ETF Insights: Don’t fall into the hype of the new spot Bitcoin ETFs (January 2024)

On 11 January 2024, the SEC approved Grayscale's spot Bitcoin ETF application, along with applications from major industry players like Bitwise, BlackRock, WisdomTree, ARK 21Shares, and Invesco Galaxy. However, the SEC Chairman cautioned investors about the risks associated with products tied to cryptocurrency, emphasising that the approval did not imply endorsement of Bitcoin.

Recently, we reiterated the dangers of trading in Bitcoin ETFs and other related cryptocurrency products. We highlighted the fact that cryptocurrencies lack fundamentals, have high volatility and low scalability, which makes them a poor form of currency. Furthermore, the space is filled with scandals and frauds, as shown by cases like the Terra/Luna algorithmic stablecoin, Three Arrows Capital, and FTX. Hence, we recommend investors to avoid trading in these newly-launched spot Bitcoin ETFs.

Related Article: The dangers of investing in Bitcoin ETFs and Crypto-related products

In this article, we delve deeper into how spot Bitcoin ETFs work, comparing their key characteristics, and exploring the potential risks involved.

What are spot Bitcoin ETFs?

Spot Bitcoin exchange-traded funds (ETFs) serve as investment instruments that enable investors to engage in the price movements of Bitcoin using regular brokerage accounts. The key difference from existing Bitcoin ETFs is that they allow investors to track the price of Bitcoin by directly owning it. This is in contrast to the existing ETFs which employ derivative instruments to enable investors to speculate on the future price of Bitcoin.

How do spot Bitcoin ETFs work?

Spot Bitcoin ETFs store Bitcoins securely in a protected digital vault managed by registered custodians. The primary objective of such ETFs is to replicate the price movements of Bitcoins in the cryptocurrency market. Initially, the ETF acquires Bitcoins from other holders or authorised cryptocurrency exchanges. These tokens are then stored in a digital wallet, employing multiple security layers, including cold or offline storage, to mitigate risks such as hacking.

Following this, the ETF issues shares corresponding to a specific quantity of Bitcoins it holds. The share price of the ETF is intended to mirror the prevailing market price of the cryptocurrency. As a result, ETF shares closely mirror the movements in Bitcoin prices, making adjustments through the purchase or sale of tokens to rebalance their holdings.

For investors, investing in a spot Bitcoin ETF resembles buying shares in any other ETF or listed security. Market makers contribute to maintaining market liquidity and efficiency by continuously offering to buy and sell ETF shares. Moreover, they remove the need to manage a cryptocurrency wallet or deal with the security concerns associated with safeguarding private keys for investors.

However, MAS has shown a negative stance towards the new ETFs, citing that they are unsuitable for retail investors.

Comparison of the spot Bitcoin ETFs

Grayscale Bitcoin Trust (NYSE:GBTC) has the highest AUM out of 11 spot Bitcoin ETFs approved by the SEC (Table 1). The reason is largely due to the longer history of GBTC, which was officially converted from a trust structure to an ETF following the approval. Prior to its now-ETF status, its AUM was at USD 26 billion and made up more than 3% of the bitcoin supply as of 29 December 2023. Despite having size, liquidity and a longer track record, GBTC possesses the highest expense ratio of 1.50% among other spot Bitcoin ETFs.

Unsurprising, other notable spot Bitcoin ETFs with considerably high AUM and volume include the iShares Bitcoin Trust (NASDAQ:IBIT) and Fidelity Wise Origin Bitcoin Fund (BATS:FBTC) as they are prominent issuers within the traditional finance space.

In terms of fees, many spot Bitcoin ETFs are pushing for fee waivers in hopes of capturing a larger pool of investors. Excluding the respective fee waivers, Franklin Bitcoin ETF (BATS:EZBC) has the lowest expense ratio of 0.19% (Table 1).

Meanwhile, the Hashdex Bitcoin Futures ETF (NYSE: DEFI) has obtained approval from the SEC regarding a change in its investment strategy, transitioning from futures to spot Bitcoin. However, as of 11 January 2024, the issuer has confirmed that the ETF does not currently possess any Bitcoin and changes to both the ETF's name and holdings will be implemented at a later date.

