Insight
March 1, 2024
Predicting the inflows and outflows of spot bitcoin ETFs has sparked intense debates. Leading up to the spot ETFs' launch, predictions on their success differed significantly among analysts and market observers. Today, nearly two months since launch, despite facing some initial challenges, the spot ETFs have proven to be a remarkable success, surpassing fundraising levels seen during the vaunted launch of GLD in 2004. Nonetheless, there is still widespread confusion surrounding their operations and the impact on traditional markets and on-chain activities.
In this week’s research, we peel back the curtain on the operations of spot ETFs and the underlying data. We use this information to present a method to make short term predictions about fund flows data and show that not all data, especially some that is highly circulated on social media, is useful.
The key to understanding and making sense of all the data around the ETFs is understanding their workflows, particularly the difference between trading and settlement. Also key is the difference between primary market and secondary market activities. Primary markets have to do with the creation and redemption of shares while secondary markets have to do with the trading of these shares or bitcoins. Examples of secondary markets are the various national securities exchanges, Nasdaq, Cboe BZX, and NYSE Arca, and well as crypto markets, like Coinbase.
To get a full picture of how the ETFs operate, two documents are instrumental to their understanding – the various registration statements (S-1s and S-3s) filed by the ETF sponsors and the presentations provided by some of the ETF sponsors in their meetings with the SEC on their workflows. These two documents, when combined, outline a picture of how the ETFs operate. Only three sponsors filed detailed workflows in their meetings with the SEC, Grayscale, BlackRock, and Fidelity, but the timing on settlement flows are fairly similar and thus offer a blueprint for the rest of the industry.
To summarize, the key distinction between trade date (T) and the day after trade date (T+1) lies in the timing of secondary and primary market actions. While exchange trading of ETF securities and spot bitcoins occurs on T, the movement of funds and creation/redemption of shares takes place on T+1. This means that today's trading activity (and creation/redemption orders with Authorized Participants) will manifest as ETF shares creations/redemptions tomorrow, along with the corresponding movement of bitcoins in and out of custody. Grayscale's "Cash Order" description in its registration statement serves as a prime illustration of this process. While we won't delve into every single detail, the workflows outlined in SEC filings (linked above) provide a comprehensive overview. Rest assured, we've simplified things for the benefit of investors and market observers.
On the trade date (T), equity market makers are actively participating in the secondary market, engaging in the buying and selling of ETF shares. Their actions are strategically focused on arbitrage opportunities, while also managing their exposure to bitcoin by hedging through various markets. Prior to a designated cutoff time, market makers place orders with an Authorized Participant (AP) to either create or redeem shares. These orders are then communicated to various entities involved in spot bitcoin market trading, liquidity providers and bitcoin trading counterparties, to facilitate the acquisition or disposal of specific amounts of bitcoin linked to the value of ETF shares being created or redeemed. These crypto entities are then in markets replicating the underlying spot index, which varies by ETF but occurs mostly in the 3 – 4 PM ET window for most ETFs or right at 4 PM ET for Grayscale.
At this stage, there has been no transfer of ETF shares or bitcoins. For the sake of clarity and practicality, we are overlooking the movement of cash, which plays a crucial role in influencing the visible variables. However, we will delve deeper into this aspect shortly.
On T+1 is when we observe changes in all of the variables that traders and analysts are so crucially focused on - fund flows and movement of bitcoins into and out of custody. We’ve highlighted this in the past, but the on-chain bitcoin transactions that are often highlighted on social media are purely the settlement of trading activity from the day before. While interesting, this information is backwards looking and therefore should not tell us much reliably about the future, other than what fund flows will be reported for that day. On chain activity usually happens in the morning of T+1 while fund flows are usually reported later that day.
The other metric which has been highly topical is ETF fund flows, the amount of money coming into and out of the various ETFs on daily basis. Again, with the case of bitcoin movements on the blockchain, this is metric recording the settlement for the prior day’s actions. The reason is that “fund flows” is a derived metric, one that requires the input (daily change) of the fund’s net asset value, share count, and index value. As can be seen in the Grayscale registration statement, shares aren’t created or redeemed until T+1. Therefore, fund flows measured for a particular day are the result of trading/arbitrage activity and create/redeem orders submitted to the AP the day prior. In essence, “fund flows” is backwards looking as well.
