The combined assets under management of recently launched Bitcoin ETFs in the US have skyrocketed to $5.1 billion in only nine days of trading since their launch.
Nevertheless, over this time frame, the value of Bitcoin has experienced a decline of approximately 20%. The price of shares for these ETFs has been declining in tandem with Bitcoin. How do ETFs manage to acquire additional Bitcoin despite the decreasing value of their shares?
Shares in commodities ETFs are created to mirror the performance of the underlying asset. Bitcoin backs spot Bitcoin ETFs as the underlying asset. When funds receive money, it is utilized to acquire Bitcoin at a corresponding rate. With the rise in demand, the worth of the ETF shares also increases.
The net asset value (NAV) is a measure used to gauge if the fund is over or overlooked compared to the Bitcoin it holds. It represents the value of the shares in relation to the underlying Bitcoin.
The Establishment of Exchange-Traded Fund Share Baskets
The stock in the ETFs is not magically conjured up when a shareholder determines to purchase them. Instead, baskets are created by Authorized Participants (APs).
According to BlackRock, only these five companies can generate or return baskets of shares for the ETF. Each basket consists of 40,000 shares, which are currently valued at approximately $906,365.
Every basket represents approximately 22.7 BTC. This implies that for every ETF share created, a minimum of 22.7 BTC (1 basket) must be purchased. When contributions are exchanged, an equivalent amount is sold for cash and given to APs. With the existing mechanisms, share baskets can only be created using cash, which implies that APs are unable to exchange Bitcoin with BlackRock for shares.
APs frequently purchase baskets of shares in advance to meet liquidity demands and subsequently sell them on the market. This process occurs daily and utilizes the CF Benchmarks Index pace for Bitcoin (New York variant) to guarantee that shares are issued in proportion to the price of Bitcoin.
When there is a significant amount of trading activity for an ETF, it indicates a strong demand for shares. As a result, it is essential to have enough liquidity to accommodate the volume. Shares will be created in accordance with the quantity, and these newly created shares will be utilized to track inflows into the ETFs.
As an example, let’s say that 7 million new shares are issued, which brings the total number of outstanding shares to 70 million. If the net asset value (NAV) price for the ETF is $22, then the assets under management (AUM) would increase by $154 million, reaching a total of $1.54 billion.
Nevertheless, it is essential to note that these shares may not have been sold on the open market and acquired by investors. The APs can still retain the newly issued shares and are available for use as liquidity for future trading.
If the price of Bitcoin goes down and investors start selling shares in the ETF, it doesn’t mean that the amount of assets under management will decrease at the same rate. If the value of Bitcoin decreases, the AUM may decrease in dollar terms. However, the amount of BTC held in the fund will only change if the AP redeems shares.
The Investment in Bitcoin That Is Made by Authorized Participants and Their Proxies
If the share price of an ETF decreases while its AUM boosts because of more Bitcoin purchases, it may indicate that the APs think that the fundamental asset is undervalued. APs have the option to retain the remaining shares without redeeming them based on their belief in the future value of Bitcoin.
The price of each share is determined based on the total value of assets under management when expressed in dollars. Thus, if Bitcoin experiences a surge in the future, the value of each share will increase as the AUM grows due to the decision not to redeem the shares.
Thus, considering that the entire Newborn Nine and the fundamental Bitcoin have experienced a decrease of approximately 18% since their launch. Simultaneously, the amount of assets under management has been increasing by around $550 million every day, and it appears that the APs are not selling off shares.
Grayscale is the sole ETF experiencing outflows due to its high 1.5% fee and the fact that most investors are currently making a profit. Every other ETF, including the Newborn Nine, is now seeing daily inflows as authorized participants create new share baskets.
The spot Bitcoin ETFs have a trading volume of approximately $1.5 billion, indicating the need for significant liquidity to support them. If liquidity decreases, there could be some redemption activity.
Currently, US institutions have utilized a staggering $27 billion in cash to enable the creation of Bitcoin ETFs. Considering the decrease in price and the creation of new share baskets, it is logical to assume that certain entities like JP Morgan and Jane Street Capital may have a significant ownership stake in this Bitcoin.
Now for the more extreme, fervent Bitcoin maximalist part of the claim. If JP Morgan had a similarly pessimistic view on Bitcoin as CEO Jamie Dimon, it would be reasonable to anticipate the redemption of baskets as long as there are sufficient shares available in the market to maintain liquidity.
However, based on the latest data, no share bags have been obtained for the Newborn Nine. The unallocated shares are owned by the APs who generated the baskets for themselves.
Bitcoin ETFs Are Known for Their High Liquidity and Active Trading
On January 24th, a significant number of shares were traded for BlackRock’s iShares Bitcoin ETF (IBIT), with a substantial number of shares still outstanding. The liquidity rate is approximately 15%.
By contrast, the iShares Core S&P 500 ETF (SPTR) from BlackRock has a substantial number of shares at 854 million and a respectable average volume of approximately 5.5 million.
This suggests a volume that represents 0.6% of the float. IBIT had a volume of roughly $270 million, while SPTR had a much higher volume of $2.7 billion, which is ten times more. SPTR has a significantly higher volume compared to IBIT, while IBIT boasts a much greater liquidity.
The significant liquidity of Bitcoin ETFs suggests a robust, though possibly more speculative, demand for these financial products. SPTR’s trading ratio suggests its stability in the stock market and a lower level of speculative trading. On the other hand, the Bitcoin ETF might be less affected by significant trades due to its ample liquidity.
According to reports, the introduction of spot Bitcoin on Wall Street has been incredibly successful. Investors’ interest is clearly reflected in the high volume, while institutional interest and confidence are evident in the significant basket creation across the board.
We will likely observe flows into the Newborn Nine ETFs every day for as long as Grayscale continues its outflows, even if volumes decrease. Buying Bitcoin from Grayscale is a great way to invest in Bitcoin gradually and take advantage of the way the Bitcoin price is determined for ETFs.
This is particularly evident when, on paper, APs are providing cash to the world’s top asset managers, such as BlackRock and Fidelity, instead of holding Bitcoin themselves. In addition, the process of Bitcoin buildup has limited public exposure, resulting in a low reputational risk.
Regrettably, unlike blockchain, TradFi remains a closed system. It is impossible to determine the number of outstanding shares held by APs and investors. Future disclosures and reports may provide glimpses of the situation, but we will be more informed once TradFi embraces a more open blockchain-based infrastructure.
Could it be that JP Morgan is utilizing Blackrock to purchase Bitcoin off the public eye?
It’s possible, but we need to figure it out. As we consider the possibility of institutions like JP Morgan and other authorized participants (APs) utilizing ETFs such as BlackRock’s as a means to purchase Bitcoin, it is worth noting a statement from BlackRock’s prospectus:
An Authorized Participant has the discretion to generate or return Baskets and is not obligated to offer Shares of any created Baskets to the public.
It is the typical language used for such a document, which raises some questions. This level of flexibility could have a significant impact. This suggests that these organizations have the flexibility to control their participation in the ETF according to their investment approaches, including their desired exposure to Bitcoin.
If an institution has confidence in the potential increase of Bitcoin’s value, it may choose to create baskets to acquire more shares and increase its exposure to Bitcoin without needing to sell the shares to the public. Alternatively, if they have a more pessimistic outlook or wish to minimize their risk, they may opt against creating baskets.
One possible approach for organizations to subsequently invest in Bitcoin is by utilizing the ETF as a means to oversee their investment without directly engaging in the buying or selling of Bitcoin.