What would a spot bitcoin ETF approval mean for the industry?

All eyes in the crypto industry are heavily focused on the current list of candidates vying to launch the first spot bitcoin ETF in the U.S.

But why is the creation of this kind of financial product such a big deal? Well, it comes down to the accessibility that the product gives — and the potential implications that come with that.

To understand this, a key parallel can be drawn with the launch of the first gold ETF, said cryptocurrency derivatives trader Gordon Grant. He told The Block that after the creation of gold spot ETFs, "trading volumes across a variety of gold instruments, ranging from the ETFs themselves to underline spot to futures and options, both OTC and listed, along with correlative proxies, increased by orders of magnitude over the years that followed."

He added that, under the right circumstances, a similar effect could happen to bitcoin.

Creating an entire value chain

Grant noted that the inclusion of a spot bitcoin ETF as an accredited financial product available for investment by both retail and institutional investors will have a bearing on the decisions made by traders. 

"Traders may not have a view on bitcoin, they may be indifferent to it, but they will have a view on efficient portfolio theory and the implications of the inclusion of a physical bitcoin ETF to their holdings and/or investment strategy" Grant added.

He added that a spot bitcoin ETF could catalyze multiple layers of financial activity in the sector. Grant explained that if the gold ETF paradigm holds, trading would likely take place not just on the underlying asset level, but throughout derivative markets developing on top of and burgeoning adjacent to this, such as ETF options and futures, and futures options.

"You will have a new layer of trading activity on top of the base layer, which will likely be options trading on the ETF. Then, if you abstract a little further, there is the volatility component of the options market, against which market makers and other participants will naturally need to hedge, and so accordingly we may move into futures and futures options trading on top of that," Grant said.

Grant proposed that the multiple layers of trading, including options, futures, and pure volatility trading, could result in the creation of a complex value chain. "All of a sudden there are four, or more, levels to this trading dynamic and an entire value chain is created based on this new product," Grant added.

Making it easier to access bitcoin

CoinShares Research Associate Luke Nolan said the introduction of a spot bitcoin ETF would simplify institutional investors' access to bitcoin exposure. "There will be no need to care about holding keys or safeguarding a seed phrase, as usually an institution would need to incur additional costs to develop some form of in house solution to hold their own crypto," he said.

Nolan further pointed out that a spot bitcoin ETF would impact the distribution channels for institutional capital inflow, making it easier for those managing their 401(k) retirement plans or handling investments on behalf of companies to include bitcoin in their portfolios.

He noted that the existing method for institutional exposure involves futures ETFs, but the approval of a spot ETF would provide investors with lower expense ratios by eliminating the need for rolling over futures contracts, which often incurs costs. 

He explained that the bitcoin futures market tends to be in contango, causing futures prices to be higher than spot prices. "The bitcoin futures market is almost always in a state of contango, and by rolling over contracts to later expirations, there is a phenomenon known as contango bleed." Nolan cited contango bleed as a major reason for futures ETFs underperforming bitcoin.

While bitcoin ETFs could have a big impact on the market, making the cryptocurrency more available for institutions in the U.S. to trade, the SEC continues to drag its feet. That said, Bloomberg analysts estimate a 75% likelihood that a spot bitcoin ETF will be approved this year, with JPMorgan analysts saying one could come within months. But until there’s a form 19b-4 approval from the SEC, nothing’s for sure.