Galaxy Digital Research Report: Once the spot bitcoin ETF is launched, it is expected to leverage the trillion-dollar market

Source: Galaxy Digital

Compilation: BitpushNews Mary Liu

The approval of a US-regulated spot Bitcoin ETF will be one of the most influential catalysts for Bitcoin adoption (and cryptocurrency as an asset class).

Significance of Spot Bitcoin ETFs

Why Spot Bitcoin ETFs Are a Better Solution Than Current Investment Vehicles

As of September 30, 2023, the total number of BTC held by Bitcoin investment products, including ETPs and closed-end funds, was 842,000 (approximately $21.7 billion).

These Bitcoin investment products have significant drawbacks for investors – in addition to high fees, low liquidity, and tracking error, these products are inaccessible to a broad group of investors who represent a significant portion of their wealth. Alternative investment options (e.g., stocks, HF, futures ETFs) that increase indirect exposure to Bitcoin suffer from similar inefficiencies. Many investors are reluctant to take on the burdens that come with holding Bitcoin directly, such as wallet/private key management as well as self-custody and tax reporting.

Spot ETFs may be suitable for any investor looking to invest directly in Bitcoin without having to own and manage it through self-custody, and spot ETFs offer a number of advantages over current Bitcoin investment products and options, such as:

Increase efficiency with fees, liquidity, and price tracking. **While fees are not yet listed for Bitcoin ETF applicants, ETFs typically offer lower fees compared to hedge funds or closed-end funds, and a large number of ETF applicants may be committed to keeping fees low to remain competitive. A spot ETF will also provide enhanced liquidity as it is traded on major exchanges and can track prices better for Bitcoin exposure than futures products or agents. ***Convenient. **Spot ETFs allow investors to gain exposure to Bitcoin through a wider range of channels and platforms, including established providers that investors are already familiar with. It provides an easier onboarding path for retail and institutional investors than direct ownership, which requires a certain level of self-education to onboard and is more expensive to administer. Regulatory compliance. **Spot ETFs may meet stricter compliance requirements set by regulators in terms of custody setup, monitoring, and bankruptcy protection than existing Bitcoin investment products. Additionally, ETFs can provide market participants with greater price transparency and discovery, which may help reduce market volatility for Bitcoin.

Why Spot Bitcoin ETFs Matter

The two main factors that spot Bitcoin ETFs have been particularly influential in Bitcoin market adoption are: (i) expanding accessibility across wealth sectors, and (ii) gaining greater acceptance through formal recognition by regulators and trusted financial services brands:

Accessibility

Expand the reach of retail and institutions. **There is a limited range of BTC investment funds currently available, which include products that are primarily driven by wealth advisors or offered through institutional platforms. ETFs are a more directly regulated product that can increase investment opportunities for more investors, including retail + affluent individuals. ETFs can be used by a wider range of clients, including directly through brokerage firms or RIAs (direct purchases of spot bitcoin are prohibited), rather than relying on wealth managers. Allocation through more investment channels. **Without an approved Bitcoin investment solution like a spot ETF, financial advisors/trustees cannot consider Bitcoin in their wealth management strategies. Wealth management departments have a lot of money and can’t access Bitcoin investments directly through traditional channels – with approved spot ETFs, financial advisors can begin to direct their wealth clients to invest in Bitcoin. Bigger opportunities for wealth. **Baby boomers and earlier (over 59) hold 62% of U.S. wealth, but only 8% of adults over 50 have invested in cryptocurrency, compared to more than 25% of adults aged 18-49 (according to the Federal Reserve’s Pew Research Center). Offering Bitcoin ETF products through familiar, trusted brands may help attract more older, affluent people who have not yet joined.

Acceptance

• **Formal endorsement/legitimacy from a trusted brand. **A large number of well-known financial brands have submitted Bitcoin ETF applications – Formal recognition/verification by these mainstream companies can improve people’s perception of the legitimacy of Bitcoin/cryptocurrency as an asset class and can attract more acceptance and adoption. Data from Pew Research shows that 75% of the 88% of Americans who have heard of cryptocurrencies are not confident in the current way of investing, trading, or using cryptocurrencies. • Addressing regulatory and compliance issues; Regulatory clarity will attract more investment and development. **As a regulated investment product with a more comprehensive risk disclosure, the SEC’s approval of ETFs can alleviate many of investors’ safety and compliance concerns. It will also provide market participants with long-demanded regulatory clarity on crypto industry operations. A more developed regulatory framework will attract more investment and development, improving the competitiveness of the U.S. crypto industry. **Advantages of BTC portfolios/acceptance as an asset class. Bitcoin can offer the benefits of diversification and higher returns in a portfolio, no matter how it is paired. To help guide investment management decisions, more retail investors and financial advisors have turned more to model portfolios and automated solutions that increasingly use ETFs and incorporate alternative asset classes to provide investors with more risk-optimized returns. A longer track record can support the use of Bitcoin in a portfolio in more investment strategies.

Estimating the inflows from the approval of the spot Bitcoin ETF

Given the accessibility reasons mentioned above, the U.S. wealth management industry is probably the most accessible and straightforward market and receives the most net new accessibility from approved Bitcoin ETFs. As of October 2023, broker-dealers ($27 trillion), banks ($11 trillion), and RIAs ($9 trillion) have a total of $48.3 trillion in assets under management.

