Talk Your Book: The Impact of a Bitcoin ETF

0:00Today's Animal Spirits Talk Your Book is brought to you by Fidelity Digital Assets. Go to Fidelity Digital Assets. dot com. They are the institutional standard for digital assets. It's fidelitydigitalassets.com. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnick and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. This podcast is for informational purposes only and should not be relied upon for any investment decisions.

0:32Clients of Ritholtz Wealth Management may maintain positions in the securities discussed in this podcast.

0:40Welcome to Animal Spirits with Michael and Ben. So is Bitcoin the best performing asset this year, Michael, of the big? It's got to be close, correct? No, it's the 2x Bitcoin. Okay. But what do you said? It's up 80 % this year? Looking at that, I mean, obviously coming from a low base. You also told me today that Carvana is up 600%, but it's down 91 % still in terms of drawdown. So you always have to put these numbers into context. But it might surprise some people that Bitcoin is doing so, especially in the face of bad news. I think the first good news crypto has gotten in a while is the fact that some of these traditional finance firms have gotten into the potential race for a more traditional fund.

1:25And we still haven't heard any announcements saying, hey, this ETF is going to happen. But I think this is the first step in the right direction for crypto in the past, I don't know, 18 months or so. It was interesting. Did you see any of Larry Frank's commentary? Not really. He was on Fox talking about Bitcoin. I was about to use the term. It was surreal to see him say that. It wasn't surreal. It was because I wouldn't go that far. It was interesting to hear him talking about it, given not too long ago, I don't know, less than five years ago, every single incumbent traditional financial institution was calling Bitcoin rat poison or worse.

2:07I've been trying to think through what the implications could be in terms of, is there a lot of money on the sidelines that has said, no way I'm getting into this space if I'm holding my own keys or using Coinbase or some other custodian like that. I'm going to wait for the ETF because it's far more regulated. It's impossible to come up with an estimate for that, but I guess the bull case would be places like BlackRock or Big, or even financial advisors, say 1 % or 2 % of our models are going into a Bitcoin ETF. Dude, how about this? This is much more realistic that Bitcoin will start going to model portfolios.

2:43That is a much more realistic thing than what happens if S &P 500 companies start putting Bitcoin on their balance sheet. Remember that nonsense? Ah, yes. Yeah, that's the company that sounds better in a bull market. I think Tesla was the only one to do it. Yes, you're right. So we'll see how long it takes till we have Bitcoin ETFs in my Vanguard target date funds. But you're right. That's the potential for good thing for this space. I do wonder what hardcore coiners are thinking about this. Because on the one hand, not only does the institutions coming in legitimize the asset class, but there's also, it opens it up to a lot more buying, which opens it up to higher prices potentially.

3:26But on the other hand, as we spoke about with Jack, the whole reason why Bitcoin was created was to live outside the financial system. And Jack made a good point. He's like, well, the two could coexist. You can have your keys and your cold storage. And if somebody wants to buy Bitcoin through an ETF, so be it. Right. You can have it both ways if you want. And I think the narrative has changed so much. You can have your coins in it too. But the narrative has changed so much in crypto over the years that I think, I don't think it's going to be a leap for some people to just be like, ah, whatever.

3:54So there's an ETF. Who cares? It's more people who can get into the system. Yeah, I agree. I think there's going to be the hardcore, hardcores, hardcore, hardcorers that are not into it, but everybody else is probably cheering it on, right? Right. So we've talked to Jack Newrider from Fidelity Digital Assets a few times, and it's always good to check on him. So here's our talk with him. We had a bunch of questions for him. We just flared him at him. So here's our talk with Jack Newrider from Fidelity Digital Assets.

4:25We're joined today by Jack Newrider. Jack is a research analyst at Fidelity Digital Assets. Welcome back to the show. Yeah, it's a pleasure to be back. Thanks for having me again. All right. We're going to start today with a question about the recent news, I think out of the institutional space was Fidelity. It was BlackRock who filed an application for an ETF, which is a big deal for many reasons. Number one, either first or second largest asset manager in the world or third or whatever it is, very influential. They don't just throw crap against the wall. I think their record was like either 475 or 575 approvals and one rejection.

