Original title: ETF Wif Hat
Original author: Arthur Hayes
Original compilation: Joyce, BlockBeats
Editors note: After the adoption of the Bitcoin ETF, everyone from the crypto community to traditional financial institutions are closely watching the impact of this incident on the global financial market. Arthur Hayes analyzed the reasons for the adoption of Bitcoin ETF in this article - Bitcoins anti-inflation properties make it an ideal asset in the current global inflation environment. Bitcoin ETF is for those who want to avoid the impact of inflation but cannot leave traditional government control. Funding under the scope provides opportunities. Then, Arthur Hayes conducted an in-depth analysis of the possible market impact of Bitcoin spot ETFs, and explained in detail the creation and redemption process of ETFs, as well as the arbitrage opportunities that may exist during the operation of Bitcoin ETFs. BlockBeats compiles the original text as follows:
(Any opinions below are the personal opinions of the author and should not form the basis for investment decisions, nor should they be regarded as recommendations or suggestions for engaging in investment transactions. The picture comes from X user@CryptoTubeYT）
Why now?
The last moments of life are the most expensive from a medical perspective. We are willing to spend unlimited amounts of money on treatments that delay inevitable death. Likewise, the elites of American hegemony and its client countries, who are responsible for maintaining the current world order, are willing to protect this order at all costs because they benefit the most from it. But American hegemony has been lying on its back since 2008, when shady mortgage lending to penniless Americans triggered a global economic crisis as severe as the Great Depression of the 1930s. On the death bed. And what were the prescriptions of those medieval neo-Keynesian barbers who blindly followed Ben Bernanke? As dying empires always say... The printing presses are humming.
The United States, Europe, and a host of client states, competitors, and allies elsewhere have all resorted to money printing to address different symptoms of the same problem: a deeply imbalanced global economic and political system. The United States, led by the Federal Reserve (Fed), prints money and purchases U.S. government bonds and mortgages. Europe, led by the European Central Bank (ECB), prints money and buys the government bonds of euro member states to keep a flawed monetary (but not fiscal) union alive. Japan, led by the Bank of Japan (BOJ), continues to print money in the pursuit of illusory inflation that disappeared after the 1989 real estate crash.
The result of this wanton money printing is that the global debt-to-GDP ratio has accelerated. Global interest rates hit their lowest levels in 5,000 years. At its peak, almost $20 trillion in corporate and government bonds had negative yields. Since interest is compensation for the time value of money, if interest is negative, are we implying that time no longer has value?
gratefulQuill IntelligenceThis chart was provided by Danielle DiMartino Booth.
As you can see, in response to the 2008 Global Financial Crisis (GFC), interest rates were pushed to 5,000-year lows.
This is the Bloomberg index of global negative-yielding debt. From nothing before the global financial crisis in 2008, it reached a high of $17.76 trillion in 2020. This is a result of central banks around the world cutting interest rates to 0% and below.
The majority of the worlds population does not possess sufficient financial assets to benefit from this global devaluation of fiat currencies. Inflation on various commodities has mushroomed around the world. Remember the Arab Spring of 2011? Remember when a piece of avocado toast was less than $20 in every major global financial center? Remember when a family with a median income could afford the median price of a home without having to turn to the Bank of Mom and Dad?
The only marginally viable way out is to own some gold. But gold is not practical to actually hold. Gold is heavy and difficult to hide in large quantities and avoid greedy government regulation. Therefore, ordinary people can only suffer in silence while the elites continue to party in Davos as if time has stopped in 2007.
Yet, like a lotus blooming in a cesspit, Satoshi released the Bitcoin white paper in the midst of a morally, politically, and economically bankrupt empire. This white paper lays out a system whereby, through internet-connected machines and cryptographic proof, one can decouple currency from state in a globally scalable way for the first time in human history. I say globally scalable because Bitcoin is weightless. Whether you hold 1 Satoshi or 1 million Bitcoins, their weight is the same 0. Additionally, you can use your mind to protect your Bitcoins simply by remembering the mnemonic phrase to unlock your Bitcoin wallet. Bitcoin provides everyone with a complete financial system that is no longer subject to ancient institutions and requires only an Internet-connected device.
