Yu Zhe'an's Perspective | Bitcoin Spot ETF = Bull Market? Understanding the Blind Spots and Actual Impact of Bitcoin ETF

The author of this article is researcher Nathan Yu, who has over ten years of experience in stock market trading and specializes in currency market analysis. Currently, he is engaged in product development and market research in the DeFi fixed income protocol Term Structure. Authorized publication.

Yu Zhean's Perspective: Understanding the Blind Spots and Actual Impact of Bitcoin ETF in One Article

Over the past month, Bitcoin's price has surged by an impressive 30%. It can be said that the recent fluctuations in Bitcoin prices have been dominated by the topic of Bitcoin spot ETF. Almost the entire cryptocurrency community is eagerly anticipating the approval and listing of a Bitcoin spot ETF in the U.S., hoping that it will bring traditional financial capital into the cryptocurrency market.

So, how does the so-called "traditional financial capital flowing into the cryptocurrency market through ETFs" actually work? Before analyzing this issue, we must first clarify the basic structure of an ETF:

1 Understanding the Basic Structure of ETF: Four Roles

In the basic structure of an ETF, we can see four main roles, namely the "index compiler," "ETF issuer," "authorized participant," and "ETF listed exchange."

Usually, each ETF will have a so-called "tracking index," which is a product of the index compiler. The ETF issuer needs to pay for the authorization from the index compiler to use the relevant data of the specific index and must find ways to ensure that the ETF's performance aligns with the index being tracked.

The authorized participant also needs authorization from the ETF issuer and has the right to subscribe to or redeem ETFs from the ETF issuer. If we consider the ETF as a token, then the authorized participant has the right to "Mint" and "Redeem" the ETF.

The advantage of being an authorized participant is the ability to engage in market-making and arbitrage trading. If a Bitcoin spot ETF is approved, authorized participants should be able to use BTC spot to subscribe to Bitcoin spot ETF from the issuer and redeem Bitcoin spot with Bitcoin spot ETF.

2 Will Bitcoin Spot ETF Affect the Spot Market Price?

How Traditional Financial Capital Flows into the Cryptocurrency Market through Bitcoin Spot ETF

Next, I will explain the process of capital inflow into ETF through a bitmap diagram.

For illustration purposes, let's assume that one unit of Bitcoin spot ETF represents the value of one Bitcoin.

As shown in the diagram below, under normal circumstances, the ETF price will be the same as the spot price. The significant difference between Bitcoin ETF and spot price also indicates the actions that the authorized participant can take.

Traditional Capital Buying Bitcoin Spot ETF Can Trigger Arbitrage Opportunities

The entry of traditional financial capital into Bitcoin spot ETF will indeed drive up the ETF's price, causing a gap between the ETF price and the spot price.

When the ETF price rises, the authorized participant will start selling the ETF inventory in hand. If the inventory is sold out and still not enough to meet the huge market demand, the ETF price will further increase to a level where the authorized participant has an incentive to carry out arbitrage.

Here we can see that the Bitcoin spot ETF price is $33,000, while the Bitcoin spot price is $30,000. Therefore, the authorized participant will spend $30,000 to buy Bitcoin spot and subscribe to the spot ETF from the issuer, then sell it at the exchange price of $33,000 to earn a price difference of $3,000.

The authorized participant completes arbitrage trading through the above process, and selling the newly issued spot ETF in the market will also depress the ETF price.

Impact of More or Less Capital Flowing into Bitcoin Spot ETF

If a significant amount of capital buys Bitcoin spot ETF, the authorized participant will buy a large amount of Bitcoin spot to subscribe to the spot ETF. This will drive up the price of Bitcoin spot.

Therefore, whether the Bitcoin spot ETF price and the Bitcoin spot price converge during the arbitrage process depends on the scale of capital inflow into the Bitcoin spot ETF.

As the capital inflow into the Bitcoin spot ETF decreases and the authorized participants engage in arbitrage for price differences, the ETF price and spot price will eventually move to a new equilibrium point, eliminating arbitrage opportunities. If the new equilibrium price is higher, it means that the issuance scale of the ETF has increased due to arbitrage trading by authorized participants; if the new equilibrium price is lower, it means that the issuance scale of the ETF has decreased due to arbitrage trading by authorized participants.

Through the above explanation, it is evident that the effect of Bitcoin spot ETF on lifting the price of Bitcoin spot aligns with most people's intuition. What about Bitcoin futures ETF? Does it also have a price-lifting effect on the spot market?

3 Bitcoin "Futures" ETF Can Also Attract Traditional Capital into the Cryptocurrency Market

Next, I will explain the process of capital inflow into futures ETF through a bitmap diagram. In comparison to the previous section, here we have added a set of futures market prices. I will separate the futures price into long and short prices to better understand the transmission mechanism.

As the underlying asset of the futures ETF is futures contracts, the authorized participant will buy futures contracts to subscribe to the futures ETF from the issuer.

The authorized participant will buy long futures contracts from the futures market, causing the futures price to rise, ultimately converging the price difference between the futures price and the futures ETF price to eliminate arbitrage opportunities.

Investors who can participate in both Bitcoin futures and spot markets, when they see a significant price difference between futures and spot prices that create arbitrage opportunities, will execute futures-spot arbitrage. A scenario where a large amount of traditional financial capital flows into Bitcoin futures ETF will lead to higher futures prices than spot prices. Investors can sell futures and buy spot simultaneously to arbitrage, and the action of buying spot will also drive up spot prices.

Ultimately, the arbitrage opportunities between futures, spot, and ETF prices will disappear. The disappearance of arbitrage opportunities does not mean that there are no price differences between these three types but indicates that the price differences are small enough that authorized participants and investors have no incentive to engage in arbitrage trading.

Conclusion: Spot ETF Can Boost Bitcoin Price, but It's a Double-Edged Sword

The spot ETF indeed meets the expectations of the cryptocurrency market. A large influx of traditional financial investors buying Bitcoin spot ETF can effectively lift the Bitcoin price. However, the spot ETF also poses concerns about loosening market conditions. In the short-term trading, futures and futures ETFs have the same effect as spot ETFs, but the transmission mechanism is not as intuitive and is often overlooked by many.

In the future, there will be more trading tools bridging traditional finance and the cryptocurrency market. New trading tools often represent new channels for capital inflows and outflows, and regulatory reforms can also be a major factor in changing the direction of capital flow, all of which are worth paying attention to.