Pump, Dump And Bump: A post-Bitcoin ETF world
By Ryan Shea
What was surprising, to me at least, was the narrowness by which the vote passed. Two out of the five SEC commissioners – both Democrats – voted against the Bitcoin ETF and it only succeeded because Chair Gensler sided with the two Republican commissioners. Ahead of the decision market pundits were attaching a 90-95% probability to the ETF being allowed, but the vote split suggests the odds were closer to 60-40. It was a closer run thing than was previously assumed.
Last month the crypto world was dominated by one topic – the SEC decision to approve spot Bitcoin ETF products in the US. Such attention is understandable given it has been ten long years since they were first proposed by the Twinklevoss twins, owners of the crypto platform Gemini. Given all of the preparation undertaken by the ten tradfi firms seeking to list these products, including back and forth meetings with the SEC, and the flurry of last minute alterations to filings, crypto investors were fairly confident these products would be given the green light, so when the announcement came it was not that much of a surprise.
Not only that but the crypto world has Gensler to thank for the vote passing. Don’t forget this is someone – let us be polite – not well-liked by the industry given the controversial regulation-by-enforcement approach his agency has adopted post the FTX-bankruptcy and his rather negative take on crypto more generally. Indeed, the day prior to the ETF vote Gensler took to Twitter (sorry X) and published a thread warning investors about the dangers of crypto – see below.
Welcome To Crypto
Be that as it may, the ETF went live on January 9 and Bitcoin, which had already doubled in value over the prior four months, surged to a fresh cycle of $49,000. However, before all the fizz had escaped the freshly opened bottles of celebratory champagne, the price started to slide. From the launch high, Bitcoin’s price fell by over 15% in the space of just over a week.
I know what you are thinking, crypto price moves of this magnitude are hardly unusual, but for regular investors in tradfi assets who don’t have much experience with crypto, such moves are both unusual and unwelcome – see image below.
Source: Author (via imgflip.com)
While the near-term optics of a pump-and-dump price move are not great, when one examines the underlying flows in the various Bitcoin ETF products the situation appears considerably less negative. In total, ten companies have listed ETF products in the US. As the chart below clearly demonstrates, there is an extremely significant difference in terms of client flows between Grayscale and the other nine spot Bitcoin ETF providers (btw - kudos to VanEck and Valkyrie for their excellent ETF tickers!).
Bitcoin ETF Flows Since Launch (BTC held)
Grayscale’s ETF was, as many know, originally a Bitcoin trust, an investment vehicle its holders could not easily exit from. At the time of the transformation, Grayscale Trust owned 619,000 BTC equivalent to $28bn in AUM. Such a large holding instantly made Bitcoin collectively the second largest commodity ETF after gold (silver ETFs were pushed to a distant third place with AUM of $11bn). Grayscale’s management fee was set at 1.5%, making it three times more expensive than any other ETF provider and over five times that of the lowest cost provider (Trakx’s Bitcoin CTI is free – just saying). Sonnenshein, Grayscale’s CEO, argued that such the relatively high fee was justified given the fund’s size, liquidity and track record in managing Bitcoin assets. Others have less favourable interpretations.
Whatever the reason for the high fee, Grayscale’s Bitcoin ETF has been steadily bleeding AUM, losing over 80,000 Bitcoin (or approximately $4bn) in little over a week. Grayscale selling does not necessarily imply downward pressure on Bitcoin’s price because sales can be either recycled into other, cheaper, ETFs and/or on-chain Bitcoin purchases. In fact, as the above chart shows, net cumulative ETF flows into all the ETFs combined are positive to the tune of 26,000 BTC (equivalent to about a month’s supply of Bitcoin issuance [6.25 BTC block subsidy x 24 hours / 10 minute block time = 900 Bitcoin per day]). Nevertheless, such persistent net selling has unnerved short-term speculators because with over 500,000 Bitcoins still in Grayscale’s ETF a potentially lengthy period of sustained buying by the other ETFs will be required to absorb this net supply, assuming Grayscale’s fees continue to be as off putting to investors as they appear to be currently.
