OKCoin Analysis: Why ETFs Affect Bitcoin Prices

As of 2017, there are more than 12 million Bitcoins in the world, in more than 100 countries, and more than 10 million Bitcoin players, which also leads to the fact that Bitcoin prices are affected by multiple global factors. From the trend of OKCoin last year, the main factors affecting Bitcoin prices are: halving of Bitcoin production, Brexit, and global popularity of blockchain technology.

Data source: Bitcoin trading platform OKCoin

One of the major events that will affect the price of Bitcoin this year is whether regulators will approve Bitcoin ETFs, and the Bitcoin dollar market has recently responded. Due to speculation that the US Securities and Exchange Commission (SEC) may support Bitcoin ETFs next week, the price of Bitcoin on foreign trading platforms has steadily increased, and finally exceeded the price of gold per ounce last Thursday. However, the price of Bitcoin on the domestic trading platform OKCoin is relatively rational.

Three years ago, the US asset management company Winklevoss first applied to the US Securities and Exchange Commission (SEC) to launch a Bitcoin ETF: Winklevoss Investment Trust, hoping to trade on the BATS exchange dominated by high-frequency traders, which may be approved before March this year. In addition, SolidX Partners also applied to the SEC for a Bitcoin ETF in July last year, which may be listed on the New York Stock Exchange in the future.

The U.S. Securities and Exchange Commission (SEC) is still evaluating whether to approve the Bitcoin exchange-traded fund (ETF) initiated by the Winklevoss brothers. The SEC has been considering whether to launch a Bitcoin ETF for three years. The Winklevoss brothers also switched from the original Nasdaq to BATS Global Exchange.

For Wall Street investors, Bitcoin, an eight-year-old cryptocurrency, is still a small asset. However, after its listing, the Bitcoin ETF (index stock fund) can serve as a bridge to help Bitcoin move from its current non-mainstream role to mainstream status.

What is ETF

ETF is an abbreviation. The first letter stands for exchange, the second letter stands for traded, and the third letter stands for funds. Therefore, the full Chinese name of ETF is: Exchange-Traded Fund.

The goal of a Bitcoin ETF is to provide a product that is more accessible to investors and can also curb Bitcoin's volatility to a certain extent, although it still cannot eliminate all risks of Bitcoin, so this ETF will still be riskier than most other ETFs.

Products like ETFs have low transaction costs (same as buying and selling stocks), effective index tracking (unlike closed-end funds which have a large discount), good liquidity (with market maker mechanism and arbitrage), and are very transparent (strictly replicate the index).

ETF is a product issued by a fund company. Its first-hand buyers (creators) are certified investment institutions, such as securities companies and large institutional investors. These buyers can exchange a basket of stocks (the types and proportions are agreed upon by the fund company, and cash can also be used when it is first issued) for ETF shares. Of course, these certified institutions can also exchange ETF shares for a basket of stocks.

Why do they switch to these ETFs? There are two possibilities. One is that they judge that holding the fund shares will bring income. Another possibility is that they can resell the shares to other investors, just like buying wholesale first and then selling them at retail. So why do they do this? What are the benefits?

There is an arbitrage opportunity here. We know that funds have a net value, which is determined by the prices of all the stocks held by the fund. ETFs are funds, and their net value is also determined by the prices of the basket of stocks they hold. This net value is also the cost of exchanging ETF shares. ETFs are directly tradable products, and their prices are determined by both supply and demand.

In this way, the same thing has two price formation mechanisms, which can easily lead to two inconsistent prices. That is, the transaction price of the ETF deviates from the net value. When the transaction price is high and the net value is low, these "wholesalers" will buy a basket of stocks to "purchase" ETF shares, and retail the shares to other investors at the same time, realizing risk-free arbitrage of buying low and selling high. On the contrary, if the transaction price is lower than the net value, you will definitely think that you can make money by "purchasing" ETF shares from the market and then exchanging them for stocks from the fund company and selling them.

If the Bitcoin ETF is approved on March 11, it will represent a milestone for the Bitcoin community. Analysts say that the existence of a Bitcoin ETF will allow authorized participants to issue shares based on real Bitcoin holdings, which may be a catalyst for new liquidity in Bitcoin.