People finally have a way to escape the global fiat currency devaluation orgy. However, after the Great Financial Crisis of 2008, Bitcoin was not mature enough to provide a credible escape route for believers. Bitcoin, and the crypto market as a whole, must grow in user numbers and prove they can withstand severe crises.
We loyal believers will face severe tests in 2022. The Federal Reserve, followed by most central banks around the world, set out to tighten financial conditions at the fastest pace since the 1980s. The hegemonic banking system and bond markets of the United States cannot withstand the onslaught of the Federal Reserve. In March 2023, three U.S. banks (Silvergate, Silicon Valley Bank, and Signature Bank) collapsed within just two weeks. The U.S. banking system was bankrupt at market value, and remains so today, especially given their holdings of Treasury securities and mortgage-backed securities. So U.S. Treasury Secretary bad girl Yellen created the Bank Term Financing Program (BTFP) as a secret way to save the entire U.S. banking system.
Cryptocurrencies are not immune to the disruption caused by high interest rates. Centralized lending platforms like BlockFi, Celsius, and Genesis have all gone bankrupt due to loans made to over-leveraged trading firms such as Three Arrows Capital. Terra Luna, a USD-pegged stablecoin, also went bankrupt as the price of its governance token, Luna, which underpinned the issuance of the UST stablecoin, went bankrupt. The incident wiped out more than $40 billion in illusory value in two days. Then, centralized exchanges also started to go bankrupt, with FTX being the largest one. FTX, run by the right type of American hegemonic white man, Sam Bankman-Fried, stole more than $10 billion in customer funds, and his scam was exposed as crypto asset prices plummeted.
What is happening to Bitcoin, Ethereum, and DeFi projects such as Uniswap, Compound, Aave, GMX, dYdX, etc.? Did they fail? Did they call the central crypto bank and get bailed out? Absolutely not. Overleveraged positions were liquidated, prices fell, people lost huge amounts of money, centralized companies ceased to exist, but Bitcoin blocks were still produced on average every 10 minutes. DeFi platforms are not bankrupting themselves. In short, there is no bailout because crypto cannot be bailed out. We suffered a lot but persevered.
In the embers of 2023, it is clear that US hegemony and its client states cannot continue to implement tight monetary policies. Doing so would bankrupt the entire system because leverage and debt are piling up too high. An intriguing thing is happening, as long-term U.S. Treasury bond yields have begun to gradually rise, Bitcoin and cryptocurrencies have rebounded, while bond prices have fallen.
Bitcoin (white) vs. U.S. 10-year Treasury yield (yellow)
As you can see in the chart above, when interest rates rise, Bitcoin, like all other long-term assets, performs lower.
This relationship reversed following the Bank Term Financing Program (BTFP). Bitcoin rises in tandem with yields. Especially as the bear market accelerates steeply, rising yields indicate that investors have no confidence in the system. In response, they have dumped the safest government bonds in the American empire, the U.S. Treasuries. This part of the funds mainly flows to the Glorious Seven artificial intelligence technology stocks (Apple, Googles parent company Alphabet, Microsoft, Amazon, Meta, Tesla, Nvidia), and to a certain extent also flows to cryptocurrency. After nearly 15 years, Bitcoin has finally shown its true nature, becoming the “people’s currency” and not just a derivative of an empire’s risk assets. This brings a very difficult problem to traditional finance.
Capital must remain in the system to eliminate large amounts of unproductive debt through inflation. Bitcoin is outside the system and now exhibits zero to slightly negative correlation with bonds (remember, when yields rise, bond prices fall). If bond vigilantes expressed their displeasure with government bonds by selling them and buying Bitcoin and other cryptocurrencies, the global financial system would collapse. It collapsed because the inherent damage done within the system was finally recognized and large financial firms and governments would have to significantly scale back. Bitcoin is outside the system and now exhibits a zero to slightly negative correlation with bonds (remember, when yields rise, bond prices fall).
