August 2023: A Step Forward for Spot Bitcoin ETFs

Last Update 09/01/2023

A down month for digital asset valuations ended with a spark of optimism after a court ruling raised the prospects for spot Bitcoin ETF approval.
The drawdown earlier in the month likely began with macro catalysts–virtually all asset classes declined in August–and then accelerated due to exchange liquidations.
The month brought other structural positives, including strong early adoption of a new social media platform, and PayPal’s entrance to the stablecoin race.
In our view, the combination of improving fundamentals and low speculative positioning have created a favorable environment for long-term holders to add to crypto portfolios.

Although crypto valuations fell during August, the month ended with a spark of optimism after the DC Circuit Court of Appeals further opened the door to potential spot Bitcoin ETF¹ approval in the US market by vacating the Securities and Exchange Commission’s denial of Grayscale’s proposal to convert Grayscale Bitcoin Trust (GBTC) to a spot Bitcoin ETF. As digital asset markets have matured, token valuations have become more correlated with other financial assets. And despite positive news for the crypto industry last month, the broad-based selloff in all other major asset classes ultimately weighed on cryptocurrency prices as well. Digital asset valuations may continue to face macro headwinds over the short-term, but the growing number of structural positives and lower speculative positioning have created an attractive environment for long-term holders to add to their crypto portfolios. Virtually all asset classes produced negative returns during August, and crypto was no different (Exhibit 1). The weakness was led by Emerging Market equities (especially Chinese equities), long-maturity US government bonds, and “risk parity” products, which usually take leveraged positions in government bonds to benefit from their typically negative correlation with stocks. When equity and bond prices fall together, these products perform especially poorly.

Exhibit 1: All major asset classes faced drawdowns in August

The pressure on global assets appeared to stem from two main sources: pessimism about China’s economic outlook, and a surplus of long-term bond issuance by the US government. China’s real estate sector has struggled for some time, and that weakness is now reflected in other segments of the country’s economy. While the government has announced stimulus efforts, so far they have failed to impress markets or economic forecasters. Meanwhile in the United States, long-term Treasury yields continued to climb, with the yield on the 30-year bond reaching its highest level since 2011. The combined effect of large budget deficits and the Fed’s quantitative tightening (QT) has apparently overwhelmed investor demand at the long end of the yield curve (Exhibit 2)².

Exhibit 2: Heavy Treasury borrowing may be weighing on long-end bond prices

Bitcoin’s price moved sharply during two short windows in August: it fell 9.9% from August 16 to August 18, and rose by 6.2% on August 29.³ Outside of those two periods Bitcoin’s annualized price volatility in August was only about 20%. Bitcoin’s mid-month selloff reflected a wave of liquidations on major exchanges (Exhibit 3). Prior to that point, Bitcoin leverage had been building up in the market, possibly in anticipation of the DC Circuit’s then-pending decision in the GBTC lawsuit. However, as the selloff in global equity markets began to spill over into crypto, a modest initial drop in prices caused exchanges to close traders’ leveraged long positions. After the liquidations on August 17, market positioning now looks much cleaner.

Exhibit 3: Wave of exchange liquidations sent Bitcoin’s price sharply lower mid-month

Bitcoin subsequently reversed course after the DC Circuit Court of Appeals ruled in favor of Grayscale in its lawsuit against the SEC. Grayscale argued that the Commission had unfairly denied its proposal to convert GBTC to a spot Bitcoin ETF, while previously approving two Bitcoin futures ETFs — arguing that you must treat like products the same. In its Opinion, the Court expressed agreement with Grayscale’s legal argument, noting that it “presented substantial evidence that Grayscale is similar, across the relevant regulatory factors, to bitcoin futures ETPs. The Commission failed to adequately explain why it approved the listing of two bitcoin futures ETPs but not Grayscale’s proposed bitcoin ETP. In the absence of a coherent explanation, this unlike regulatory treatment of like products is unlawful. We therefore grant Grayscale’s petition for review and vacate the Commission’s order.”

While the Court decision does not imply immediate conversion of GBTC to an ETF, it does represent a major step toward spot Bitcoin ETF approval in the US market. Many investors believe that a spot Bitcoin ETF has been a long time coming, and Grayscale has repeatedly said that the spot Bitcoin ETF is a matter of “when, not if.” According to Bloomberg data, there are already about 150 exchange-traded cryptocurrency products listed globally, with assets totalling more than $7bn.⁴ Other developed market economies–including Canada, Switzerland, Sweden, and Germany–have approved spot cryptocurrency exchange-traded products, including for Bitcoin, Ethereum, a variety of other digital assets (e.g. SOL, XRP, BNB), as well as digital asset indices. In the US market there are eight existing products, and all of these products hold Bitcoin futures as the underlying asset, including a short strategy, a 2x leveraged fund, and a product using option overlays. There are currently ten applications for a spot Bitcoin ETF awaiting SEC approval, including Grayscale’s application that was the subject of the lawsuit.

Exchange-traded funds now account for about 30% of the US fund market for corporate equities and capture the lion’s share of new investment flows (Exhibit 4).⁵ Providing access to digital assets through this type of investment vehicle will likely attract new participants. Although futures-based products are available in the market today, many investors are aware of their negative “roll yield,” and therefore may be awaiting more direct Bitcoin exposure.

