Galaxy Research How big is the market size of Bitcoin ETF? What other widespread impacts does it have on Bitcoin?

Exploring the Market Size of Bitcoin ETF Impact on Bitcoin and Beyond

Author | Charles Yu

Translation | Colin Wu

Original article link:

https://www.galaxy.com/insights/research/sizing-the-market-for-a-bitcoin-etf/

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The approval of a US-regulated spot Bitcoin ETF will be the most influential catalyst for the adoption of Bitcoin (and cryptocurrency as an asset class).

The significance of a Bitcoin ETF

Why a Bitcoin ETF is more ideal than current investment tools

As of September 30, 2023, the amount of BTC held by Bitcoin investment products (including ETPs and closed-end funds) reached 842,000 (approximately $21.7 billion).

These Bitcoin investment products have significant drawbacks for investors – in addition to high fees, low liquidity, and tracking errors, they are inaccessible to the majority of investors who represent the bulk of wealth. Alternative investment options that increase indirect exposure to Bitcoin (such as stocks, hedge funds, futures ETFs) also have similar tracking efficiency issues. Many investors prefer not to directly own Bitcoin to avoid the administrative burdens that come with it, which involve managing wallets/private keys under self-custody and tax reporting.

A spot ETF may be suitable for investors who want to invest in Bitcoin directly but do not want to have and manage Bitcoin through self-custody. It offers numerous advantages compared to current Bitcoin investment products and options, such as:

● Improved efficiency in terms of fees, liquidity, and price tracking. Although the applicants for Bitcoin ETFs have not listed their fees yet, ETFs typically offer lower fees compared to hedge funds or closed-end funds, and a significant number of ETF applicants may strive to maintain low costs for competitiveness. A spot ETF will also provide better liquidity as it trades on major exchanges and can track Bitcoin exposure better compared to futures products or proxies.

● Convenience. A spot ETF enables investors to access Bitcoin exposure through a wider range of channels and platforms, including established providers that investors are already familiar with. It offers an easier entry point for retail and institutional investors compared to direct ownership, which requires a certain level of self-education and has higher management costs.

● Regulatory Compliance. Compared to existing Bitcoin investment products, a spot ETF may meet more rigorous compliance requirements regarding custody arrangements, monitoring, and bankruptcy protection as required by regulatory bodies. Additionally, ETFs may provide market participants with greater price transparency and discovery capabilities, which could help reduce Bitcoin market volatility.

Why Bitcoin ETFs are so important

Two major factors that make Bitcoin spot ETFs particularly influential in the Bitcoin market are: (i) expanding accessibility to various wealth segments, and (ii) gaining greater acceptance through formal recognition by regulatory bodies and trusted financial service brands:

Accessibility

● Greater coverage for both retail and institutional investors. The range of available BTC investment funds is currently limited, with products primarily driven by wealth advisors or offered through institutional platforms. An ETF is a more directly regulated product that will increase access for a larger investor base (including retail and high-net-worth individuals). The ETF can be accessed by a wider range of clients, including directly through brokers or through Registered Investment Advisors (RIAs), instead of relying on wealth managers.

● Allocation through more investment channels. Without approved Bitcoin investment solutions like spot ETFs, financial advisors/trustees cannot consider Bitcoin in their wealth management strategies. Wealth management departments hold a significant amount of capital but have been unable to access Bitcoin investments through traditional channels—approved spot ETFs would allow financial advisors to begin guiding their wealth clients towards Bitcoin investments.

● Greater wealth opportunities. Baby boomers and older (ages 59 and above) hold 62% of America’s wealth, but only 8% of adults aged 50 and above are investing in cryptocurrencies, compared to over 25% of adults aged 18-49 (Federal Reserve, Pew Research Center). Making Bitcoin ETF products available through familiar and trusted brands may help attract older, wealthier demographics that have not yet entered the space.

Acceptance

● Formal recognition/legitimacy from trusted brands. Numerous well-known financial brand names have submitted Bitcoin ETF applications—official recognition/validation from these mainstream companies can improve perceptions regarding the legitimacy of Bitcoin/cryptocurrencies as an asset class and attract more acceptance and adoption. According to Pew Research, among the 88% of Americans who have heard of cryptocurrencies, 75% lack confidence in the current ways of investing, trading, or using cryptocurrencies.

● Addressing regulatory compliance issues; regulatory clarity will attract more investment and development. The approval of ETFs by the U.S. Securities and Exchange Commission as a regulated investment product with more comprehensive risk disclosure can alleviate many security and compliance concerns for investors. It also provides market participants with the long-term regulatory clarity required to operate in the cryptocurrency industry. A more robust regulatory framework will attract more investment and development and enhance the competitiveness of the U.S. cryptocurrency industry.

● The advantages of BTC portfolios/acceptance as an asset class. Bitcoin can provide diversification benefits and higher returns in portfolios, regardless of where the funds are allocated from. To help guide investment management decisions, more retail investors and financial advisors have started turning to model portfolios and automated solutions that increasingly use ETFs and incorporate alternative asset classes to provide investors with optimized risk returns. A longer track record can support the use of Bitcoin in more investment strategies within a portfolio.

Estimating the influx of funds from Bitcoin ETF approval

Due to the accessibility reasons mentioned above, the US wealth management industry may be the most accessible and direct market and is expected to gain the most new net accessibility from approved Bitcoin ETFs. By October 2023, the total assets managed by broker-dealers ($27 trillion), banks ($11 trillion), and RIAs ($9 trillion) add up to $48.3 trillion.