Hopium To Hodl
The hype responsible for driving Bitcoin higher in advance of the ETF launch (an effect that spilled over into the broader crypto due, in part, to anticipation other spot crypto ETFs will be permitted by the SEC1), may be unwinding, but the real determinant of whether the spot Bitcoin ETFs are a success or not will be whether they can attract sustained capital inflows from new investors to crypto. As I mentioned in a research note published a day or two after the ETF launch, there are very sound reasons for believing these sustained inflows will materialize.
I have no wish to rehash that note, but let me just add one other item I omitted to mention but which I believe is also pertinent. Bitcoin managed to go from a worthless tech plaything to a $800bn market cap asset in a decade and a half on a zero advertising budget. That is impressive by any standard. Imagine what happens in the years ahead now that it effectively has a PR/marketing budget paid for by large reputable tradfi investment firms promoting their ETF products.
What will make this advertising2 particularly effective is that the long-term macro drivers that have propelled crypto prices higher over the past several years continue to favour hodling.
Long-term Macro Drivers
It is an indisputable fact that government debt levels are extremely elevated in almost all advanced countries. After the rise in borrowing costs witnessed over the past 18 months (as central banks belatedly responded to the post-Pandemic surge in inflation) it is increasingly obvious to increasing numbers of people that unless efforts are made to cut budget deficits, fiscal policy is on an unsustainable trajectory.
History is full of examples of how this ends. Central banks get coerced into “financing” budget deficits via freshly printed money and inflation moves from the centre stage of policy-making to being a residual. This is the future, encapsulated in the Printer Go Brrr meme, that awaits us if nothing is done to rein in government budget deficits.
Now, what are the prospects of such a policy shift occurring this year when 64 countries, representing around half of the global population, are scheduled to hold national elections? Close to none because fiscal consolidation implies tax increases or spending cuts or both, and none of those options are vote winners.
That said, the path to this crypto positive outlook will not be straight, there will be some bumps in the road that need to be cleared first, and one of these bumps is not too far off.
Let me explain.
This time last year there was widespread conviction the US economy was heading for recession given the Fed hiking cycle was the most aggressive in decades. This call turned out to be wrong (mea culpa – I too was in this bearish camp). As has just been confirmed with the release of stronger than expected Q4 GDP data, the US economy grew a trend-like 2.5% in real terms.
How come we all got it so wrong? The answer is two-fold.
The biggest surprise, to me and I suspect many others, was US fiscal policy. Between FY 2022 and FY 2023 US government borrowing rose from 3.9% of GDP to 7.5% of GDP in FY 2023 (when corrected for Biden’s student loan forgiveness programme that was ruled unconstitutional. This was a much larger increase than forecast and generated a growth-boosting fiscal impulse of two percentage points of GDP3.
While the Fed was striving to slow the economy to bring down inflation, the Treasury was injecting stimulus in the form of higher budget deficits (crazy huh?). This push-and-pull of easy fiscal/tight money helps explain why US macro data have been so schizophrenic over the past several months.
Actually, that is not entirely correct. US monetary policy has not been as restrictive recently as a glance at the main Fed policy instruments would suggest, which is the second reason why the US economy fared better than expected (and why risk assets finished the year strongly).
Sustained QE programmes like the ones introduced during the GFC and the Covid pandemic bloat the central bank’s balance sheet and this adds additional complexity when it comes to calibrating monetary policy. In order to have better control over money market interest rates the Fed introduced the ON RPP (overnight reverse repo facility) in 2015 to allow them to raise interest rates at a time when commercial banks were flush with reserves4.
This facility was not heavily utilized in its first few years, but as the Fed began to ramp up interest rates at a pace that commercial banks couldn’t match, usage soared because people flocked to money markets funds who were eligible to access the facility and could offer higher (and safer) returns. At its peak in early 2023, more than $2.2tr was parked at the Fed.
When the debt-ceiling agreement was signed in early June the US Treasury, which had been drawing down its account with the Fed (TGA) to keep things ticking over, started to replenish its account. It did so by issuing T-bills bought by money market funds who paid for them with funds held in the ON RPP facility. As a consequence, the balance on the ON RPP facility has fallen by a substantial $1.7 tr. This constitutes new liquidity being injected into the banking system that helped cushion the impact of the Fed’s ongoing QT programme.
