Title: How will Spot ETF Start the Next Bull Run of Bitcoin?

Author: Feng & Carol, DFG Official

Introduction

The largest cryptocurrency by market capitalization, Bitcoin, has seen rapid development recently, with a cumulative increase of nearly 25% over the past month, breaking through the $35,000 mark and reaching a new high in nearly 17 months. This surge is mainly attributed to the expectations surrounding the imminent approval of Bitcoin spot ETFs in the United States. The SEC has been providing fewer reasons to reject ETFs, repeatedly delaying decision times, and has abandoned appeals regarding the Grayscale ruling… All these signs indicate that the approval of spot Bitcoin ETFs seems to be getting closer. JPMorgan recently stated in a report that the SEC may soon approve multiple applications for spot Bitcoin ETFs, with the most likely approval date being before January 10, 2024.

The approval of spot Bitcoin ETFs in the U.S. is a significant milestone for the entire cryptocurrency industry. Although the exact timing of the final approval is difficult to determine, some potential impacts of the approval of Bitcoin spot ETFs can be roughly predicted. On one hand, Bitcoin and the entire cryptocurrency market are highly sensitive to the approval of spot ETFs, as evidenced by recent market fluctuations; on the other hand, the approval of Bitcoin spot ETFs will greatly enhance the convenience and compliance of Bitcoin exposure, potentially bringing a large influx of funds into the cryptocurrency market, which will significantly benefit the long-term development of the entire industry. The following sections will elaborate on our views.

Highly Sensitive Cryptocurrency Market

The BTC market and the entire cryptocurrency market have shown considerable price sensitivity to news related to U.S. Bitcoin spot ETFs, especially given the prolonged bearish sentiment. In recent months, the main market focus has been on Bitcoin and the new developments regarding its spot ETFs. Since BlackRock submitted its Bitcoin spot ETF application in June, every subsequent piece of news regarding the approval of Bitcoin spot ETFs has clearly resonated in the secondary trading market for Bitcoin, highlighting the cryptocurrency market's high sensitivity to institutional actions. Despite some subsequent positive news being confirmed as false, Bitcoin's trading activity remains highly active, with BTC currently oscillating around the $35k high.

Development History and Insights of Gold ETFs

Bitcoin is often referred to as "digital gold," and the connection between gold and Bitcoin as stores of value is evident. Therefore, studying the approval process and historical price trends of gold ETFs is of significant importance for predicting the future market of Bitcoin ETFs. The key time points and price trends surrounding the approval of gold ETFs are as follows:

1. In March 2003, the world's first gold ETF, named Physical Gold, was listed in Sydney, Australia. Following this, gold experienced a significant price increase, which continued until U.S. ETFs began trading.

2. In October 2004, the SEC approved the first U.S. gold ETF, StreetTracks Gold Trust (GLD); gold prices continued to rise slightly after the approval.

3. In November 2004, the U.S. gold ETF GLD officially began trading on the New York Stock Exchange (NYSE). The market fell about 9% in the two months following the start of GLD trading, briefly dropping below the price at the time of ETF approval. It wasn't until nearly eight months of consolidation that gold began its rapid upward cycle.

Price trends of spot gold before and after ETF listing / Source: macrotrends.net

The approval of gold ETFs allowed more traders to invest through ETFs without the need to store the metal or have it custodied in banks. In the following years, gold ETF products sparked a subscription frenzy globally, becoming a mainstream investment tool for gold and attracting significant capital inflows. The market generally believes that the approval of gold ETFs directly propelled the subsequent decade-long bull market in gold. Of course, the strong performance of gold also owes much to a relatively stable economic environment and monetary easing policies.

Drawing on the historical process of gold ETFs, we can make some preliminary predictions about the market trends before and after the approval of Bitcoin ETFs:

Phase 1: Before the approval of U.S. Bitcoin spot ETFs, the market will have sustained positive expectations.

Phase 2: After the official approval of U.S. Bitcoin spot ETFs, the market will still see a slight surge.

Phase 3: Shortly after the listing of U.S. Bitcoin spot ETFs, a significant drop may occur after reaching a peak, potentially falling below the price before the ETF approval, followed by a consolidation period to absorb more funds, before accelerating upward.

Phase 4: In the long run, the listing of U.S. Bitcoin spot ETFs will open the floodgates for traditional capital to enter, becoming an important catalyst for a Bitcoin bull market.