5:07So it seems like, again, they think they know something, or at least maybe the market thinks they know something. Bitcoin had a nice run up after the announcement. There are many implications for a potential spot ETF for Bitcoin. If you think about the most important things, what do you think that is? Yeah, I think overall it's ease of access to the asset class and normalization. So you're not getting an ETF approved or building the infrastructure to support an ETF for Bitcoin if you're not planning on it having some sort of staying power or not to say that it legitimizes the asset class, but it allows a wide set of investors that at the moment wouldn't or can't access the asset class to be able to access it.

6:00So to me, it's a normalization thing. And then beyond that, when you think about allocations to digital assets, it's usually small percentages, because how do you account for a volatile asset that at least historically has had high levels of returns? It's position sizing. And so when we're talking to investment advisors, family offices, or kind of you name it, investors are looking at this as a small percentage of their portfolio. And so how much of an operational and due diligence headache do you want to go through in order to be able to access the asset class? Historically, you've needed to set up a separate relationship.

6:37And are you willing to do that for 1%, 2%, 3 % of a traditional portfolio? And I think for the average person, it's not worth the squeeze a lot of the time. Have you or your team spent any time thinking through what that possible cash on the sidelines, for lack of a better phrase, could be in terms of how an ETF could open up new investors in crypto? Yeah. I mean, the problem with any market sizing is you can get to – it's kind of like a discounted cash flow. if you change the growth rate or you change your set of assumptions, you can get the number that you're trying to back out. So I don't know that it's all that useful to frame it from the context of perfectly addressable market.

7:28But we know, I mean, we know, generally speaking, that the number is big. Do you have any, while getting into the weeds and the nitty gritty, any sense of why you think it's taken so long to get one to market? Do you think it's just because this is such a new asset class that the regulators just want to be very careful? What is a good sense of the reason why it's taken so long? Yeah, I mean, anytime you get a new asset, especially in the context of a digital bearer instrument that if you're holding on to the private keys, you have that asset. And if you lose those private keys or if someone gets access to them, that they can take those assets.

8:09And so I think part of it has been the fact that it's a bearer asset. And then the other piece is that the regulatory environment hasn't fully regulated spot market trading. Those are sort of the two qualms that regulators have had around approving a 33-act spot fund, right? And so we've seen the futures funds have been approved, but at least thus far, largely from regulators, it's been that the futures funds, well, they're cash settled, so you don't have to worry about the custody piece. And then the futures markets, at least CME that the approved funds trade on, have the ability for those trades to be monitored by regulators.

8:56Whereas I guess the argument around spot markets largely to date has been that a lot of trading takes place offshore. And even a lot of the onshore exchanges, there isn't a ton of regulatory clarity or regulation involved in that spot market trading. You mentioned the futures ETF. There's also a two times a levered Bitcoin future ETF that was approved. I think it started trading a couple of weeks ago. Matter of fact, Grayscale, in a letter this morning, Jack, you might have seen this, called this out specifically. For people that don't know the regulatory landscape, how do you – it is hard to make sense of this.

9:41Like if you're just a normal person who wants a Bitcoin ETF and can't get it, but then you see them allowing a leverage Bitcoin ETF, even though understanding that the underlying might be slightly different mechanically, it's odd. Yeah, I mean, that's why we've seen so many traditional financial firms filing for spot ETFs, because I think one could make the case quite clearly that it would be a better long-term investment product for the average investor. and you would have a competitive landscape. Whereas at the moment, you have a set of trusts that are traded on the secondary market. They're rather inefficient.

10:23They tend to be higher fee because there's not a lot of competition in the liquid ones. And from there, they trade at a discount. So they're not very efficient. And then - Matter of fact, I'm sorry, keep going, sorry. No, no, yeah. And then on the futures side, you can look at the futures market and it'll trade either in contango or backwardation, which means ultimately that there's a role cost or in some sense, sometimes a role yield, but it doesn't perfectly track the underlying. And so I think that's a lot of the debate here around wanting a spot product in the market is to have overall just a better way to access the asset class.