We use the $48.3 trillion TAM of selected U.S. wealth management aggregators in our analysis (excluding the family office channel that manages approximately $2 trillion), although the addressable market size of the Bitcoin ETF and the indirect scope/impact of the Bitcoin ETF approval may extend far beyond the U.S. wealth management channel (e.g., international, retail, other investment products, and other channels) and have the potential to attract more capital into the Bitcoin spot market and investment products.

The onboarding cycle for Bitcoin ETFs across these segments is likely to last for years as the channel opens up. The RIA channel is primarily made up of independent registered investment advisors of a complex nature and has the potential to be accessed earlier than advisors affiliated with banks and broker-dealers, and therefore has a larger share of initial access in our analysis. For the bank and broker-dealer channels, each individual platform will decide when to unlock access to Bitcoin ETF products for its advisors – with certain exceptions, financial advisors affiliated with banks and b/d cannot offer/recommend specific investment products unless approved by the platform. Platforms may have specific requirements before providing access to new investment products (e.g., track record of > 1 year or AUM exceeding a certain amount, general suitability issues, etc.) that will affect the access cycle.

We assume that the RIA channel will grow from 50% in year 1 and increase to 100% in year 3. For the broker-dealer and banking channels, we assume a slower rate of growth, starting at 25% in year 1 and steadily increasing to 75% in year 3. **Based on these assumptions, we estimate the addressable market size of the US spot Bitcoin ETF to be approximately $14 trillion in year 1, $26 trillion in year 2, and $39 trillion in year 3 after launch. **

Bitcoin ETF Inflow Estimates: Based on these market size estimates, if we assume that 10% of the total assets available in each wealth channel are in BTC, with an average allocation of 1%, we estimate that Bitcoin ETF inflows will reach $14 billion in the first year after the ETF launch, increase to $27 billion by the second year, and $39 billion by the third year after launch. Of course, if Bitcoin spot ETF approval is delayed or denied, our analysis will change due to time and access restrictions. Alternatively, if the price underperformance or any other factor causes the use or adoption of the Bitcoin ETF to be lower than expected, our estimates may be overly aggressive. On the other hand, we believe our assumptions about access, exposure and allocation are conservative, so inflows are likely to be higher than expected.

Potential impact on BTCUSD

According to the World Gold Council, as of 30 September 2023, global gold ETFs held a total of about 3,282t (approximately US$198 billion in assets under management), representing approximately 1.7% of the gold supply.

As of September 30, 2023, a total of 842,000 BTC (AUM of about $21.7 billion) held in investment products (including ETPs and closed-end funds) accounted for 4.3% of the total issuance.

The market cap of gold is estimated to be about 24 times higher than that of Bitcoin, while the supply in investment vehicles is 36% smaller, so we assume that the inflow of dollars equivalent of funds has an impact on the Bitcoin market by about 8.8 times greater than that of the gold market.

If we apply the estimate of $14.4 billion in first-year inflows (about $1.2 billion per month, or about $10.5 billion adjusted using an 8.8x multiplier) to the historical relationship between gold ETF flows and changes in the gold price, we expect the price impact on BTC to increase by 6.2% in the first month.

Keeping the inflows unchanged, but adjusting the multiplier downward each month based on the change in the gold/BTC market cap ratio due to the rise in BTC prices, we can see a gradual decline in monthly returns from +6.2% in the first month to +3.7% in the last month In the first year of ETF approval, BTC is expected to rise by 74% (starting from the BTC price of $26,920 on September 30, 2023).

The broader financial impact of ETFs on the Bitcoin market

The above analysis estimates the potential inflows into the US Bitcoin ETF product. However, the second-order effect of Bitcoin ETF approval is likely to have a greater impact on BTC demand.

In the near term, we expect other global/international markets to follow the US in approving and offering similar Bitcoin ETF products to a wider range of investors. In addition to ETF products, a variety of other investment vehicles may also add Bitcoin to their strategies (e.g., mutual funds, closed-end funds, and private funds, among others) – spanning investment goals and strategies. For example, Bitcoin exposure can be increased through alternative funds (e.g., currencies, commodities, and other alternatives) and thematic funds (e.g., disruptive technologies, ESG, and social impact).

In the long term, the addressable market for Bitcoin investment products is likely to expand further to all third-party assets under management (AUM is around $126 trillion according to McKinsey & Company) and even more broadly to the global wealth space (AUM at $454 trillion according to UBS). Some believe that as Bitcoin is monetized, it will systematically reduce the monetary premium applied to other assets such as real estate or precious metals, greatly expanding Bitcoin’s TAM.

Based on these market sizes, and keeping our adoption/allocation assumptions unchanged (Bitcoin is adopted by 10% of funds with an average distribution of 1%), we estimate that the potential incremental size of new Bitcoin investment products will be around $125 billion to $450 billion over a long period of time.

Summary & Conclusion

For a decade, various companies have been looking to list spot Bitcoin ETFs. During this time, Bitcoin’s market capitalization has risen from less than $1 billion to $600 billion today (up to $1.27 trillion in 2021). Bitcoin ownership and usage has increased dramatically around the world, with the emergence of many different types of wallets, cryptocurrency-native exchanges and custodians, and traditional market access tools. But the United States, the world’s largest capital market, still lacks Bitcoin’s most effective market access tool – spot ETFs. Expectations for ETFs to be approved soon are rising, and our analysis suggests that these products could see significant inflows, largely driven by wealth management channels that currently do not have access to safe and efficient Bitcoin exposure at scale.

Money inflows from ETFs, market narratives about the upcoming Bitcoin halving (April 2024), and the possibility that the Fed’s rate hikes have peaked or will peak in the near future, all suggest that 2024 could be a big year for Bitcoin.