Conversation with Galaxy Digital Potential Impact of Spot Bitcoin ETF on the Market

Exploring the Possibility A Discussion with Galaxy Digital on the Potential Impact of a Spot Bitcoin ETF on the Market

The launch of Bitcoin ETF in the spot market will allow restricted wealth management advisors to offer Bitcoin investments to their clients, thereby opening a new channel for capital inflow into the Bitcoin market.

Edited & Compiled by Deep Tide TechFlow

In this episode of the Bankless podcast, hosts David and Ryan, along with guest Alex Thorne, discuss the potential impact of a Bitcoin ETF. Alex Thorne is the research director at Galaxy Digital and shares his views on Bitcoin ETFs, particularly the interest in spot Bitcoin ETF and its possible market effects.

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Hosts: David & Ryan, Bankless podcast

Speaker: Alex Thorn, Research Director at Galaxy Digital

Two-way Impact of Spot Bitcoin ETF and Traditional Investments

Alex points out that the total assets under management in the US wealth management industry is approximately $48.3 trillion, which does not include self-directed accounts such as individual retirement accounts (IRAs) or self-managed brokerage accounts. The wealth management industry is divided into three main categories: brokerage firms (approximately $27 trillion), banks (approximately $11.9 trillion), and registered investment advisors (RIAs) (approximately $9.3 trillion).

Alex explains that a spot Bitcoin ETF will provide a new investment channel for wealth management firms that currently cannot purchase Bitcoin directly. While individual investors can buy Bitcoin directly on cryptocurrency exchanges like Kraken, many wealth management institutions are unable to offer direct investment services in Bitcoin or other cryptocurrencies due to compliance and approval processes.

Alex explains that many banks and brokerage firms do not allow their wealth management advisors to invest client funds in Bitcoin trust products or physically settled Bitcoin futures ETFs because these products are considered too risky or unsuitable. Alex believes that the launch of a spot Bitcoin ETF will enable restricted wealth management advisors to offer Bitcoin investments to their clients, thereby opening a new channel for capital inflow into the Bitcoin market.

Alex points out that wealth management advisors cannot simply buy Bitcoin on cryptocurrency exchanges like Kraken due to issues related to subaccounts, regulation, custody, and integrated investment management tools. The advantage of a spot Bitcoin ETF is that it can be integrated into existing investment management tools and backend operating systems, making Bitcoin investment as easy to manage as other investment products.

Alex said that although the full $48 trillion won’t flow into the Bitcoin market, the total market value of Bitcoin is less than $1 trillion. Even if only a small portion of funds enter, it could have a significant impact on the price of Bitcoin.

Alex mentioned that they expect the spot Bitcoin ETF to bring in $1.44 billion in funds in the first year, based on analysis of the wealth management industry. They further predict that in the second year, inflows could increase to $2.65 billion as market access expands. Alex emphasized that these inflows are seen as net new funds, meaning if it weren’t for the ETF, these funds wouldn’t flow into the Bitcoin market. These predictions are based on analysis of the wealth management channel.

The host suggested that investor behavior may not be as uniform and rational as the spreadsheet model suggests. If the price of Bitcoin rises, investors may experience FOMO, even extreme Bitcoin supporters who consider it a long-term holding asset. This could result in actual inflows being more volatile than predicted. Alex explained that wealth managers are less likely to trade as frequently as individual investors, as they tend to focus on long-term planning rather than short-term market reactions.

Alex mentioned that they like to compare Bitcoin to gold because both are scarce assets and have similarities in investment tools. After the approval of the gold ETF, the gold market experienced a long and significant bull market in the following decade. They predict that an equivalent amount invested in Bitcoin will have an impact on the Bitcoin price that is 8 times greater than the impact on the gold price.

Alex emphasized that this prediction is extremely bullish and their calculations are based on simple estimations. They also acknowledge that the rise in gold prices in the mid-2000s was not solely due to increased accessibility but was also influenced by macroeconomic events such as the financial crisis.

Alex mentioned that the inflow of funds into ETFs does not happen immediately, but gradually increases. In their analysis, as the Bitcoin market grows, the monthly impact multiplier gradually decreases because the proportion of Bitcoin in investment tools increases with the growth of the market capitalization.

Alex stressed that their analysis is a defendable way to consider this issue, but by no means a definite guarantee. They predict that if the fund inflow predictions in other analyses are correct, the Bitcoin price could rise by approximately 75% from the launch of the ETF to one year later.

Possible market dynamics in the future

Alex and the host discussed the potential reactions of the market to the expected fund inflows, particularly in the case of price increases, which could lead to forward-buying behavior that “overdraws future demand.”