Impact of Spot ETF Approval on BTC Market Size

We examined the distribution of institutional investors among publicly traded companies with Bitcoin exposure and a market capitalization exceeding $1 billion. According to incomplete statistics, the total market capitalization of institutional holdings in these publicly traded companies exceeds $60 billion. Major holders include internationally renowned asset management firms such as Vanguard, BlackRock, and Morgan Stanley. Since these asset management firms have already engaged in Bitcoin-related services for their clients, we believe that a shift of 10% to 20% of the stock positions of these publicly traded companies to directly hold BTC ETFs as an investment exposure is possible, estimating an AUM scale between $6 billion and $12 billion.

Major publicly traded companies with Bitcoin exposure / Source: Yahoo Finance

From a more macro perspective, according to recent analysis by Galaxy Digital Research, the U.S. wealth management industry may be the most accessible and direct market for BTC ETFs, so the approval of Bitcoin ETFs will gain the most net new accessibility. As of October 2023, the total assets managed by U.S. traditional broker-dealers ($27 trillion), banks ($11 trillion), and RIAs ($9 trillion) amount to $48.3 trillion.

Galaxy has categorized the growth rates of various channels in the industry entering Bitcoin spot ETFs. Assuming that 10% of the available assets in each wealth channel adopt Bitcoin, with an average allocation of 1%, achieving a final conversion of 1‰. The final conclusion is that nearly $80 billion will flow into Bitcoin spot ETFs over the next three years.

Estimated market size and capital inflow for BTC ETFs in the first three years / Source: Galaxy Digital Research

Matt Hogan, CEO of the well-known crypto index fund management company Bitwise, recently stated that if spot Bitcoin ETF products can be approved, the overall scale could quickly reach hundreds of billions of dollars. He believes that in the first year of the launch of spot Bitcoin ETFs, it could easily reach $5 billion, and within five years, it may attract about $50 billion in funds. The current total size of the U.S. ETF market is approximately $7 trillion, and it is estimated that Bitcoin ETF products could attract 1% of the existing size, which is $70 billion. Currently, GBTC (Grayscale Bitcoin Trust) already has $20 billion, leaving about $50 billion of space.

Therefore, an initial inflow scale of $10 billion for BTC spot ETFs is reasonable, but the actual speed of capital inflow will ultimately depend on the market conditions at the time of ETF approval and the preferences of institutional and retail investors.

Impact of Spot ETF Approval on BTC Prices

In a recent article titled "Sizing the Market for a Bitcoin ETF," Galaxy Digital provided very insightful estimates regarding the impact of ETF capital inflows on BTC prices. However, due to the high time sensitivity of this prediction, as of now, BTC prices have increased by at least 30% compared to when the article was written, and some parameters may no longer be applicable. Therefore, we have further updated and optimized the data based on Galaxy's estimation model.

Comparison of gold and BTC market sizes / Data: World Gold Council, buybitcoinworldwide

Currently, the total market capitalization of gold is approximately 19.74 times that of Bitcoin's circulating market capitalization. Based on assumptions, the impact of equivalent dollar capital inflows on the Bitcoin market compared to the gold market is about 7.3 times.

Considering the impact of monthly capital inflows on BTC prices, we believe that using early time data will introduce too many outlier data points (such as those affected by the 2008 subprime mortgage crisis), but being too close to the present may lead to overly concentrated data trends. Therefore, we selected two periods for analysis: from 2016 to the present and from 2020 to the present (corresponding to the last two halving years for BTC).

Note: We initially used nearly 12 years of data from 2012 to the present, which yielded results similar to those from the data since 2020. However, due to the presence of many outlier data points in the dataset, the curve fitting was relatively poor, and the statistical patterns were not obvious, so we will not expand on that analysis.

Comparison of gold ETF capital flows and price changes since 2016 / Data: World Gold Council

Comparison of gold ETF capital flows and price changes since 2020 / Data: World Gold Council

Both fittings exhibit relatively high R-squared values (0.57 and 0.71), indicating statistical reliability. We still apply the estimated inflow of $14.4 billion in the first year (Galaxy has provided a good estimate of about $1.2 billion per month, adjusted with a 7.3 times multiplier to about $8.76 billion) to the historical relationship between gold ETF fund flows and gold price changes, substituting them into the above two fitting functions. We estimate that the impact of the first month of the spot ETF on Bitcoin's price is between 2.9% and 3.3%.

Considering the decrease in the gold/BTC market capitalization multiplier due to the rise in Bitcoin prices (which has already occurred; in Galaxy's article, it was 24x, and it is currently 19.74x), we can see that the monthly return rate gradually declines from 2.9%~3.3% in Month 0 to 1.68%~1.98% in Month 12. Ultimately, it is estimated that Bitcoin's price will increase by 27%~31% in the first year after the ETF approval (using the Bitcoin market capitalization of $673.4 billion on October 31, 2023, as the starting point, which is the 15th birthday of Bitcoin, a significant day).