10:59So to that point, it's July 10th and year to date, Bitcoin is up 80 % or so. And Biddo, the futures ETF is up 57 % due to the costs associated that you just mentioned, which is, I mean, that's a gigantic spread. 81 versus 57? Yeah. Not to speak to any single investment product in particular. The one piece I would add is you have to look at total returns because currently the futures market trades in backwardation. So there's a role in cash interest. And so there's actually a dividend associated with a lot of those funds at the moment. So there is a disparity. I don't think it's quite as extreme as looking at price only.

11:40Oh, noob whale. Noob whale written all over my forehead. Always total returns, Michael. Oh my God. You know what? I feel a lot of that floating around. Okay, Jack, I stand corrected. In that case, the gap shrinks basically to zero. So I'm going to take the L on that. Thank you for clarifying. I wouldn't have known that. That's interesting. It's not zero though. You are right in calling it out. It is meaningful. If you were a buy and hold investor, if it's 5%, I don't know what exactly it is. It's somewhere between 5 % and 10 % last time I looked over the past year. And so that is an exorbitant cost to roll forward.

12:12You have to reinvest your Bitcoin dividends? That is interesting. So you mentioned the cost of running a fund like that, like a Bitcoin spot ETF. I don't think anyone thinks if they're holding a gold ETF, they don't think, well, how does this ETF, where do they store my gold? Like what are the vaults in London or wherever they store it? But there are going to be different costs associated with this than a stock market ETF, like an index fund. So I guess could we assume that the cost for this kind of fund, if and when it happens, would be a little higher because there are more costs to own and operate it?

12:47Yeah, I mean, a lot of, you know, custody has been commoditized largely. Most of the fees that folks are paying on the average retail app is a commission. And then the actual custody, if you choose to utilize those services. is either free or 10, 20, 30 basis points, depending on the platform that you're using. But for the most part, the custody piece gets commoditized away because there's a bunch of scale once you actually have the infrastructure in place. So I don't know that if you had a landscape of five or 10 of these approved and it was a competitive landscape, I think that you could get fee compression, especially considering when you look at the cost of trusts or investment vehicles that give you kind of similar exposure, even those futures funds, they're 50, 75, 95 basis points, depending on the fund.

13:40I think that you'd get, you know, again, I'm completely speculating here across the market, want to make that clear. But I do think that you could get, you know, a pretty competitive market on fees all in. I can't, I saw somebody tweet this, I can't remember who it was. So forgive me for stealing this idea. But somebody mentioned that there's going to be these, assuming, let's assume that the ETFs do get approved, which isn't, you know, we don't know, we'll find out. By the way, is there any timeframe for that? Is there any date that we should be aware of? Yeah. So the few dates that I'm aware of, and most of this is just following Balchunas and the Bloomberg guys, but early August, second week of August, the ARC 21 shares filing, I believe were supposed to hear on, and they did make an amendment that sort of roughly would make it have that sort of surveillance sharing piece that seems to be the new kind of piece of information that people are maybe hopeful on.

14:33And then in the fall, potentially hearing on the Grayscale case, that's another sort of thing to watch, at least moving forward. And then I think the rest of them are end of year into next year. I want to get back to the surveillance piece of this, but my question was going to be this. So let's say they get approved. These ETFs need to get off the ground. They need to be seeded with some money, right? So there's going to be potentially buying pressure from a handful of ETFs? Is that, would that, again, obviously we're speculating, would that be enough to potentially move the market? Let's say that there's, again, I'm making this up, $100 million of buying pressure from ETFs being seeded.

15:08Would that, like what sort of volume are we seeing in Bitcoin on a daily basis? Yeah, so the one caveat here is, depends on what happens also with the Grayscale Trust as well, right, because there's a discount embedded in that trust at the moment. And so necessarily, again, we're completely speculating here. But that trades at a 30 % discount at the moment. Assuming that you went into it with a 30 % discount and it became an ETF, that would be redemptions of the fund, right? And you'd be selling Bitcoin in order to close out shares. So there's an offsetting pressure there of, I don't know what the AUM in that fund is.