Exhibit 4: ETFs capture the lion’s share of new investment in public equities

August included a number of other positive developments aside from the progress on spot Bitcoin ETFs. For example, social media platform friend.tech emerged as a notable application on the Base Layer 2 blockchain. The app enables users to sell unique access—referred to as ”keys”—to their followers. Holding these keys grants the right to exchange private messages with the main profile of the user. On August 21st, friend.tech saw an impressive spike in daily revenue, reaching nearly $850,000, although this fell back to a range of $100,000 to $200,000 by the 26th. This surge in popularity was so significant that it contributed to Base Layer 2 overtaking both Ethereum and Bitcoin in daily transactions on the same day, with a total of 1.37 million transactions. Of these, friend.tech alone accounted for nearly half, with 530,000 transactions (Exhibit 5). Despite its successful rollout, it remains to be seen whether the app will have staying power among users.

Exhibit 5: New social media application friend.tech caused surge in Base transactions

Separately, major announcements by Paypal and USDC signaled an optimistic shift towards stablecoin adoption.⁷ Paypal’s announcement to launch its PYUSD stablecoin⁸ could offer tremendous onboarding potential, presenting a crypto on-ramp for Paypal’s 435 million active users⁹. Despite an initially low adoption rate¹⁰, we believe the traditional financial giant’s foray into crypto undeniably underscores a promising shift. Incumbent stablecoin issuer Circle (USDC) also shared some potentially positive news, as it announced an investment from Coinbase¹¹. With revamped governance and funding, Circle has shared that it plans to launch USDC on six new chains¹² and also announced that it would partner with Latin America payments giant Mercado Pago to bring the USDC stablecoin to Chile¹³.

Protocol-specific upgrades drove outsized performance for select tokens in August. For example, ThorChain’s RUNE token was a standout performer–with a gain of 66%–on anticipation of the launch of its lending protocol.¹⁴ Originally designed as a bridge and decentralized exchange, ThorChain has expanded its suite of products to include borrowing and lending. This addition allows users to lend native BTC and ETH while borrowing USD-denominated debt. The recent surge in the price of RUNE appears to be fueled by positive sentiment around its tokenomics. Specifically, the RUNE token undergoes deflation when new loans are issued. Given the success of other lending protocols, even capturing a small slice of the current market could have a deflationary impact on RUNE’s overall supply.

Standout performers also included Akash Network, which was up 71% on the month¹⁵. Akash provides a decentralized marketplace for cloud computing and attempts to compete with existing services by addressing the nearly one-third of server capacity¹⁶ that goes unused. Recently the network has capitalized on the AI boom and related graphics processing unit (GPU) shortage¹⁷ as it announced support for GPU deployment¹⁸— in effect, Akash provides a way for users with spare GPU capacity to share it over the network. Akash will provide financial rewards to those offering what would otherwise be idle GPUs, as well as cost effective means of training AI models for developers.

In digital asset markets today, we see a striking divergence between ongoing innovation on the one hand and low investor enthusiasm on the other. For example, the number of new entrants to the market seems very low: for Bitcoin in particular, the share of tokens held by short-term holders reached an all-time low in August (Exhibit 6). Other indicators including exchange volume, price volatility, and NFT sales also point to a relatively quiet period for the industry from a trading and investment perspective. Yet structural positives for the asset class continue to pile up, including possible ETF approval, adoption of new technologies like friend.tech, and participation from major TradFi players like PayPal. Historically, digital assets have delivered high returns over reasonably long holding period¹⁹, but the best returns have come when investors accumulated assets during periods of low engagement by short-term speculative traders when prices were at local lows (i.e. crypto “winters”). We think investors could be similarly rewarded in the future from building crypto allocations during today’s quieter markets.

Exhibit 6: Engagement from short-term traders notably low

^{1. We use the generic term “ETF” to refer to exchange-traded investment vehicles, including those that are required to register under the Investment Company Act of 1940, as amended (the “‘40 Act”), as well as other exchange-traded products which are not subject to the registration requirements of the ‘40 Act.}

^{2. Since the start of QT, the US government has run a cumulative budget deficit of about $2.5 trillion, but public investors have only needed to purchase around $1 trillion in additional bonds and notes with greater than 1yr remaining maturity. The difference has been made up by higher bill issuance, a drawdown of the government’s cash reserve, and other sources. Financing of government spending from these alternative sources is now limited, and long-term bond issuance will need to increase. These plans were disclosed with the Treasury’s Quarterly Refunding Announcement at the start of August. Source: US Treasury, Bloomberg, Haver Analytics, Grayscale.}

^{3. Prices based on 5pm NY close. Source: Bloomberg.}

^{4. As of August 31, 2023.}

^{5. Including mutual funds, closed end funds, and ETFs, and excluding money market funds. Source: Federal Reserve’s Flow of Funds statistics.}

^{6. Bitcoin futures expire, and therefore must be periodically “rolled” into new contracts. Because the Bitcoin futures curve is upward sloping (i.e. in “contango”), the process of rolling involves a sell-lower/buy-higher transaction, which can be thought of as a negative yield for the futures portfolio.}

^{7. Tether (USDT) also returned to its $1 peg after wobbling early in the month.}

^{8. PR Newswire}

^{9. Demand Sage}

^{10. The Block}

^{11. CoinDesk}

^{12. CoinDesk}

^{13. The Block}

^{14. Coin Gecko}

^{15. Coin Gecko}

^{16. Messari}

^{17. Venture Beat}

^{18. Mintscan.io}

^{19. For example, Bitcoin price returns have been greater than 150% for every three-year holding period since July 2010. Source: Bloomberg, Grayscale.}

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