• Bitcoin ETFs could reduce the influence of whales (large holders) in the market and reduce Bitcoin’s volatility, analysts said.
• In traditional markets, spot ETFs tend to increase the liquidity of their underlying assets.
• One market source said that if a Bitcoin ETF involves “cash generation,” it may allow volatility to remain high.

The U.S. Securities and Exchange Commission (SEC) is widely expected to approve exchange-traded funds (ETFs) that invest directly in Bitcoin, rather than Bitcoin (BTC) futures.

Analysts agree that the approval will have a bullish impact on prices. But analysts are divided on whether the approval will reduce Bitcoin’s notorious price volatility, which has made it less attractive as a safe-haven asset.

Although the Bitcoin blockchain is decentralized, its native token, BTC, is concentrated in the hands of a relatively small number of large holders known as whales. Because of the size of their holdings, whales have great influence on prices, often causing wild price fluctuations. Physical ETFs, which are said to closely track the value of the underlying assets, could reduce the influence of whales by broadening the base of their holders.

“Spot ETFs will provide exposure to Bitcoin to a broader range of market participants, including institutional investors and financial advisors,” said Nate Geraci, president of investment advisory firm The ETF Store. Ta.

“Expanding the Bitcoin investor base through ETFs could theoretically contribute to lower volatility by increasing the number and diversity of investors. It will be difficult to move prices.”

According to an estimate by Galaxy Digital, the market size that can be captured by a US Bitcoin ETF will reach $14 trillion (approximately 2,100 trillion yen, at an exchange rate of 150 yen to the dollar) in just one year after the launch of the spot ETF. It could reach $39 trillion in the third year.

Improving liquidity

Such strong uptake can increase the liquidity of the underlying asset and create less volatile trading conditions where prices do not fluctuate rapidly. Liquidity refers to the ability of a market to absorb a large number of orders at a stable price.

“Volatility tends to decline as the space matures, more institutional liquidity and infrastructure is in place, and assets adjust to normal conditions,” said Co-founder of crypto asset liquidity provider GSR. said Richard Rosenblum, CEO and President.

Tugkan Tuzun, Mehmet Saglam Associate Professor of Finance at the University of Cincinnati’s Carl H. Lindner College of Business and Federal Reserve economist; In the stock market, as ETF holdings increase, the underlying stocks tend to become more liquid, according to a 2018 paper by Russ Wermers, associate professor of finance at the School of Business.

The paper, which looked at S&P 500 and Nasdaq stocks, found that “ETFs increase the liquidity of their underlying stocks using several measures of liquidity: illiquidity indicators, effective spread, quote spread, and Amihud. We find that illiquidity measures and implementation shortfall all increase as equity ETF holdings decline.

“After examining the price dynamics of large order executions, we find that one of the main causes of the increase in liquidity is due to arbitrage trading against potential mispricing between the ETF and the basket of underlying stocks. ” (same paper)

Arbitrage investors take opposing positions in two markets and profit from the price difference between the two markets. For example, if an ETF is trading at a discount to the price of the underlying stocks, an arbitrage investor will buy the ETF and sell the underlying stocks, adding liquidity to the underlying stocks.

Volatility due to cash-based contributions

Laurent Kssis, ETF expert and crypto trading advisor at CEC Capital, takes the opposite position, arguing that physical ETFs can be a driver of BTC price fluctuations. .

ETFs are created and redeemed in kind or in cash. In the widely used contribution-in-kind model, authorized participants (APs) deposit a basket of securities with the issuer in exchange for new ETF units. In the cash contribution model, the AP provides the cash and the issuer purchases the physical assets.

With a cash contribution model, the issuer is exposed to the difference between the price at which the asset was acquired and the daily reference price at which the NAV is calculated, Kusis said.

“To calculate NAV, you need a reference price to value the fund,” Kusis said.

“In the case of an in-kind contribution type, AP purchases the asset and delivers it to the issuer.In the case of a cash contribution type, if the issuer buys the asset at a low price, it will make a small profit, but if it buys it at a high price, the AP will absorb the difference by itself. You will have to pay.”

He added: “Therefore, at the time of execution, more arbitrage investors will either trade around that time period, increasing trading volume and pushing up the market, or they will trade the difference between the spot and futures prices of Bitcoin, and the “You’re essentially creating volatility inadvertently,” Kusis added.

Recently, there was a rumor on X (formerly Twitter) that the SEC wants ETF applicants to operate on a cash contribution basis.

｜Translation and editing: Akiko Yamaguchi, Takayuki Masuda
｜Image: Shutterstock
｜Original text: Gauging Spot Bitcoin ETF’s Impact on Price Volatility