Bitcoin ETFs—downside risk ahead!

Much industry fanfare surrounds the imminent approval of BlackRock’s Bitcoin Spot ETF. It has been something that the industry has been waiting on for years, each time their hopes dashed by some small administrative kink or technical issue that delayed approvals in the past. Many in the so-called “crypto” industry herald the coming of spot ETFs as the ‘opening of the BTC floodgates’ to the average investor, with the practically assured jump in BTC price as a result. Well, if you are one of those people who have been waiting with bated breath for years for this very moment when you finally ‘strike the motherlode,’ I prithee, stop reading now, for I will NOT be reassuring you of your imminent wealth and riches.

I will, however, give a very somber rationalized argument of how the introduction of Bitcoin spot ETFs will spell the end of the insane bull runs in price that BTC has enjoyed up until now. It will literally spell the end of the first era of Bitcoin speculative markets and the beginning of the controlled, efficient, regulated markets in digital assets.

To lay out the argument, first, we must establish the common ground that the current markets in the so-called “crypto” assets have not been an efficient one. Nor a fair one. Oh, they do their best to make themselves look legitimate in the same way a pig with lipstick will call themselves Cinderella. Still, we all know, deep down, that all of them suffer the same conflicts of interest that FTX suffered, the irresistible temptation to commingle and play with their clients’ funds.

Given the lack of proper regulatory oversight and, in some cases, their deliberate actions to evade regulatory scrutiny and jurisdiction—including the most famous case of the ‘crypto’ giant Binance refusing to disclose a corporate headquarters to avoid any jurisdictional fealty—exchanges have had pretty much free reign to steal your money and run away to Timbuktu. This represents the first conflict of interest that most current digital currency exchanges suffer. In the normal world, brokers and exchanges are separate entities for this exact reason.

Second, and this is the bigger influence in terms of market manipulation, is the fact that you have an unlicensed money printer by the name of Tether, which continues to issue its ubiquitous stablecoin (USDT) with dubious and unconfirmed reserves backing it.

In fact, given that they have to date avoided any proper audits of their books and relied on a couple of one-time ‘attestations’ from not-so-independent parties, we may as well assume that they print and introduce USDT into the market whenever they feel like it, whether or not they have any real USD equivalents to even back it with. Given that they control strictly how much can be redeemed back to USD and when, they can never suffer a ‘run on the bank’; thus, they can run a fractional reserve bank indefinitely. Of course, printing USDT will gain them nothing because nobody in the real economy would ever accept USDT as payment for anything, however…

Partners in crime, a match made in heaven

In steps, the unlicensed exchanges with their ongoing moral dilemma with their customers’ money. Real money. They are more than happy to trade with Tether, sell them BTC, and get USDT in return. Investors in “crypto” don’t mind taking profits or holding positions in USDT because it is the standard currency of unlicensed “crypto” exchanges, so if they want to lock in their profits trading BTC or ETH or whatever, they just sell it for USDT, and keep their positions stable vis-a-vis USD. USDT is also useful for moving around between these illegal bucket shops, as it moves as fast (and even faster) than BTC can. So speculators who deposit their real fiat into exchanges, trade in crypto, and use USDT to move between exchanges.

It seems good for everyone all around. What’s to stop this all from going on forever? Well, simply put, if Tether is printing unbacked USDT, then the amount of USD in the system cannot be equal to the amount of USDT and the value of the crypto markets in totality. So, as long as BTC prices keep on rising to make up for the deficit in USD value originally put in for a given amount of USDT outstanding, the system stays afloat, and people bask in their paper riches. But if BTC and crypto prices crash and enough people start withdrawing fiat out of their exchanges, it will cause an industry-wide market crash and bank run on the whole system.

But I digress. This isn’t an article about how USDT and the unlicensed exchanges will crash the crypto markets. It is about how the introduction of legitimate spot ETFs will prevent BTC prices from ever surging up with double-digit gains ever again.

Why? Simple—the holy trinity of financial markets.

For those of you who don’t know what that means, it is the markets of Spot, Futures, and Options. Up to now, we have only Futures¹ ETF markets being traded legitimately by the regulated markets. But, because of the lack of spot ETFs, supporting an exchange-traded options market is impossible. To understand why that is, it will require you to take a Financial Derivatives 101 course² or work on Wall Street, so if you have no time or patience to do either, then just take my word for it. To hedge the risk of an option, you require liquid futures and spot markets.

Due to the lack of the latter, options could not be safely written (not at any appreciable scale, anyhow). But once that changes, then what will happen is that the market will soon see calls and puts being written and sold. This will have the effect of reducing the volatility in the BTC market in that manipulation of the price will become very, very costly for those who would attempt it because of the ability of options to bet against large movements in spot prices with leverage (you only pay the premium). Options, in a way, ensure that the markets of Spot and Futures remain in balance and that anyone who has a view on volatility will be able to express it directly.

What this means is that people who secretly harbor the belief that BTC prices are too high or that they are unfairly manipulated will have a new tool on their belt to express their view, which is to buy put options. And big market players like BlackRock will be more than happy to write the options for them, given that they can be hedged with liquid futures and spot ETF markets. Once people can go ‘long vol’ or ‘short vol,’ we will soon find out that vol will cease to be unpredictable, as those who operate outside of the legal markets will only be able to push the price up by buying BTC from bucket shops with funny money, while the legitimate markets will be able to counterbalance them by buying leveraged puts against what they see as unnatural market movements. In essence, this is how legitimate money will be able to bet against the manipulators, tempering the wild, uncontrolled BTC markets.

The age of BTC price free-market regulation has begun… I’m just not sure if most of the people who cheer it on really realize what they are routing for. If people wanted to buy into BTC, there were plenty of shady exchanges to allow them to do so. They don’t mind messing with wallets, cold storage, and self-custody anyhow. The crypto-enthusiasts already all have their crypto demands fulfilled. This new age of ETFs will just allow the big market makers and institutional investors to come in, and ruin your little self-contained manipulated market…for their own profit, and they will short a market as easily as they go long.

Be careful what you wish for.

TheWallStreetTechnologist

NOTES:
[1] We aren’t counting the unlicensed bucket shops or even Coinbase (NASDAQ: COIN) because they are not exchange-traded ETFs
[2] Covered well in Hull’s seminal book https://www.pearson.com/nl/en_NL/higher-education/subject-catalogue/finance/Options-Futures-and-Other-Derivatives-Hull.html

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