Why approving a Bitcoin ETF might unleash $18 billion in sell-pressure

The introduction of a spot-based Bitcoin (BTC $30,964) exchange-traded fund (ETF) would make the asset more accessible to individual investors and mutual funds. What's more, unlike a futures-based Bitcoin ETF, a spot-based ETF involves actually buying BTC.

So will the approval of the first Bitcoin ETF be a bullish event? Not necessarily.

GBTC 'discount' remains in the double digits 

Over the years, the U.S. Securities and Exchange Commission (SEC) has rejected every Bitcoin ETF applicant, and the latest denial was issued to VanEck Bitcoin Trust on March 10, 2023.

The SEC concluded that the offer did not have a "comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot Bitcoin." Regulators are hesitant to release what many believe would be a more equitable and transparent Bitcoin product. 

Investors now question whether the latest bids from ARK Investment and BlackRock to launch their spot Bitcoin ETFs might be the solution to Grayscale’s Bitcoin Trust (GBTC), an investment vehicle with shares traded on the stock exchange.

Interestingly, the GBTC "premium" jumped to its best levels in months after BlackRock announced its ETF filing. 

Grayscale GBTC premium/discount to net assets. Source: CoinGlass

But while the potential approval of a spot Bitcoin ETF might seem bullish at first, its consequences for BTC price can be negative, at least in the short term.

What's an ETF?

First, an ETF is a form of security that holds diverse underlying investments, such as commodities, stocks and bonds. The ETF may resemble a mutual fund because its issuer pools and manages the given assets.

The most well-known example of this instrument is SPY, the ETF that tracks the S&P 500 index. State Street is in charge of managing the mutual fund's $436 billion worth of assets.

Buying an ETF grants the investor direct ownership of the fund's contents, resulting in different tax consequences than holding futures contracts or leveraged positions. While Bitcoin spot ETFs continue to be rejected, identical products have been available for decades for bonds, global currencies, gold, Chinese equities, real estate, and oil.

30% GBTC discount is likely justified

The Grayscale Bitcoin Trust (GBTC), an investment fund with $18.4 billion of assets under management, is currently trading at a -30% discount versus its Bitcoin holdings. This gap between their 626,778 Bitcoins at market value and the GBTC shares trading on regular stock exchanges reached as low as -49% in December 2022.

Consequently, this discount is likely justified as the instrument lacks the tools to allow arbitrage. Grayscale's GBTC is the undisputed leader in the cryptocurrency market, despite being classified as a closed-end fund, which means that the number of available shares is limited.

Shares of GBTC are not freely created, nor do they have a redemption plan. Due to this inefficiency, there are large price differences when compared to the fund's actual Bitcoin holdings. In contrast, an ETF gives the market maker the ability to issue and redeem shares, ensuring that the premium or discount is typically small.

GBTC charges a set 2% annual administrative fee; therefore, the discount may be acceptable given that the SEC continues to reject appeals and requests from all fund managers.

On the other hand, ETFs typically trade at par with net assets, as opposed to GBTC. For example, the Purpose Bitcoin ETF (BTCC.U) held a $5.63 net asset value per share on June 27, and the shares closed at $5.65 on the Toronto Stock Exchange.

Similarly, the U.S. derivatives ProShares Bitcoin Strategy ETF (BITO)'s underlying price was $16.89 on June 28, while its shares traded at $16.89.

Spot Bitcoin ETF approval might initially pressure BTC

Essentially, an investment trust product is considerably less desirable than an ETF, and Grayscale has done little to mitigate the impact on GBTC investors thus far. However, market sentiment improved modestly after the world’s largest asset manager, BlackRock, filed to launch a Bitcoin spot price ETF.

The share price discount versus its contents will eventually trend to zero as redemptions and arbitrage opportunities arise if the SEC grants the asset manager Grayscale permission to convert its GBTC Trust to a bonafideBitcoin ETF.

In this scenario, odds are that a considerable amount of BTC could enter the market as investors will finally be able to exit their position at par.

The only question is: how much of that $18 billion will flow into other Bitcoin-related instruments or get sold on exchanges?

In any case, there's a good chance that a spot Bitcoin ETF approval will produce significant sell-pressure from Grayscale's GBTC conversion as BTC that's been locked for 3-8 years reenters the market.