Table 1: Comparison table of spot Bitcoin ETFs

No.	Name	AUM (USD mil)	Volume (‘000)	Expense Ratio	Note
1	Grayscale Bitcoin Trust (NYSE: GBTC)	20,840	8,800	1.50%
2	iShares Bitcoin Trust (NASDAQ:IBIT)	2,190	18,100	0.25%	Fees are reduced to 0.12% for first 12 months of trading or first USD 5 billion in AUM, whichever comes first.
3	Fidelity Wise Origin Bitcoin Fund (BATS:FBTC)	1,940	10,400	0.25%	Fees are waived till 31 July 2024.
4	ARK 21Shares Bitcoin ETF (BATS: ARKB)	605	2,800	0.21%	Fees are waived for first six months of trading or first USD 1 billion in AUM, whichever comes first.
5	Bitwise Bitcoin ETF (NYSE:BITB)	570	2,700	0.20%	Fees are waived for first six months of trading or first USD 1 billion in fund assets, whichever comes first.
6	Invesco Galaxy Bitcoin ETF (BATS: BTCO)	287	786	0.39%	Fees are waived for first six months of trading or first USD 5 billion in AUM, whichever comes first.
7	VanEck Bitcoin Trust (BATS: HODL)	124	189	0.25%
8	Valkyrie Bitcoin Fund (NASDAQ:BRRR)	111	209	0.25%	Fees are waived for the first three months.
9	Franklin Bitcoin ETF (BATS:EZBC)	57	446	0.19%	Fees are waived till 2 August 2024, or first USD 10 billion in AUM, whichever comes first.
10	Hashdex Bitcoin Futures ETF (NYSE:DEFI)	17	13	0.90%
11	Wisdomtree Bitcoin Fund (BATS: BTCW)	8	69	0.30%	Fees are waived for first six months of trading or first USD 1 billion in AUM, whichever comes first.
Source: Bloomberg Finance L.P., iFAST Compilations. Data as of 26 Jan 2024

Risks involved

Lacking fundamentals

The major risk regarding these spot Bitcoin ETFs or other cryptocurrency-related products is that they lack fundamentals and intrinsic value. The true value of an asset might be derived from the value of its future cash flow discounted to the present day or its book value. Unlike companies, cryptocurrencies like Bitcoin do not have any prospects for their cash flows. Hence, by investing in these spot Bitcoin ETFs, you are essentially investing in an underlying asset with no intrinsic value.

Moreover, there is no reliable method to assign a proxy value to cryptocurrencies, as they cannot be linked to any tangible asset. This limitation arises from their lack of real-world utility, as they cannot serve as inputs for commercial products. Unlike commodities, cryptocurrencies like Bitcoin cannot be used in the production of a tangible asset that might otherwise offer a proxy value for such input.

Cryptocurrencies also lack a proven long-term relationship with economic fundamentals, unlike traditional asset classes like equities, fixed income, commodities, and currencies. Establishing a dependable relationship, especially for speculative and volatile cryptocurrencies like Bitcoin, proves challenging.

In summary, the lack of fundamentals makes it difficult to determine the intrinsic value of cryptocurrencies, resulting in their prices being driven by sentiment, rendering them highly speculative and risky.

High volatility and low scalability

A frequently advocated use for cryptocurrencies, particularly Bitcoin, is their potential role in money transfers or as a currency. However, two key factors make Bitcoin unsuitable for such purposes – its volatility and transaction processing limitations.

Firstly, Bitcoin’s volatility makes it impractical as a medium for everyday transactions. The instability could result in significant fluctuations in the prices of daily goods, creating an unfavourable environment for everyday citizens. Central banks and governments frequently aim for price stability, a criterion that Bitcoin, functioning as a currency, does not fulfill.

Secondly, the energy and computing power needed to process a transaction with Bitcoin is high. Hence, Bitcoin can only process about up to seven transactions globally per second and requires about ten minutes for a transaction to be processed. In contrast, a Visa payment is processed within seconds and can handle up to 24,000 transactions per second. Hence, due to scalability issues, Bitcoin's transaction rate falls significantly short of what is required for it to function as a global currency.

A hotbed for fraudsters, money launderers and thieves

The cryptocurrency space has been plagued by scandals in recent years. From the collapse of the Terra/Luna algorithmic stablecoin, essentially a Ponzi scheme, to the downfall of Three Arrows Capital (3AC) and FTX, where investors' assets were used for speculative trading, these incidents serve as significant warnings about the high-risk nature of the cryptocurrency space.

