Bitcoin will go down as the biggest financial story of 2017, and on its current course, the biggest story of 2018 as well – for better or for worse.
It is highly likely that the “cryptocurrency” is in a bubble. It has no internal rate of return, like shares and bonds. It has no industrial use, like commodities. It has no claim on states, like fiat currencies. Nor is bitcoin gold: billions of dollars of bitcoin do not sit in the vaults of central banks and investment banks, nor on the balance sheets of pension funds.
Yet bitcoin is now worth more than New Zealand, according to a recent headline from Bloomberg. One is reminded of the Japan bubble in the late-1980s, when the Imperial Palace was said to be worth more than France.
It’s also obvious that bitcoin is bound up in fraud. The cryptocurrency’s illiquidity has been concealed by wash trades. Its use by darkweb criminals is well known. So too is its mysterious correlation with Tether.
Its rocketing value in 2017 was driven largely by hedge funds. And what made bitcoin’s growth in 2017 so astronomical appears to be that institutional money got very involved for the first time.
Next year looks set to be even bigger for bitcoin. ETF issuers are getting ready to erect products in its honour. Exchanges are clamouring for more. And the financial press hasn’t had this much fun since 2008.
So what should ETF investors and the ETF investors expect from bitcoin and ETFs in 2018?
1) Expect bitcoin ETFs, which will be structured like commodity ETFs
Bitcoin ETFs are on their way. To date, many ETF issuers have tried to get bitcoin ETFs off the ground. But they failed because they have been unable to shoehorn bitcoins into an ETF structure approved by regulators. With bitcoin futures on the table, that will change. Issuers will be able to use bitcoin futures and futures indexes as the underlying assets and indexes that ETFs track.
When bitcoin ETFs are launched, expect more noise from the financial press, as bitcoin stories drive eyeballs like nothing else. More noise from exchanges, as they profit from the listing fees, and more noise from issuers, especially the smaller and medium sized issuers which are more likely to take a punt on this type of product (discussed in point 3).
2) Do not expect bitcoin ETFs to gather much AUM
If there is one thing 2017 has taught us is that assets go where fees are low and where the benchmark is well known. According to Bloomberg data, a clear and robust correlation is emerging between fees and inflows. ETF investors are a highly fee conscious bunch and on the current trend line, we will have ETFs charging as little as 1 or 2 bps for plain vanilla products in the coming years.
Bitcoin ETFs will not be offered at cut-throat costs as they come with risk and higher running costs. The higher prices alone will be a reason that low assets are gathered. The high volatility will be another.
3) Do not expect big issuers to get behind bitcoin ETFs
The bitcoin bubble may have several years left of juice in it yet, meaning more than one ETF issuer gets behind it. But don’t expect the biggest and most famous names in Europe and North America to be among them.
Founders of major ETF issuers have spoken out against bitcoin (Jack Bogle called it the “plague”, Larry Fink an “index of money laundering”). Riskier and boutique products, like 3x leveraged and VIX trackers, tend to be of greater interest to smaller issuers. These issuers are leaving the plain vanilla battlefield because they do not have the scale required for the fee war.
Smaller issuers also tend to be keener on boutique ETFs, as they can come with a marketing free-ride of sorts. Hence most of the “novel ETFs” – that track things like marijuana, whiskey, computer games – have come from smaller issuers.
Conclusion: expect and avoid bitcoin ETFs
One suspects that bitcoin will go down with tulips, beanie babies and South Sea stock as one of the greatest bubbles in financial history. But for the time being, the bubble is inflating and there’s money to be made – in bitcoin ETFs and elsewhere. But beware the ides of March.