Source: Fred database
Are We There Yet?
Encouraged by the ongoing decline in inflation, and despite the more positive growth backdrop, at the last FOMC meeting Chair Powell admitted the committee had already shifted to discussing when it would be appropriate to start easing monetary policy. Indeed, the updated dot-plots indicated that, on average, FOMC members expect to cut the funds rate by a cumulative 75bp in 2024.
Investors, by contrast, are taking a much more aggressive view. Short-term interest rate futures are pricing in the equivalent of six 25bp rate cuts by year-end, with the first cut possibly coming as early as March. That’s double what FOMC officials are anticipating. Quite a gap!
Part of the reason for this gap could be that having (incorrectly) anticipated a recession for much of 2023, investors are looking for validation that their bearish assessment was ultimately correct – monetary policy, after all, is well-known to operate with substantial lags. It also probably reflects concern about tail risk.
As things currently stand, the ON RPP facility sits around $550bn meaning there is very limited scope for it to continue to act as a QT buffer. On current trends, it will be exhausted by March, at which point bank reserves will start to decline. At the same time, the Fed’s emergency BTFP programme, cobbled together last year after the failure of three US commercial banks (Silvergate, SVB and Signature), is due to expire.
Some $160bn is parked in this other Fed facility. Admittedly, this number has been inflated by banks using it as a risk-free arbitrage prompting the Fed to announce recently that it was changing the terms of the facility, but the bulk is still serving as a life-line to regional banks whose bond portfolios remain underwater. If, as seems almost certain, this programme ends in March, these regional banks will be left scrambling for liquidity. There are already signs that US policymakers are prepping for such an outcome because, to quote Bloomberg, they are...
“… preparing to introduce a plan to require that banks tap the Federal Reserve’s discount window at least once a year to reduce the stigma and ensure lenders are ready for troubled times.”
This stigma argument has been around for a long time, and was much discussed during the GFC, but legislating to force commercial banks to use the facility at least once a year is simply stunning. It certainly does not help assuage investor concerns.
My sense, although I can’t prove it, is that the 150bp of Fed easing implied by US rate future constitutes a weighted-average of two views: one camp who believes, like the Fed, that only 75bp of rate cuts are warranted as the US economy slowly glides back to equilibrium, and a second camp that thinks we are facing a deeper recession-like outcome where the Fed will be forced to slash rates by more than a cumulative 150bp with at least some parts of the US banking sector coming under renewed strain (think GFC-lite). One of these is wrong, but which one is unclear at this point. What is clear though is neither of these outcomes – sharp economic deceleration or a backing up in US rate expectations – are particularly favourable for risk assets, including stocks and crypto.
(NB: This assumes, of course, that inflation behaves itself and continues to converge with the Fed’s 2% inflation goal. In light of events in the Red Sea and its potential to generate cost-push inflation as global supply chains come under pressure, the downside risks could be further increased for both of the aforementioned scenarios.)
This is the bump and March appears to be crunch time.
Stop press: The article was written prior to the January 31 FOMC meeting and press conference, where the Fed did two interesting things. First, it pushed back on the market timing of when interest rate cuts would occur. Second, it removed the phrase "The U.S. banking system is sound and resilient." from its policy statement. Coming the same day that New York Community Bancorp shares – who, somewhat ironically, purchased deposits from failed Signature Bank last year – plummeted 45% after announcing a dividend cut, it strongly hints that policymakers are concerned about parts of the US commercial banking system.
1 Notwithstanding the Gensler’s negative crypto stance, ETF analysts are attaching a more than 70% chance that a spot ETH ETF gets approved by May.
2Google banned any cryptocurrency ads in 2019 along with Facebook. But the search giant last month announced that it would permit Bitcon ETF products to be advertised from January 29 – see: https://cointelegraph.com/news/google-ad-policy-allows-crypto-trusts-spot-bitcoin-etf-approval-us
3Fiscal impulses are calculated by looking at the change in the cyclically-adjusted budget balance. That is why it is smaller than the 3.5 percentage point gap between the headline deficits.