Estimated impact of first-year capital inflows on BTC prices; adjusted capital inflow = (Estimated average monthly inflow of ETF) * (Gold/BTC multiplier); Data: World Gold Council, Galaxy Research

Compared to Galaxy's estimated first-year growth rate of 74%, our results are more conservative and convergent, but theoretically more reliable for the following reasons:

1. Our estimates are based on two fittings with higher R-squared values, indicating better curve fitting and relatively higher statistical characteristics.

2. Our data baseline, such as Bitcoin's market capitalization, has increased by over 30% compared to Galaxy's estimates, so a reduced growth rate is reasonable.

3. This estimate is entirely based on capital inflows, excluding price fluctuations caused by short-term market FOMO buying, Bitcoin halving, macro policy interventions, and other uncontrollable factors.

Possible Timing for the Next Bull Market to Start

Recent market trends indicate that the market has already digested some of the positive expectations. Combining the historical trends of gold ETFs, the timing of Bitcoin halving, historical market performance, and the effects of the Federal Reserve's macro policies, we have made rough predictions regarding the approval time of Bitcoin spot ETFs and the initiation time of the crypto bull market:

In January 2024, the U.S. SEC will approve the applications for Bitcoin spot ETFs, and at the same time, the Federal Reserve is expected to stop raising interest rates or the market will no longer have expectations for rate hikes. These will drive Bitcoin to undergo a round of high testing in January. Before this, due to the realization of positive expectations in November 2023, there may be a period of sustained increase, while December may see some fluctuations or corrections due to the holiday season, as many Wall Street institutions, hedge funds, and market makers may take vacations.

In April 2024, Bitcoin spot ETFs will officially begin trading, and the market will enter the countdown to Bitcoin halving, which will help absorb a large amount of capital.

In July 2024, the Bitcoin bull market will officially start. After the market adjustment following the halving, along with increased expectations for loose monetary policies, Bitcoin will have significant momentum to surge.

In September 2024, the Federal Reserve will enter a rate-cutting cycle and implement monetary easing policies.

We expect the bull market to start around July next year, rather than when the U.S. spot ETF officially takes effect. The main consideration is that the market often experiences a period of adjustment 2-3 months after Bitcoin halving, rather than immediately starting an upward trend; additionally, relying solely on the existing capital in the crypto space cannot sustain a long-term independent market. The approval of Bitcoin ETFs, such a significant positive factor, will need to be accompanied by some improvement in the economic situation to bring greater market stimulation and attract more external capital. The market generally expects the Federal Reserve to enter a rate-cutting cycle in September next year, making it reasonable for the market to start realizing rate-cutting expectations around July.

Potential Demand and Long-Term Trends for BTC ETFs

As the process of Bitcoin's ETF listing becomes clearer and institutional participation increases, its role as a powerful financial fortress in the global landscape becomes increasingly evident. With Bitcoin's next halving approaching in 2024, its annual inflation rate will fall below that of gold, making it one of the scarcest value assets. Because the total supply of BTC is fixed and halves every four years, it possesses high scarcity and reliable store of value, leading to a historical low exchange rate with currently depreciating fiat currencies such as the Argentine peso, Nigerian naira, and Turkish lira. The spot ETF will continue to provide BTC with unprecedented asset compliance and liquidity on top of its scarcity, further expanding the overall potential market size (TAM) for Bitcoin ETFs.

Current total supply and inflation of Bitcoin and gold / Data: World Gold Council, U.S. Geological Survey

Due to the potential strong demand, it is expected that other global and international mainstream markets will soon follow the U.S. in approving and offering similar Bitcoin or Ethereum spot ETF products to a broader range of investors. Various traditional investment or wealth management institutions will inevitably increase their Bitcoin exposure in their investment strategies (e.g., sovereign, mutual, closed-end funds, and private equity funds).

In the long run, the target market for Bitcoin investment products may further expand to all third-party managed assets (with an estimated AUM of approximately $126 trillion according to McKinsey) and even more broadly to global wealth (estimated at $454 trillion according to UBS). Based on these market sizes, if we maintain Galaxy's previous assumptions (10% of funds adopting Bitcoin, with an average allocation of 1%, i.e., 1‰ conversion), it is expected that the potential new inflows into Bitcoin investment products will range between $125 billion and $450 billion for a long time, representing a significant capital scale in the hundreds of billions. If we refer to the overall asset scale of gold, a multi-trillion-dollar crypto financial market is on the horizon.