for hedge funds to take out large leveraged positions, and there are around 150 to 200 specialist funds focused on crypto operating today.

“Similarly to the story for interconnectedness, there is evidence of rapid growth,” Cunliffe proposed, offering the example of CME crypto futures trading volume has increased tenfold this year to around $2bn a day.

On DeFi he says it is clear that the sector is “opaque, complex and [with] pronounced market integrity challenges given the absence of investor protection,” adding that “even if such provisions were in place, there may be no one for regulators to engage and hold accountable.”

The senior civil servant is no crypto sceptic: in fact, he believes that cryptocurrencies and cryptoassets have and will continue to revolutionise finance.

Crypto technology offers great opportunity. As [Ralph Waldo] Emerson said: ‘if you build a better mousetrap the world will beat a path to your door’...Bringing the crypto world effectively within the regulatory perimeter will help ensure that the potentially very large benefits of the application of this technology to finance can flourish in a sustainable way. Sir Jon Cunliffe, speech to SIBOS 2021

Markets

BTC/USD

Bitcoin soared over the fortnight as news rumbled along of the likelihood that the SEC would make a landmark move to approve the first US ETF. From a starting point below $50,000, BTC added 26.9% across the two-week trading period, climbing to $63,305.78. This position is just 2.4% off its all time high of $64,881, reached on 14 April 2021. As evidenced by the steady climb north, the bulls are in full control as we turn towards the latter stages of October 2021.

ETH/USD

Ethereum has not yet managed to reclaim the $4,000 mark it first breached in May 2021; significant efforts were made by traders in this direction across the fortnight but prices stalled short of the key level, making it up to $3,962.28 before retracing those gains. That’s not to say ETH is not looking bullish; a total of 14.6% was added across the two weeks. As the trading period came to a close, ETH sat at $3,858.41, still nearly 14% below its all time high reached on 12 May.

LTC/USD

Litecoin showed a little more volatility against the dollar than we have traditionally come to expect from the payments blockchain, swinging markedly back and forth throughout the trading session. Across the fortnight LTC dipped by 3.9% to a low of $163.74 before climbing strongly to add 17.6% and reach $192.66. Recent positive adoption news for Litecoin may still be playing a part in bullish attempts to break $200, but the steam ran out by 19 October with Litecoin at $183.19.

BCH/USD

The trading story over the past two weeks for Bitcoin Cash is that the bulls tipped it, although not by much. From a starting point of $557.91 BCH dipped a fraction of a percent, before starting its upward ascent. Across the fortnight BCH swung back and forth as markets digested the wider Bitcoin ETF news, with the coin adding a total of 16.3% to hit $648.86. BCH backslid from here by 6.8% to end just above the key $600 level.