By combining market activity knowledge from the trade date with the settlement actions on T+1, we can explore the relationship between observed variables. Our analysis delves into the correlation between daily fund turnover (dollar trading volume) on T and the fund flows reported on T+1, utilizing a linear regression approach. While GBTC only exhibits outflows and the other 9 ETFs have only seen inflows (with an exception one fund on one day), segregating the model into "inflow ETFs" and an "outflow ETF" doesn't significantly enhance the analysis, so we use a measure of absolute fund flows. The results reveal a strong relationship between trading volume and the following day's reported fund flows, with an R Squared exceeding 70% and statistical significance. In simple terms, an ETF's fund flows can be approximated by 29% of the previous day's turnover (plus the intercept). In using this as a predictive model, one would have to know the direction of the fund flows, in or out. The visual representation in the scatter plot demonstrates the linear relationship between trading turnover (on T) and fund flows reported/calculated (on T+1).
As we delve deeper into the intricacies of trading and settlement processes, one crucial aspect we previously mentioned is the movement of cash. The timing difference between trade execution and settlement necessitates a substantial amount of capital for both the securities and crypto market makers and liquidity providers.
With trades settling T+1, the funding costs for trading activities typically amount to one calendar day from Monday to Thursday. However, the scenario changed on Fridays, where trades settle three calendar days later (still T+1). The additional cost of two days of funding over the weekend significantly impacts the ability to finance trading activity, which manifests in a tangible effect on the of fund flows for ETFs. Notably, the trading activity on Fridays is reflected in Monday's reported fund flows, resulting in a discernible decrease in both average creations and redemptions.
This weekend funding gap translates into an average of $183.7M fewer creations on Mondays (across all nine "inflow funds") and a $126.0M decrease in redemptions for GBTC compared to the rest of the week. On a percentage basis, this translates into a 39% decrease in outflows and a 28% decrease in inflows are associated with the weekend funding costs. Given the intense rivalry in the spot bitcoin ETF market, it should be imperative for fund sponsors to address this crucial aspect.
Bitcoin zoomed higher again this week, breaching the $60,000 level and rising 19.1% on the week. Bitcoin hit an intraweek high of $64,100, just shy of the level it hit in April 2021of $64,900, right around the time of the Coinbase IPO. In 2021, bitcoin then went through a correction process hasted by the ban in China before resuming its upward trajectory and hitting a cycle high of $69,000 in November of that year. Bitcoin is now up a remarkable 45.7% on the year, far outpacing any other asset class. Equities were up slightly on the week, with the S&P 500 up 0.2% and Nasdaq Composite up 0.3%. Bonds were mixed with investment grade corporate bonds down 0.1%, high yield corporate bonds up 0.1% and long term US Treasuries up 1.7%. Gold rallied 1.7% while oil fell 0.4%.
Bitcoin On Verge of ‘Violent’ Move After Surge Toward Record, Options Show - Bloomberg
Chart Pundit Peter Brandt Raises Bitcoin's 2025 Target to $200K on Channel Breakout - CoinDesk
Crypto Hedge Fund LedgerPrime Restarts Under New Name - Bloomberg
Bitcoin Plummets 7% After Hitting $64K; Reversal Triggers Over $600M Crypto Liquidations - CoinDesk
BlackRock’s IBIT Spot Bitcoin ETF Crosses $10 Billion in AUM - The Block
SEC in ‘Enforcement-Only Mode’ for Crypto, Commissioner Peirce Says - CoinDesk
SEC Faces Mounting Pressure from Lawmakers to Back Off Crypto Industry - Decrypt
MicroStrategy Announces New Bitcoin Purchases, Holds 193K BTCs - Twitter
Grayscale Is Open To M&A-Related Opportunities, Firm’s CEO Says - Blockworks
Bitcoin Miners Continue to Sell BTC Ahead of Halving, Blockchain Data Show - CoinDesk
Announcing The Successful Resolution of Earn - Gemini
Marathon Digital Ready to Deploy ‘Dry Powder’ In Push to Double Hash Rate - Blockworks
Mar 12 - Feb CPI reading
Mar 20 - FOMC rate decision
Mar 29 - March CME expiry
April 21 - Bitcoin block reward halving
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