Market View
The US Securities and Exchange Commission (SEC) officially approved 11 spot bitcoin ETFs in the US (8 of which are partnered with Coinbase) on January 10, 2024 – after extending its decision window to the furthest extent allowed by its regulatory framework. Predictably, the immediate impact of the announcement on BTC and ETH trading volumes (both spot and futures) across global centralized exchanges has been to the upside, with the daily average over the last few days rising to over US$170B, 3x higher than the $56B average per day in 4Q23. That said, as we go to publish, it’s still difficult to disentangle how much of these volumes represent the net creation of new ETF shares.
Meanwhile, in the last two days, open-interest-weighted funding rates on bitcoin perpetual futures climbed from around 10% annualized (longs paying shorts) to almost 20%, making leverage more expensive, though still below where we started the year (above 36%). Interestingly however, the total open interest on perps hasn’t increased materially over the last week, hovering above $10B. Expectedly, the basis between CME futures and spot compressed given the anticipated fall in demand for traditional (term) futures, as more people pivot away from futures-based bitcoin ETFs. Also, we think this means more institutional players are closing their long positions, as the CME basis tends to reflect the premium this cohort is willing to pay for long bitcoin exposure.
The outstanding question remains: what will be the size of the net inflows that ETFs attract through their first day, week, month and year of launch. Ultimately, we think this will put more attention on the next ETF chapter, as the banks and broker-dealers (who manage over 80% of the assets in the wealth management industry) run the due diligence reviews needed to offer these products to their clients. That is, we suspect there will continue to be an outstanding pool of capital that will be unable to access these products until those processes are completed, which can take months. In the interim, we expect to see new financial products in lending and derivatives that may start to use regulated ETFs as their underlying.
Beyond bitcoin
What’s interesting is that the ETF approval is not only having a significant effect on BTC performance but on ETH as well. In fact, ETH seems to be emerging as the bigger beneficiary of the SEC’s decision, which reinforces the view we published in our 2024 Crypto Market Outlook that many market players overlooked ETH in 2H23 as they sought to capture alpha from altcoins further down the risk curve. Beyond ETH’s potential undervaluation relative to BTC, we see two key reasons for this rally in ETH.
First, the approval of spot BTC ETFs formalizes crypto as an asset class among institutional investors, and both bitcoin and ether are the two most popular cryptocurrencies in that asset class with nearly 80% of the total US$1.8T crypto market cap. To put it another way, ETH is a critical part of many market player benchmarks, so as more institutions enter this space, under-owning ETH potentially represents real career risk. Second, having spot BTC ETFs in the US also improves the odds for a spot ETH ETF, possibly as early as end-May 2024. Although the Cancun (Dencun) Fork in February may potentially represent the faster-approaching market catalyst, we suspect the evaluation of spot ETF applications in 2Q24 ultimately represents the more important driver for investor flows.
Onchain: Ethereum gas limits
Separately, there has been a flurry of discussion around measures to reduce the base layer transaction costs on Ethereum, largely triggered by Vitalik Buterin’s comments that he believes an increase of the gas limit to 40M (up 33% from the current 30M) would be reasonable today in line with computational growth from Moore’s law. However, other Ethereum researchers pushed back on a fast release with some stating that EIP-4844 for Dencun effectively accomplishes the same, only that the additional blockspace would be reserved for layer-2 (L2) storage. Many in the community are also looking for better clarification on the concrete impacts that such an upgrade would have, with some highlighting risks on state size, sync times, history growth, and other knock on impacts to client diversity and more. That said, in our view there appears to be a constructive willingness to explore this topic further.
However, widespread adoption for such a change would likely be after the Dencun release goes live on mainnet and the additional load is better studied. It is worth noting that such a change would not require a hard fork to the chain, but is a client and validator configuration change that needs to be adopted by the majority of the network – thus this change could be adopted independently from either the Dencun or Pectra upgrades.
Meanwhile, the rift within the Bitcoin core community over Ordinals (which we highlighted early last month) continues on with some members claiming that it’s accelerating Bitcoin adoption and creating a more sustainable transaction fee model, while others believe it is spam and point to the increasing mempool and UTXO set sizes that result from this activity. This debate has been heating up over the past few months, but doesn’t appear to be nearing a resolution in the short-term. We believe the status quo behavior will remain unchanged for the time being because any upgrade requires finding consensus, which does not seem imminent. How this resolution plays out will be worth tracking as it is one of the most prominent Bitcoin base layer debates going into 2024. Even if usage of Bitcoin Ordinals tapers without any network changes, the philosophies driving these discussions shed light on the current Bitcoin community sentiment.
