Assess the size of the Bitcoin ETF market: it will reach $39 billion in the third year after launch

By Charles Yu, Galaxy; Compiled: Pine Snow, Golden Finance

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

Significance of Bitcoin ETF

Why Bitcoin ETFs are a more ideal solution than current investment vehicles

As of 9/30/23, Bitcoin investment products, including ETPs and closed-end funds, held a total of 842,000 BTC (approximately $21.7 billion).

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These Bitcoin investment products have significant drawbacks for investors – in addition to high fees, low liquidity, and tracking errors, these products are unavailable to a large portion of the investor base. Alternative investment options that increase indirect exposure to Bitcoin (e.g. stocks, HFs, futures ETFs) suffer from similar tracking inefficiencies. Many investors are reluctant to deal with the administrative burden that comes with directly owning Bitcoin, which includes self-custodial wallet/private key management and taxes.

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

**Increase efficiency with fees, liquidity, and price tracking. ** While Bitcoin ETF applicants have not listed fees, ETFs generally offer lower fees compared to hedge funds or closed-end funds, and a large number of ETF applicants may aim to keep 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 compared to futures products or proxies. ***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 entry path for retail and institutional investors than direct ownership, which requires a certain level of self-education to achieve and is more expensive to manage. ** Regulatory compliance. ** Spot ETFs are likely to meet stricter compliance requirements set by regulators for custody setup, monitoring, and bankruptcy protection compared to existing Bitcoin investment products. In addition, ETFs can provide greater price transparency and discoverability to market participants, which may help reduce Bitcoin’s market volatility.

Why Bitcoin ETFs are important

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

Easy to use

**Expand the influence of retail investors and institutions. ** The range of BTC investment funds currently available is limited, including products 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. ETFs can be used by a wider range of clients, including directly through brokerage firms or RIAs (which prohibit direct purchases of spot Bitcoin), rather than relying on wealth managers. ** Allocation through additional investment channels. ** Without an approved Bitcoin investment solution like spot ETFs, financial advisors/trustees cannot consider Bitcoin in their wealth management strategies. The wealth management sector has a lot of money and cannot directly access Bitcoin investments through traditional channels – with an approved spot ETF, financial advisors can begin to guide their wealth clients to invest in Bitcoin. Greater wealth opportunities. ** Baby boomers and older (over 59) hold 62% of U.S. wealth, but only 8% of adults over 50 have invested in cryptocurrencies, compared to more than 25% of adults aged 18-49. Offering Bitcoin ETF products through familiar, trusted brands may help attract more older, affluent people who have not yet joined.

Recognition

**Formal recognition/legitimacy from a trusted brand. ** A large number of well-known financial brands have submitted Bitcoin ETF applications - formal recognition/verification of these mainstream companies can raise perceptions of the legitimacy of Bitcoin/cryptocurrencies as an asset class and can attract more acceptance and adoption. According to Pew Research, of the 88% of Americans who have heard of cryptocurrencies, 75% are not confident in the way they currently invest, trade, or use cryptocurrencies. Addressing regulatory and compliance issues; Regulatory clarity will attract more investment and development. ** As a regulated investment product with more comprehensive risk disclosure, SEC approval of ETFs could alleviate many of the security and compliance concerns of investors. 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, increasing the competitiveness of the US crypto industry. ** Advantages of BTC portfolio/acceptance as an asset class. ** Bitcoin can offer the benefits of diversification and enhanced returns no matter where allocations are withdrawn from the portfolio. To help guide investment management decisions, more retail investors and financial advisors have increasingly turned 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 inflows from Bitcoin ETF approvals

Considering the accessibility reasons mentioned above, the US wealth management industry is likely to be the market with the most potential to gain the most accessibility through an approved Bitcoin ETF. As of October 2023, the total assets under management by brokers ($27 trillion), banks ($11 trillion) and RIAs ($9 trillion) reached $48.3 trillion.

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We use $48.3 trillion from selected U.S. wealth management aggregators as the benchmark TAM in our analysis (excluding the family office channel that manages approximately $2 trillion), although the addressable market for Bitcoin ETFs and the indirect impact of Bitcoin ETF approvals may extend well beyond U.S. wealth management channels (e.g., international, retail, other investment products, and other channels) and potentially attract more money into the Bitcoin spot market and investment products.