To avoid this liquidation, the elite must financialize Bitcoin by creating a highly liquid exchange-traded fund (ETF). This is the same trick they played on the gold market when the SEC approved ETFs like SPDR GLD in 2004 that allegedly held gold bullion in vaults around the world. If all the capital that wanted to escape the collapse of global government bond markets bought Bitcoin ETFs managed by large traditional financial firms like BlackRock, then capital would still be safely within the system.
BlackRock formally applied for a Bitcoin ETF in June 2023 as it became apparent that the Federal Reserve and all other major central banks must once again turn to money printing in order to protect global bond markets. Spot Bitcoin ETF approved in US. However, in 2023, the US SEC seems to have finally accepted such an application. I offer the following to highlight the strangeness of current events surrounding the ETF approval process. The Winklevoss brothers applied for a spot Bitcoin ETF in 2013, but the SEC rejected their application for more than a decade. BlackRock applied and was approved within six months. This makes people sigh: Well...
As I mentioned in my previous article Expression》, the spot Bitcoin ETF is a trading product. You buy it with fiat currency to earn more fiat currency. Its not Bitcoin. It is not a path to financial freedom. It is not divorced from the traditional financial system. If you want to escape, you have to buy Bitcoin, withdraw it from the exchange, and keep it for yourself.
I wrote this lengthy preface to explain “Why now?” Why is a spot Bitcoin ETF finally approved at this critical moment for the Empire and its financial system? I hope you can appreciate the importance of this development. The global bond market is estimated to be $133 trillion; imagine the influx of money into Bitcoin ETFs if bond prices continue to fall, even if the Federal Reserve may start cutting interest rates in March. If inflation bottoms out and resumes its rise, bond prices could continue to fall. Remember, war causes inflation, and war is definitely happening in the outer reaches of the empire.
Market Impact of Spot Bitcoin ETFs
The remainder of this article discusses the market impact of spot Bitcoin ETFs. I will only focus on BlackRocks ETFs because BlackRock is the largest asset manager in the world. They have the best ETF distribution platform in the world. They can sell to family offices, retail financial advisory firms, retirement and pension plans, sovereign wealth funds, and even central banks. Everyone else will do their best as well, but when it comes to assets under management, the BlackRock ETF will be the hands-down winner. Whether or not this prediction is correct, the following strategy will work for any issuer with a high volume of ETF trading.
This article will discuss the following and how the inner workings of ETFs will create amazing trading opportunities for those able to trade in traditional financial and crypto markets: the creation and redemption process of ETFs, time series analysis of spot trading arbitrage and trading, Impact of ETF derivatives such as listed options and ETF financing transactions.
Put all that aside and let’s make some money!
Cash rules everything around me
The problem is solved. The injection (creation) and withdrawal (redemption) of funds can only be done in cash. The most worrying aspect of this ETF is that it allows ordinary people to purchase the ETF with fiat currency and choose to redeem the ETF in the form of Bitcoin. The purpose of this product is to store fiat currency, not to provide an easy way to purchase Bitcoin with a retirement account.
create
To create ETF shares, an authorized participant (AP) must send the dollar value of the creation basket (i.e., a certain number of ETF shares) to the fund by a certain time each day.
AP is a large traditional financial trading company. Some important institutions in traditional finance have registered as APs of different ETFs. Some companies that have called on the government to ban cryptocurrencies, such as JP Morgan CEO Jamie Dimon’s company, will also participate. This surprises me ;)
example:
Each share of the ETF is worth 0.001 BTC. The creation basket contains 10,000 shares, and at 4 p.m. ET, these Bitcoins are worth $1,000,000. The Authorized Participant (AP) must wire this amount to the Fund. The fund will then instruct its counterparty to purchase 10 Bitcoins. Once the Bitcoin purchase is completed, the fund will credit the ETF shares to AP.
1 basket = 0.001 BTC * 10,000 shares = 10 BTC
10 BTC * 100, 000 BTC/USD = 1, 000,000 USD
redemption
To redeem shares of an ETF, an authorized participant (AP) must send shares of the ETF to the fund by 4 p.m. ET. The fund will then instruct its counterparty to sell 10 Bitcoins. Once the Bitcoin is sold, the fund will release $1,000,000 to the AP.