Regarding the impact of forward buying on demand, Alex said it’s a complex issue. On one hand, if the price of Bitcoin rises, it may cause some investors to wait for a price drop because they perceive it as too high. On the other hand, as Bitcoin volatility decreases and the market size increases, investors can actually allocate more funds to Bitcoin.

Alex mentioned that they used the Sharpe ratio and risk adjustment in their analysis to determine the investment ratio. If the Bitcoin market becomes larger and the volatility decreases, it may be possible to allocate more funds to Bitcoin from a risk-adjusted perspective. Additionally, there are some very large capital players, such as sovereign wealth funds or central banks, who may only participate in the Bitcoin market once it matures, volatility decreases, and liquidity increases.

Alex emphasized that although their analysis is based on the current demand and the inability of the wealth management industry to access Bitcoin, actual capital inflow may be influenced by market expectations and other macroeconomic events.

The host mentioned that once a Bitcoin ETF is approved, it will trigger a series of market promotions and educational activities, all aimed at attracting investor attention and gaining market share. This will help improve the legitimacy and institutionalization of Bitcoin.

Alex agrees with this and adds that there have been similar promotion waves in the past during the launch of ETFs. Alex believes that if a Bitcoin ETF is approved, it will be a recognition of Bitcoin’s maturity, indicating regulators’ satisfaction with issues related to the regulation, custody, and transfer of cryptocurrencies.

Potential Risks and Challenges

Alex mentioned that the approval and launch of a Bitcoin ETF may cause a “buy the rumor, sell the fact” reaction in the market, with some investors buying Bitcoin in anticipation of the ETF approval and selling after its actual launch, thereby affecting the flow of funds into the ETF.

He stressed that even if the market is optimistic about Bitcoin ETFs, the speed of capital inflows may be slower than expected. This is because even the most optimistic platforms may take several months to activate an ETF, which also requires a risk approval process.

Alex also mentioned that regulatory issues may affect the flow of Bitcoin ETFs. While Bitcoin may not be the primary focus of regulatory agencies in the cryptocurrency ecosystem, other regulatory issues, such as Financial Crimes Enforcement Network (FinCEN) regulations related to all cryptocurrencies, may affect the entire crypto market.

He pointed out that all companies applying for Bitcoin ETFs have updated their S1 files to include risk disclosures regarding mining, especially the potential political backlash due to the electricity consumption of mining, which may lead to regulatory changes.

Alex mentioned that political figures like US Senator Elizabeth Warren may have a negative attitude toward self-custodied cryptocurrencies, which is detrimental to Bitcoin and the entire cryptocurrency market.

Compared to spot Bitcoin, futures ETFs are not ideal investment tools for long-term holders due to rolling costs and decay. Wealth management advisors are more inclined towards long-term investments, which may affect their interest in Bitcoin ETFs.

How does Bitcoin ETF Impact Ethereum ETF

Alex and the host believe that if a Bitcoin spot ETF is approved, there is also a possibility of an Ethereum ETF being approved in the next few months. Although the possibility of an Ethereum ETF is lower than that of a Bitcoin ETF, once a Bitcoin ETF is approved, the approval process for an Ethereum ETF might accelerate.

In terms of market impact for Bitcoin and Ethereum ETFs, Alex believes that although their analysis primarily compares Bitcoin to gold, the accessibility aspect applies equally to Ethereum. Currently, many advisors cannot access spot Bitcoin or spot Ethereum, thus ETFs will greatly enhance the accessibility of these assets.

Alex mentioned that the investment community’s perception of Ethereum lags behind that of Bitcoin. Bitcoin is widely seen as “digital gold,” while Ethereum is more often viewed as a risk asset or a technology investment. Therefore, Bitcoin and Ethereum ETFs may attract different types of investors.

Alex believes that Ethereum is typically seen as an investment in technological innovation rather than just a purely digital commodity. If an Ethereum ETF is approved, it could have a significant impact on the price of Ethereum. Due to Ethereum’s lower market capitalization and less legitimacy in the traditional financial world compared to Bitcoin, an ETF might amplify its price effect.

One unique feature of Ethereum is its staking function, which is likened to internet bonds. If a future Ethereum ETF includes staking functionality, it could provide investors with additional returns, thereby increasing its attractiveness.

Although Bitcoin and Ethereum are both tokens that fuel their respective networks and both possess relative scarcity, their roles and influences in the eyes of investors are different. Bitcoin’s scarcity is predictable, while Ethereum is mainly seen as a technological platform.

Alex mentioned that he agrees with the views of Bloomberg Intelligence analysts Eric Balchunas and James Seyffart, who have a deep understanding of the timeline for the legal and regulatory approval process of a Bitcoin ETF. Alex believes that the most likely time for an Ethereum ETF to be approved is January 10, 2023, or earlier.

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