15:51Got it. GBTC is like 30. It's a 30 or something? Well, and you've probably had people sitting in that. That's been the widowmaker trade for a few years now, right? So you probably have people who are waiting for a parachute for that. Exactly. Well, the question there is, you know, who's a long-term investor or who got stuck in the fund? And then at the same time, we've seen the discount closing, but is that closing? Ben totally got stuck. Ben, admit it. You got stuck. But is that discount closing because they're speculating on the prospects of an ETF approval. I think there's probably some amount of funds of people that are doing that.

16:27And then are they hedging that with Bitcoin or not? There's a question, or are they leaving it open-ended? There's not a clean way, I don't think, to be able to hedge that out. But if you're - But Jack, the discount is only, I'm using air quotes, only 27%, which is, but it was 44 just like a couple of weeks ago. Exactly. So if you say some percentage of those folks that are bidding it up are doing it because of the potential for an arbitrage if it were to convert into an ETF. Again, a lot of ifs here. But if that is the case, then you have some folks that would unload the asset if it traded at NAV.

17:03And again, so there's some portion of these assets, including the discount, where you would say, well, that is a net sell pressure at the same time as you potentially have new ETFs spawned, right? So there's an offsetting piece of there's this large sort of to some degree elephant in the room of the Grayscale fund that trades at a discount and some of these other funds as well that if they were approved to be an ETF. Again, these are two different things. Like potentially ETFs would be approved and maybe they wouldn't be able to convert right away or something. So there's a lot of like different muscle movers here.

17:39But you have to think overall that if an ETF was approved, that at least from a sentiment perspective, you have a rather bullish sentiment and narrative for a period of time. We've spent the last 14 minutes discussing the potential ramifications of an ETF or not and what it might do to price. And has Bitcoin lost the plot a little bit in the sense that it came to existence because it was outside the sphere of traditional financial markets? This was something that you could own. All you needed to remember was your password or your cold storage key. And this was not censorable, uncensorable. What the heck is it?

18:21What do they call it? You can tell I'm not crypto native. But it was uncensorable. Uncensorable. It served that purpose. And do you see this evolution as is crypto just a speculative asset or is this validation? Is this bad? Is it good? I'm not sure what to think. I think you could make a case both ways here. But also at the same time, if we're being realists about how this industry will scale, then it always necessarily had to cross paths with the traditional financial system. I think you can see some, like I've heard Ben Hunt make the argument of Bitcoin TM, which is this idea that, in theory, over time, Wall Street will take the crypto industry or Bitcoin and sort of put it inside of the existing system.

19:15And there's some of that happening here. But at the same time, it doesn't take away from the fact that anybody can access Bitcoin themselves, that anybody can send it across the world. And it doesn't know or matter where you're located. It is uncensorable. There will, according to its current rules and the rules that it's had for the last 13 years and going, only be 21 million Bitcoin. Those rules don't change. If you want to take counterparty risk and own the asset inside of an ETF because that's an easier way to access it, well, then you're able to do that, right? But at the same time, that doesn't take away my or anybody else's ability to use our private keys and sign transactions across the world or hold on to those private keys ourselves.

19:59And so while I can see the argument that you're losing the plot to some degree, it doesn't change the fact that it still works as designed. It's just starting to be put inside of an existing system or framework in some capacity here. I think for the total market cap wise, one of the coin market cap has it like Bitcoin got to like in the high 30s for percent of total crypto assets. Now it's back to like 50 percent almost. So strangely, this whole bear market in crypto, and I know there's been a comeback, has been good for Bitcoin. Do you think it's just the brand or were a lot of those things just so speculative that they just needed to go out of business?

20:43And actually, it's a good thing for the Bitcoin and ETH, which are the two kind of main building blocks. Yes, I think if you zoom whatever Bitcoin dominance chart you're looking at out on a long enough timescale, you'll kind of see a pattern that during bear markets, you tend to see consolidation and strength in Bitcoin. In particular, Bitcoin in the earlier days. I mean, the market was basically entirely Bitcoin until 2014, 2015. Then you have Ethereum. And then during sort of bull runs and manias and euphoria, you see that the Bitcoin dominance level lowers. And so this kind of a continuing pattern over time where during this bear market, we're seeing consolidation into in particular Bitcoin now being over 50 percent of crypto's market cap.

