Assets Pull Back from Post Election Highs

March 14, 2025

Insight

IN TODAY'S ISSUE:

We look at how the market pullback has affected asset prices, including bitcoin.
An analysis of hedge fund activity and its effect on ETF fund flows.
We look at the changes underway with banking regulators and crypto activities.

Assets Pull Back from Their Post-Election Highs

The election of Donald Trump, along with Republican control of the House and Senate, sparked widespread optimism about financial markets, driven by hopes of deregulation and economic growth. While the digital asset industry was among the most enthusiastic about the potential changes brought about by the change in administration, the optimism extended across various sectors and asset classes. Following the election, bitcoin, select equity sectors (such as financials and consumer discretionary), specific investment styles (including small-cap and value stocks), and the U.S. dollar and gold, all experienced a boost.

However, the economic volatility and uncertainty that have accompanied Trump’s economic and geopolitical actions have caused many asset prices to reverse course recently, including bitcoin. Also well off their post-election highs are US stocks of all styles, sectors, and size, and the US dollar. Gold has been and continues to be a standout performer, and bonds have held in. Not surprisingly, volatility is way up, although presently off its peak.

What does bitcoin have to do with tariff wars? Nothing, other than it’s a highly liquid, globally available asset that trades 24/7. If anything, bitcoin stands to benefit from the rise in global entropy, the political and economic disorder created by the administration. If Trump’s first term is any indication, unpredictability and volatility are likely to be key features of this presidency. That also didn’t stop bitcoin from rising 39x during his first presidency, from $896 on his inauguration day in 2017 to $35K when he left office in 2021. With that in mind, we suggest investors ignore the short-term noise and take a long-term view of the asset.

Hedge Funds Are Likely Just One of the Factors Affecting ETF Flows

With bitcoin's price decline recently, investors have withdrawn significant funds from spot ETFs, $4.6 billion over the past three weeks, and questions have arisen as to the role hedge funds play in ETF fund flows. The following analysis explores recent hedge fund activity and highlights that they are not the sole reason for ETF outflows.

Some facts first. The largest holders of the spot ETFs are non-filers, entities not required to file 13F quarterly shareholder reports. We presume these to be retail investors, but there could be other reasons institutional investors would not be required to file 13Fs, like size of their AUM for instance. Retail investors control most of the spot ETF shares, 74% of the AUM or nearly $78B at the end of last quarter.

Hedge funds are the largest identified class of investors with $12B worth of ETFs last quarter, or 11.4% of the collective industry AUM. (Bloomberg – fix your data, Digital Currency Group (DCG) does not own 36M shares of GBTC). Hedge funds typically own ETF shares as a hedge to their short futures positions, classified in the CME Commitment of Trader (COT) report as “Leveraged Funds.” Leveraged Funds are a collection of CTAs (Commodity Trading Advisors) and hedge funds. CTAs employ momentum strategies, going both long and short, while we assume hedge funds are engaged in delta neutral strategies like the basis trade (short futures, long ETF shares to pick up the “funding spread”). For simplification, we assume the Leveraged Funds short position is driven mostly by the “basis trade.” When the basis expands, futures short positions increase and hedge funds buy ETF shares, and when it comes in, short futures positions are closed and hedge funds sell ETF shares.

As the following graph shows, short futures positions have been coming in recently - they peaked along with spot price on December 17th. The basis (1 month rolling annualized) also peaked around this time, registering in the mid 16% range.

Since short futures positions peaked in December, hedge funds have unwound $2.6 billion in notional futures short positions (calculated as the change in contract open interest multiplied by the average price). However, as the following weekly ETF fund flow data shows, this doesn’t fully align with spot ETF flows. While we acknowledge that hedge funds unwinding their basis positions is influencing ETF fund flows, it appears to be just one of several factors at play.

Our best guess is that retail redemptions are having a larger impact on fund flows than hedge funds, given their relative size—approximately 6.5 times larger. CTAs engaging in shorting may be distorting the net-short changes reported by leveraged funds. However, considering the significant size discrepancy between long and short positions at the peak of price momentum and the basis—where shorts were over 5x the size of longs—hedge funds remain the dominant traders in these markets compared to CTAs.

Obstacles Being Removed for Banks to Engage with Crypto

One of the most frequently asked questions since the election has been, "When will banks be able to custody crypto?" While there’s no clear timeline, change is underway, and the following are some of the important events that have occurred since the election.

Last week, the Office of the Comptroller of the Currency (OCC) published updated guidance regarding banks and a variety of crypto-related activities. The OCC removed the requirement for banks to obtain non-objection letters before they can custody crypto, hold stablecoin reserves, run digital asset nodes, and use stablecoins to facilitate payments.

This follows the repeal of SAB 121, the highly unpopular accounting rule which required SEC registrants that custodied crypto on behalf of customers to recognize a liability and a related asset on their balance sheet.

Although the FDIC has yet to issue explicit guidance, the agency wrote that it is committed to working with the President’s Working Group on Digital Asset Markets. It also wrote that it was re-evaluating its supervisory approach to crypto-related activities and working to replace FIL 16-2022, the notice that required supervised institutions to notify the agency of their crypto activities. This letter set off a series of events that later became known as "Operation Chokepoint 2.0," the effort to restrict crypto-related activity at banks, which then in turn became the subject of Congressional hearings.

There are still several banking regulators that have yet to weigh in on the evolving landscape of cryptocurrency and digital asset regulation. However, given the recent shifts in policy driven by the administration, we are confident that meaningful change is underway. As the financial sector continues to adopt digital assets, we anticipate further clarity and guidance from additional regulators.

Market Update

Bitcoin tumbled 10.0% on the week, hitting an intraweek low of $76,555 on Monday before recovering some of its losses. Markets were impacted by the ongoing back and forth with tariffs as well as the associated geopolitical turmoil. Against that backdrop, the S&P 500 fell 3.7% and the Nasdaq Composite fell 4.2%, while gold rallied 2.2%.

With inflation coming in lighter than expected on Wednesday, traders are looking for the next potential catalyst, which could come on Wednesday with the FOMC's interest rate decision. Bitcoin traders appear to be neutral on the market right now, with perp funding rates at essentially 0% right now. The basis on CME futures reinforces that viewpoint, with an annualized basis of 6.0% for March and 7.7% for April contracts right now. The spot ETFs continue to show outflows, with $1.3B in the past week, although Thursday saw inflows for the first time since early March.

Important News This Week

Upcoming Events

Mar 19 - FOMC interest rate decision
Mar 28 - CME expiry
Apr 10 - CPI release
May 27 - Bitcoin 2025 conference
Jul 2 - Final SEC deadline for decision on GDLC ETF conversion
Jul 22 - EO Working Group report deadline

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IN TODAY'S ISSUE:

We look at how the market pullback has affected asset prices, including bitcoin.
An analysis of hedge fund activity and its effect on ETF fund flows.
We look at the changes underway with banking regulators and crypto activities.