(Note: While we use TAM-style analysis to estimate inflows into Bitcoin ETFs, we acknowledge that money flowing into Bitcoin ETFs may also drive new net inflows rather than simply shifting from existing allocations – so applying the capture percentage assumption to the estimated TAM numbers does not fully reflect our view on how Bitcoin ETFs are adopted, as it does not capture this new demand flow.) ）

As the channel opens up, the Bitcoin ETF entry cycle across these segments may last for several years. The RIA channel consists primarily of independently registered investment advisors of a complex nature that have the potential to allow access earlier than bank- and broker-dealer affiliated advisors and therefore have a larger share of initial access in our analysis. For the banking and broker-dealer channel, 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. The platform may have specific requirements before providing access to new investment products (e.g., track record > 1 year or AUM exceeding a certain amount, general applicability issues, etc.), which will affect the access cycle.

Let’s 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 slower growth, starting at 25% in Year 1 and growing steadily to 75% in Year 3. Based on these assumptions, we estimate the addressable market size of the US Bitcoin ETF to be around $14 trillion in Year 1 after launch, approximately $26 trillion in Year 2, and approximately $39 trillion in Year 3.

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Estimating Bitcoin ETF Inflows: Based on these market size estimates, if we assume that 10% of the total assets available in each wealth channel are BTC, with an average allocation of 1%, then we expect that the inflow into Bitcoin ETFs will reach $14 billion in 2019. In the first year after launch, the ETF grew to $27 billion in the second year and $39 billion in the third year after launch. Of course, if Bitcoin spot ETF approval is delayed or rejected, our analysis will change due to timing and access restrictions. Alternatively, if the price underperformance or any other factors cause the use or adoption of a Bitcoin ETF to be lower than expected, our estimates may be too aggressive. On the other hand, we believe our assumptions about access, exposure and allocation are conservative, so inflows may also be higher than expected.

Potential impact on BTCUSD

According to the World Gold Council, global gold-backed ETFs held a total of around 3,282 tonnes (approximately US$198 billion in AUM) as at 30 September 2023, representing approximately 1.7% of the gold supply.

As of 9/30/23, a total of 842,000 BTC (approximately $21.7 billion under management) was held in investment products, including ETPs and closed-end funds, representing 4.3% of the total issuance.

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Compared to Bitcoin, gold’s market capitalization is estimated to be about 24 times higher, while the supply in investment vehicles is reduced by 36%, so we assume that the inflow of funds equivalent in US dollars has an impact on the Bitcoin market by about 8.8 times compared to the gold market.

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

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Keeping the inflows unchanged, but adjusting the multiplier down each month based on the change in the gold/BTC market cap ratio due to the rise in BTC prices, we can see the monthly return gradually decline from +6.2% in the first month to +3.7% in the last month of the first year, with an expected 74% increase in BTC in the first year approved by the ETF (starting from the BTC price of $26,920 on September 30, 2023).

The impact of ETF inflows on BTC prices in the first year is expected

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

In the short term, we expect other global/international markets to follow the U.S. in approving and offering similar Bitcoin ETF offerings to a wider range of investors. In addition to ETF products, various other investment vehicles may also add Bitcoin to their strategies (such as mutual funds, closed-end funds, and private equity funds, among others) – across investment objectives 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 run, the addressable market for Bitcoin investment products could be further extended to all third-party assets under management (around $126 trillion under management, according to McKinsey) and even more broadly to cover global wealth ($454 trillion under management, 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/distribution assumptions unchanged (Bitcoin is adopted by 10% of funds, with an average distribution of 1%), we estimate the potential incremental funding size of Bitcoin investment products over a long period of time to be around $125 billion to $450 billion.

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Summary and Conclusion

For a decade, applicants have been seeking to list spot Bitcoin ETFs. During this time, Bitcoin’s market capitalization has risen from less than $1 billion to $600 billion today ($1.27 trillion in 2021). At that time, the owners and use of Bitcoin increased dramatically around the world, and many different types of wallets, cryptocurrency-native exchanges and custodians, and traditional market access tools emerged around the world. 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 are likely to see significant inflows, driven primarily by wealth management channels that currently do not have access to safe and efficient Bitcoin exposure at scale.

Inflows from ETFs, market narratives about the upcoming Bitcoin halving (April 2024), and the possibility that interest rates have peaked or will peak in the near term, all suggest that 2024 could be a big year for Bitcoin.