In our analysis, we apply the $48.3 trillion to the selected US wealth management aggregator as the baseline TAM (excluding the $2 trillion managed by family office channels). However, the addressable market for Bitcoin ETFs and the indirect impact of Bitcoin ETF approval may far exceed the US wealth management channels (e.g. international, retail, other investment products, and other channels) and may attract more funds into the Bitcoin spot market and investment products.

(Note: While we apply TAM-style analysis to estimate the influx into the Bitcoin ETF, we acknowledge that the flow into Bitcoin ETFs could also drive new net inflows and not just reallocate from existing allocations—thus applying a percentage capture assumption to an estimated TAM figure does not fully capture our view on how the adoption of Bitcoin ETFs may evolve as it does not capture this potential new demand.)

With channel openings, the admission cycle for Bitcoin ETFs across these segmented markets may last for several years. The RIA channel, primarily composed of nature-complex independent registered investment advisors, may have a larger initial accessibility share as they are potentially allowed access earlier than advisors affiliated with banks and broker-dealers. For the bank and broker-dealer channels, each independent platform will determine when to unlock access to Bitcoin ETF products for their advisors—except for some exceptions, financial advisors associated with banks and b/ds cannot offer/recommend specific investment products unless approved by the platform. The platform may have specific requirements before granting access to new investment products (e.g. track record > 1 year or asset under management exceeding a certain amount, general suitability issues, etc.), which will affect the access cycle.

We assume that the RIA channel will start at 50% in the first year and increase to 100% by the third year. For broker-dealer and bank channels, we assume they will start at 25% in the first year and steadily increase to 75% by the third year. Based on these assumptions, we estimate the addressable market for a US Bitcoin ETF to be approximately $14 trillion in the first year after release, $26 trillion in the second year, and $39 trillion in the third year.

Estimated Bitcoin ETF inflows: Based on these market size estimates, if we assume that 10% of the available assets in each wealth channel adopt BTC, evenly distributed at 1%, we estimate that Bitcoin ETF inflows will be $14 billion in the first year after release, increasing to $27 billion in the second year, and $39 billion in the third year. Of course, if approval for a Bitcoin spot ETF is delayed or denied, our analysis will be affected by timing and access limitations. Alternatively, if poor price performance or any other factors lead to lower-than-expected access or adoption of the Bitcoin ETF, our estimates may be overly aggressive. On the other hand, we believe our assumptions regarding access, exposure, and distribution are conservative, so inflows may also exceed expectations.

Potential impact on BTCUSD

As of September 30, 2023, according to data from the World Gold Council, global gold ETFs collectively held about 3,282 tons (approximately $198 billion in assets under management), accounting for about 1.7% of gold supply.

As of September 30, 2023, Bitcoin in investment products (including ETPs and closed-end funds) totaled 842k BTC (approximately $21.7 billion in assets under management), accounting for 4.3% of the total supply.

Considering that the market value estimate for gold is approximately 24 times larger and the supply in investment vehicles is 36% less than Bitcoin, we assume an equivalent inflow of funds as gold will have about 8.8 times the impact on the Bitcoin market.

If we apply our first-year inflow estimate of $14.4 billion (approximately $1.2 billion per month or about $10.5 billion after adjusting with our 8.8 multiplier) to the historical relationship between gold ETF inflows and gold price movements, we estimate that Bitcoin would have a price impact of +6.2% in the first month.

If we keep the inflow amount constant but adjust the multiplier based on the BTC/gold market value ratio, we might see the price impact gradually decrease from +6.2% in the first month to +3.7% in the last month of the first year, resulting in an estimated +74% increase for Bitcoin in the first year of ETF approval (using a Bitcoin price of $26,920 as a starting point on September 30, 2023).

ETF: A Broader Financial Impact on the Bitcoin Market

The above analysis estimates the potential capital inflow from US Bitcoin ETF products. However, the second-order effects of Bitcoin ETF approval may have a greater impact on BTC demand.

In the short term, we expect other global/international markets to follow suit with the US, approving and offering similar Bitcoin ETF products to a broader range of investors. Apart from ETF products, other investment tools are likely to add Bitcoin to their strategies (e.g., mutual funds, closed-end and private equity funds) – spanning investment objectives and strategies. For instance, alternative funds (currency, commodities, and other alternatives) and thematic funds (disruptive technology, ESG, and social impact) can incorporate Bitcoin exposure.

In the long run, the available market for Bitcoin investment products could further expand to all third-party managed assets (according to McKinsey, asset management is approximately $126 trillion) and even more broadly to global wealth (according to UBS, asset management is $454 trillion). Some believe that as Bitcoin gets monetized, it will systematically reduce the currency premium applied to other assets like real estate or precious metals, significantly enlarging Bitcoin’s TAM.

Based on these market sizes and keeping our adoption/allocation assumptions unchanged (BTC is adopted by 10% of funds with an average allocation of 1%), we estimate potential net inflows into Bitcoin investment products to be between $125 billion to $450 billion over an extended period.

Summary and Conclusion

For a decade, applicants have been seeking the listing of a physically backed Bitcoin ETF. In this time, Bitcoin’s market cap has risen from less than $1 billion to today’s $600 billion (reaching a peak of $1.27 trillion in 2021). Ownership and usage of Bitcoin have skyrocketed globally during this period, with various types of wallets, native crypto exchanges, and custodians, as well as access to traditional markets worldwide. However, the largest capital market in the world, the US, still lacks an efficient market access tool for Bitcoin—an ETF based on spot prices. Expectations for quick ETF approval continue to rise, and our analysis suggests that these products could witness significant capital inflows primarily driven by the wealth management channels that currently cannot access Bitcoin exposure on a large scale.

The influx of funds from ETFs, narratives around the upcoming Bitcoin halving (in April 2024), and the possibility of interest rates reaching their peak in the short term all indicate that 2024 could be an important year for Bitcoin.

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