21:29But Bitcoin and Ethereum in large part, like if you look at Bitcoin, ETH and the tokens on top of Ethereum, that's like 90 percent of crypto's market cap if we exclude stable coins. And so there's consolidation into really the two networks that have some degree of institutional interest or ownership that we can see on chain have real users that are using the network. and for their particular use cases, I think they have kind of different use cases or at least different main use cases. We continue to see like activity based on for Bitcoin, people buying and holding the asset on chain and for Ethereum, people using applications on chain.

22:10Okay, so right now, Bitcoin is at 30 ,800. It's actually been trading in a very tight range since June 22nd. I saw a tweet from Bespoke this morning saying there have only been a handful of other times in the last six years that Bitcoin has traded in as narrow a range as it has over the last two weeks. And the range is when it's less than 7.5%, there's one, two, three, it looks like eight times over the last six years. So it's been trading pretty tightly. Somebody asked us, Bitcoin just broke 30 ,000. Is this meaningful at all? Technically, are we hitting any important milestones in terms of price?

22:48Yeah. So from a technical perspective, there's not really a level other than the fact that 30 ,000 is a round number and we all know we're irrational and cling to things like that. So I think there's something to be said for an asset breaking, whether it be equities, S &P breaking 4 ,000 or below 4 ,000, whatever. So the same thing kind of applies here in terms of the mental sentiment indicator. But in terms of like an actual price level associated with$30 ,000, the moving averages don't sit at$30 ,000. Right now, the 50 days at$28 ,000, I think, roughly. The 200 week and the 200 day are down sort of more towards$25 ,000.

23:33So what I would say is you kind of broke the range and period of low volatility that we were in back in early June that we were going on for a couple of months with some of this ETF news. And you broke into this kind of new range where we're in now, which, as you said, I think we've traded in a 4 % range for the past three weeks. So another week, week and a half, we'd be going on a month. Those periods of very low volatility don't tend to last too long. And that's actually been kind of how I would characterize a lot of this year is consolidation and shop. And there's no narrative for a period of time.

24:09And it kind of gets boring. and then all of a sudden volatility gets very low and very suppressed and then it snaps, right? Because it's like a rubber band in any asset class, but especially in an asset class that is typically very volatile. And so it feels like we're kind of on the precipice of that again. And I do think that this move will be important as we head into the second half of this year of defining, like, are we headed in an uptrend amidst still down 50 % from here, but could we head towards 40? or are there macro headwinds and do we break back down into that lower range and does sentiment kind of wane again?

24:42I don't know the answer there to be clear, but I think one of those things is going to happen. Michael has two ways of explaining charts and technical analysis as far as I'm concerned. One is this chart looks like crap and two is this looks like it's ready to explode. Right, Michael? Is that fair? Yes. So one of those two things is going to happen. Well, I mean, am I... It could go up or it could go down. It could definitely go up or down or continue to go sideways. To me, holding high here, I'm going to say that it's going to explode out of this range to the upside. But with that, it's actually a good segue for the next question, which is this.

25:19Crypto, Bitcoin, whatever, the industry has had a lot thrown at it recently. In November was FTX. And then Binance, there's a lot of smoke around that. the SEC is suing Coinbase. There's a lot of bad news out there. And yet, the price of Bitcoin, it's up 80 % this year. What do we make of this? Well, if we look at broader risk assets, right, we're seeing tech equities are up 40 % this year. I think the Nasdaq's up close to 40 % this year. You're coming off of a year that ended on lows. Right. And so overall, I think we're kind of in this, to some degree, ambiguous state in most markets, to some degree.

26:11Jack, I was told that risk assets can't rally when the 10-year is above 4%. Well, is it ironically, could it be that inflation falling is good for Bitcoin and crypto? Is that, I mean, right? So I think here in lies the issue is, and we've talked about this before, is forward inflation expectations really never changed the whole way through. It was nominal yields moving up and down. And nominal yields have been responsive. And now they're back at highs, right, near November, October of, what are we at, 4 % on the 10-year, over 4 % on the 10-year. But why is it real yields? Unpack that a little, please.