Are our expectations for spot ETFs too high?

Cryptocurrency market participants are as hyped up as spider monkeys on Skittles and Mountain Dew.

They know that spot ETFs for crypto’s largest assets (ETH and BTC) are close to being approved and hope that outside investors are just waiting to start deploying capital.

Analysts at legendary crypto investment firm Galaxy predict that Bitcoin spot ETF approval would translate into $14.4 billion in demand and should drive Bitcoin prices up 74.1% in the first year, indicating the broader market’s bullish expectations for spot crypto ETF approval!

Today, we temper some of these expectations, highlighting why the evidence does not support the current narrative that the approval of a spot crypto ETF would bring such massive inflows.

1. Canadians’ disappointment

Launching a spot crypto ETF in the U.S. is far from a revolutionary feat; Canada has had it for over two years!

Holding of Canadian spot Bitcoin instruments would have been expected to grow if the approval of a spot crypto ETF unleashed unprecedented demand in the U.S. Instead, they have remained virtually unchanged since July 2022.

Canadian investors face the exact same investment narrative as Americans. Their lack of demand for spot Bitcoin products demonstrates latent demand in the U.S. and suggests that the narrative of Bitcoin as a hedge against inflation and depreciation is not enough to create asset inflows for non-crypto investors in the current market regime.

2. Form is not important

ETF gurus would have you believe that the introduction of a better investment vehicle will lead to billions of dollars of inflows following your portfolio, but the evidence to support this claim is weak.

They claim that investors simply don’t want cryptocurrency futures ETFs because they are a suboptimal way to track the price of the asset compared to spot products — since rolling futures contracts into expiration expose investors to contango and backwardation effects (i.e., next month’s contract could be priced above or below the expiring contract, respectively).

Yet the fact is that if the narrative is strong enough, investors don’t care at all about the form of the instrument they are investing in. Investment vehicles that offer a popular narrative will attract inflows, no matter how bad the product is!

A prime example of this fact is the explosive run experienced by the Grayscale Solana Trust (GSOL), which is currently trading at a ridiculous premium of 869%.

Source: Grayscale

Grayscale’s trust products, like GSOL and GBTC, are arguably much worse products than existing cryptocurrency futures ETFs because there is no redemption mechanism, meaning the market value of the assets you purchase can actually trade at a discount to the underlying trust holdings.

Despite GSOL’s flaws, investors still managed to find Solana’s narrative compelling enough to copycat the tool at a massive premium, leading to further confusion in market prices as private placements (i.e. the path to creating shares) are currently closed, meaning supply cannot meet market demand.

3. Bitcoin futures demand stagnates

If the approval of spot crypto ETFs actually leads to significant inflows into the asset class, then we would expect to see continued inflows into futures products.

Conversely, the outstanding shares of BITO, the largest BTC futures ETF, have been largely unchanged since July 2022, a deviation from the trends exhibited in June 2023 (the month BlackRock first applied for a spot BTC ETF) and early November 2023. A week later, the crypto market began pricing in imminent approval of spot Bitcoin.

BITO shares issued

External capital is using BITO to speculate on the launch of a spot Bitcoin ETF in advance, and the increase in outstanding shares can serve as an alternative indicator of the market's view on the approval of a spot Bitcoin ETF, but in reality there does not seem to be any real external demand for Bitcoin futures products, especially considering that the number of outstanding shares had already fallen below 60 million before the recent wave of spot ETF approval hype.

IV. Conclusion

While the vision of pre-emptive approval of spot crypto ETFs has impacted prices in the second half of 2023, spot BTC ETFs are about to be listed and the market’s demand theory will be put into practice.

Traders were caught off guard a few weeks ago by failing to price in the potential impact of a spot BTC ETF, but they may be caught in the wrong trade again when approval arrives, with the resulting inflows disappointing.

In the face of an uncertain macroeconomic environment and with limited evidence of outside capital willing to purchase crypto assets, which forces potential buyers to focus on their financial stability amid growing debt concerns rather than chasing the next 100x speculative project, there is no harm in observing whether spot ETFs can actually live up to expectations before increasing crypto exposure.