Cryptocurrency markets continued to unwind some of 2023's gains in the week to January 19, largely tracking Bitcoin (BTC) lower in the wake of long-awaited spot ETF approvals on January 11. Though the unit price of BTC spiked to a two-year high of nearly $49,000 in the opening minutes of trading on ETF launch day, it had been drawn down to less than $41,000 by this morning, giving back a short-lived rally at the start of the new year. Part of the drop-off has certainly come from a post-ETF hype hangover, but prospective changes to monetary policy have played a significant part as well.
This time last week, CME's FedWatch tool showed fed funds futures traders were pricing in a near 77% probability that Federal Reserve rate cuts would begin as soon as March. The odds for a continued pause on rates versus a 25bps cut are now split at nearly 50-50. A continuation of elevated short-term rates should help the U.S. Dollar Index (DXY) hold its ground, potentially capping Bitcoin's performance against USD in the near term. Declining interest rates have historically been a positive signal for BTC prices, considering rate cuts have typically preceded the expansion of USD supply and, therefore, further debasement of the currency.
Though the U.S.'s monetary base was trimmed at a record pace throughout late 2022, the latest data shows that the pace of decline slowed in 2023 and returned to growth throughout four consecutive months to last November. Bitcoin moved largely in step with this trajectory, tumbling by more than -65% throughout 2022 and rebounding by about 155% in 2023.
The story of Bitcoin's initial experience with ETFs has been a mixed picture. Among newly-created spot BTC products, interest has been explosive, with more than $3.3 billion worth of net inflows filling these nine funds with more than 79,600 BTC in just six days of trading. BlackRock and Fidelity's funds are the largest among this cohort, each boasting AUM north of $1 billion, and equivalent to 28,622 BTC and 24,857 BTC, respectively. However, the pre-existing Grayscale Bitcoin Trust product (converted to an ETF on January 11) is creating a massive overhang on the BTC market.
As MRP suspected might be the case prior to the launch of the funds, Grayscale has been the main origin of outflows in the BTC ETF ecosystem due to its previous structure as a trust and a high rate of fees. As MRP noted in the previous week's Crypto Wrap, GBTC shot out of the gate with the largest-ever first-day turnover for an ETF, pulling in $2.3 billion in volume. But much of this volume was related to outflows from the fund by arbitrageurs who sought to capitalize on the trust's long-standing discount to NAV (which is now nearly closed as a result of the ETF conversion).
Prior to becoming an ETF, the purchase of GBTC trust shares was subject to a six-month lockup period. As an example, buyers who may have bought the fund in early September would have watched the value of the trust's underlying BTC increase by more than 80% by January 8.
Topped off with a narrowing of the fund's discount from nearly 20% to 6%, which would increase the rate of return to more than 110%. With the trust now converted to an ETF, however, the remaining two months of lockup that those investors would have been subject to were eliminated, and it makes sense that some level of profit-taking has gotten underway.
Additionally, outflows from GBTC could be fueled by those seeking to rotate into a fund with much lower fees. The fee associated with GBTC was reduced from 2.0% to 1.5% upon ETF conversion, but this was multiple times greater than fees on many of the competing funds, which could be as low as 0.2% – excluding promotional rates. Due to the scale of GBTC, with AUM prior to the ETF conversion near $28.6 billion with over 619,000 BTC in custody, the asset manager likely assumes they will be able to hang onto a large chunk of their current business without entering a race to the bottom on fees with the newly-originated funds. Since January 11, outflows from GBTC have been equivalent to more than -$2.2 billion. That is only worth about two-thirds of the net inflows from all other BTC ETFs, but it has been enough to blunt the impact of strong buying among Grayscale's smaller competitors.
CoinDesk cites a JPMorgan estimate of up to $3 billion entering GBTC in the secondary market during 2023 to exploit the trust's discount to NAV, which at one point was as large as 49%. If this estimate is correct, and given that -$2.2 billion has already exited, there could be an additional $800 million headed for the exits on arbitrage positions alone. The amount of cash that could leave GBTC to rotate to cheaper funds would be harder to estimate, but it could be in the many billions of Dollars.
CryptoSlate estimates that, at the current pace of inflows, it would take approximately 178 days for BlackRock's iShares Bitcoin Trust (IBIT) to surpass the size of Grayscale's GBTC. However, accounting for the current rate of depletion at Grayscale, GBTC could be flipped by IBIT in just 37 days' time. Surely, some of the rotation from GBTC will simply go to IBIT; it is likely that such a move will be more dispersed among spot BTC funds. Additionally, it's likely that the aggressive flood of cash out of GBTC will need to be addressed at some point before they give up too much market share to competing funds.
It's important to note that all of the figures cited in this analysis are essentially related to just 30% of Bitcoin's circulating supply, as 70% of BTC has not been transacted in a year or longer. Long-term adopters of Bitcoin have remained virtually unmoved by the ETF launch or recent price swings. As MRP has noted in previous crypto wraps, crypto bull markets typically coincide with a material decline in the share of Bitcoin's supply that has been idle for at least a year, indicating that even long-term accumulators cannot resist profit-taking or believe that a peak could be nearing. We've yet to see this cycle-defining feature appear in the on-chain data, which could indicate a real bull market is yet to be confirmed or that it remains in early stages with supply remaining relatively illiquid.
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