Bitcoin: Back on track
Bitcoin’s behemoth year-to-date rally does not seem to run out of fuel. Despite the series of bottom-up implosions that characterized 2022 and the consequential widespread scrutiny, the asset has remained resilient amidst a non-uneventful 2023, outperforming most of the market. Truth is, singling out a key driver for the rally, would be largely inappropriate. Not only did the US exchange-traded fund (ETF) saga play a central role, but so did US liquidity, accumulation, and an impending speculation ahead of next-year’s halving, in our view.
The Bitcoin ETF Saga
In all honesty, this was not supposed to happen. Bitcoin maximalists likely saw the beginning of the saga as nightmare fuel, as it would entail a monstruous mutation of the original thesis behind Satoshi Nakamoto’s whitepaper of “A Peer-to-Peer Electronic Cash System”. Leaving ideology aside, the rising interest that some of the largest asset managers in the world have been displaying towards the asset, have been indicative of something more; Bitcoin’s newfound role within a portfolio context, underlines the growing convention of Bitcoin as a store of value. By the way, spot Bitcoin ETFs are nothing new in the eyes of Europe, Switzerland, and Canada, amongst other jurisdictions, where physically replicated products have been around for years. So, why are US-listed counterparts so important? On simple terms, they become an investment vehicle that is accessible by large tranches of capital, US capital markets are the most important ones, and US institutional investors have been reluctant to engage because of the characteristics of existing products; starting with the replication mechanisms and ending with the issuing counterparties. The market has converged towards two very different investment vehicles, one, the largest closed-ended fund is representative of USD 27bn at the time of this publication, and the other one, is the largest derivatives-based open-ended fund, which amasses USD 1.7bn. The problem is evidently neither on the assets under management (AUM) side, as both products are large enough, nor on the expense ratios which at 200bpps and 95bps, are pretty much in-line with European counterparties. Truth is, the former is constrained in terms of the redemption mechanisms, so if enough investors want to exit, as they did back in 2022, the product will likely start trading at a discount against the net asset value (NAV). This is not the major problem in itself, the problem is the price divergence against spot prices, that make institutional investors think twice. On the other end, futures-based products have a major problem, the costs of carry, as rolling over the contracts is likely to result in a strict underperformance against spot prices. Even though ETFs are subscribed to a 9-5 trading window, these could help Bitcoin find a place in retail investors’ portfolios, given the high costs and counterparty risks that some of the on-ramping solutions entail. At the same time, if an approval happens it is likely to happen en-masse, as it is not in the Securities and Exchange Commission’s (SEC) best interest to approve only one of the nearly identical gamut of products, as evidenced in 2021. By the way, as much as the approval might be priced in, investors should bear in mind that there are no guarantees on what happens next.
Yes, the ETFs could spike demand; but given the dire outlook on Bitcoin’s supply schedule, the ETFs can also play a central role in a supply-squeeze. In what concerns Bitcoin’s supply, accumulation reigns, over 70% of it has not changed hands in a year, and 77% of it has not changed hands in over 6 months. Long-term holders have gained much from short-term ones. The shallow market depth has been a direct consequence of this. Centralised exchanges account for a fair share of Bitcoin spot volumes, and as of now the broad spreads between bid and ask prices and the high slippage can represent additional costs to investors, which at the same time must bear in mind that large orders will have a strong impact over the fragile order books. As of late, the lack of market depth has played out positively for prices, nonetheless, the frailty works both ways. An approval of a physically-backed product would require asset managers to buy the actual assets, instead of derivatives contracts, and it is unlikely that this will not add pressure to a highly constrained liquidity. Fortunately Bitcoin’s fundamentals go further down, and 2024 is not a key year in Bitcoin’s history because of ETFs, but rather because of the halving of the blockchain’s block rewards. The last days of April will meet a reduction in block rewards, which will decrease from 6.25 to 3.125 Bitcoins, stemming into a large deceleration of the supply’s growth. Yes, speculation looms large, as halvings have triggered bull runs due to the supply-side constraints, additional buying on fears-of-missing-out, and an improving market mood, which can all be evidenced in miners’ reactions to these events. Past performance is no indicator of future performance. Nonetheless, ahead of the “halvings”, and perhaps given the correlation with a higher profitability, Bitcoin miners have opted to accumulate, as they need to sell less Bitcoins to cover their fiat-based costs. Bitcoin’s supply will continue to play a fundamental role in any price development.
US macroeconomic expectations
Bitcoin is crypto’s risk-off asset, crypto investors tend to favor the largest digital asset when global liquidity conditions deteriorate, as evidenced by the shifts in Bitcoin’s dominance relative to crypto’s market share. Nonetheless, crypto’s behavior has followed more closely that of risk-on assets in the past. Improving US macroeconomic expectations in the 4th quarter of 2023, have played as much of a fundamental role over US equity markets, as on Bitcoin. Looking back, positive momentum in US net liquidity tends to meet improved sentiment over crypto markets. There is no doubt that rising interest rates casted doubt over crypto, as the nascent technology’s broader ecosystem’s development, was highly contingent on private investors’ capital. There is no doubt, either, that the attractive yields “low-risk” assets were offering, also heightened the opportunity costs towards risky investments, as evidenced by the adoption of US Treasuries, and the almost USD 6tn that beset US money market funds. Lately, the market’s positioning towards a more ‘dovish’ US Federal Reserve in 2024, has sparked all sorts of speculation over risky assets.
Amidst record accumulation and liquidity constraints, 2023 marked the underpinning of Bitcoin’s value proposition as a store of value, which is the sole reason for the extent of the spot ETF saga impact. Increasing volumes have not been exclusive to spot markets, as derivatives markets have registered the highest open interest to record, on both futures and options contracts. What’s more striking is the skew towards the bulls, as attested by the put/call ratios. On the approval of Bitcoin spot ETFs in the US, speculation looms large, and despite the general market biased towards an approval by the 10th of January, there are no guarantees. All in all, we see a very sound fundamental backdrop for Bitcoin, with US regulators’ playing a fundamental role. That said, bullishness is back in the market, suggesting that any negative news or disappointment of current expectations could cause a consolidation
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