In addition to these prominent examples, the cryptocurrency space continues to attract money launderers and thieves. Criminals exploit the anonymity offered by cryptocurrencies to conceal their activities and channel illicit funds into various sectors, including the economy, banks, financial institutions, and legitimate investments. On another note, the substantial number of coins necessary for a viable spot Bitcoin ETF makes them attractive targets for these criminals.

Despite ETF issuers implementing robust security measures such as cold storage and encryption, no system is completely immune. Successful major breaches at spot Bitcoin ETFs could result in the theft of significant amounts, potentially reaching thousands or even millions of dollars in Bitcoins. Stolen Bitcoins, unlike funds in a bank, can be quickly transferred anonymously and are impossible to recover. While cyber theft incidents are rare, some cryptocurrency exchanges and holders have been affected. A breach of this nature for a spot Bitcoin ETF could significantly erode investor confidence and jeopardise the fund's stability.

Without greater transparency and a well-defined regulatory framework, the cryptocurrency space remains dangerous. The current lack of comprehensive oversight and established standards introduces significant uncertainty regarding how risks like fraud, manipulation, and asset loss will be addressed.

The possibility of stringent regulations could limit access to cryptocurrency markets, which could reduce the overall market activity and affect the performance of Bitcoin. For example, countries like Algeria, Bolivia, Morocco, Nepal, China and Bangladesh have implemented strict bans on Bitcoin. Moreover, in Singapore, MAS' disapproval of any cryptocurrency-related products reiterates its stance.

Disparity in returns

It is important to recognise that the trading hours of the underlying Bitcoin and the various spot Bitcoin ETFs are different. Bitcoin trades continuously without any downtime while spot Bitcoin ETFs trade within 9:30am to 4pm E.T on weekdays. Furthermore, exchanges like NYSE and NASDAQ can close on stock market holidays.

This disparity could be more apparent as compared to traditional asset classes as Bitcoin are highly speculative and could experience significant price movements. In short, price volatility, declines in trading volumes, closing of Bitcoin trading platforms due to fraud, failures, security breaches that occurs outside of the stock market trading hours will not be reflected in the trading prices of these ETFs. These would only be reflected when the stock market opens.

Heavily concentrated on Coinbase as its custodian

Most of the new spot Bitcoin ETFs chose Coinbase as their crypto custodian (Table 3). This means a single entity would provide custodial, trading and lending services to these issuers, resulting in huge concentration risks.

Table 3: Custodian of these spot Bitcoin ETF

No.	Name	Custodian
1	Grayscale Bitcoin Trust (NYSE: GBTC)	Coinbase
2	iShares Bitcoin Trust (NASDAQ:IBIT)	Coinbase
3	Fidelity Wise Origin Bitcoin Trust (BATS:FBTC)	Fidelity
4	ARK 21Shares Bitcoin ETF (BATS: ARKB)	Coinbase
5	Bitwise Bitcoin ETF (NYSE:BITB)	Coinbase
6	Invesco Galaxy Bitcoin ETF (BATS: BTCO)	Coinbase
7	VanEck Bitcoin Trust (BATS: HODL)	Gemini
8	Valkyrie Bitcoin Fund (NASDAQ:BRRR)	Coinbase
9	Franklin Bitcoin ETF (BATS:EZBC)	Coinbase
10	Hashdex Bitcoin ETF (NYSE:DEFI)	BitGo
11	Wisdomtree Bitcoin Fund (BATS: BTCW)	Coinbase
Source: Bloomberg Finance L.P. Data as of 11 Jan 2024

Our take – stay away from Bitcoin ETFs

In summary, investing in cryptocurrency is akin to embracing the Greater Fool Theory. Followers of this theory, whether investors or gamblers, ignore fundamentals and knowingly invest in assets with inflated values, counting on the belief that there will be subsequent individuals willing to take over these overvalued assets. However, the joy of the game fades when one finds themselves as the last participant left, signifying substantial risk for minimal rewards.

In a nutshell, we do not recommend investors to invest in the new spot Bitcoin ETFs or any other cryptocurrency-related products due to the highlighted reasons. As Bitcoin remains a highly volatile asset class with no fundamentals, we view it as worthless in the long term.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.