1 basket = 0.001 BTC * 10,000 shares = 10 BTC
10 BTC * 100, 000 BTC/USD = 1, 000,000 USD
For us traders, we want to know where Bitcoin has to trade. Of course, counterparties that help the fund buy and sell Bitcoin can trade on any trading venue they like, but to reduce slippage they must match the fund’s net asset value (NAV).
The funds NAV is based on CF Benchmarks BTC/USD price at 4 p.m. ET. CF Benchmark pulls prices from Bitstamp, Coinbase, itBit, Kraken, Gemini and LMAX between 3-4pm ET. Any trader wishing to perfectly match NAV and reduce execution risk by trading directly on all these exchanges can do so.
The Bitcoin market is global and price discovery happens primarily on Binance (based in Abu Dhabi I guess). CF Benchmark excluded another large Asian exchange, OKX. This would be the first time in a long time that the Bitcoin market has seen a predictable and persistent arbitrage opportunity. The hope is that billions of dollars in trading flow will converge on less liquid exchanges within an hour and more follow the prices of their larger Asian rivals. I expect there will be some attractive spot arbitrage opportunities available to exploit.
Clearly, if ETFs are wildly successful, price discovery could shift from East to West. But dont forget Hong Kong and its copycat ETF products. Hong Kong only allows its listed ETFs to be traded on regulated exchanges in Hong Kong. Binance and OKX will likely serve this market, but new exchanges will also emerge.
No matter what happens in New York or Hong Kong, neither city will allow fund managers to trade Bitcoin at the best price, and they may only be able to trade on selected exchanges. This unnatural state of competition only makes the market less efficient, and we as arbitrageurs can profit from it.
Here is a simple arbitrage example:
Average Daily Volume Days (ADV) = (Exchange CF Benchmark Weight * Daily Closing Market Price (MOC) USD Notional) / CF Benchmark Exchange USD ADV
Choose the least liquid exchange in CF Benchmark, that is, the exchange with the highest ADV days. If buyer pressure increases, Bitcoin price will be higher on CF Benchmark exchange than on Binance. If seller pressure increases, Bitcoin price will be lower on CF Benchmark exchange than on Binance. Then, sell Bitcoin on an expensive exchange and buy Bitcoin on a cheap exchange. You can estimate the direction of creation/redemption flows by the premium or discount an ETF trades to its intraday net asset value (INAV). If ETFs trade at a premium, there will be a flow of creation. Authorized Participants (APs) short on expensive ETFs and then create at cheaper net values. If the ETF trades at a discount, there will be a flow of redemptions. AP purchases the ETF at a low price in the secondary market and redeems it at a higher NAV price.
In order to trade this in a price-neutral way, you need to stake USD and Bitcoin on the CF Benchmark exchange and Binance. However, as a risk-neutral arbitrage trader, your Bitcoin needs to be hedged. To do this, buy Bitcoin with USD and short the BitMEX Bitcoin/USD Bitcoin per-coin perpetual swap contract on BitMEX. Place some Bitcoin margin on BitMEX and the remaining Bitcoins can be spread across relevant exchanges.
ETF options
To really make ETF casinos work, we need leveraged derivatives. In the United States, the market for zero-day options (0 DTE) has exploded. Options that expire in one day are akin to lottery tickets, especially when you buy them out-of-the-money (OTM). Today, 0 DTE options have become the most traded options instrument in the United States. Of course, people like to gamble.
Some time after the ETF is listed, options will begin to appear on U.S. exchanges. Now the real fun begins.
Its hard to get 100x leverage in TradFi. They dont have a place like BitMEX that solves the problem. But the premium for OTM options with shorter expiration dates is very low, which creates high leverage, or gearing. To understand why, brush up on your theoretical option pricing knowledge by studying Black-Scholes theory.
Degen traders with brokerage accounts that can trade on U.S. options exchanges will now have a liquid way to place highly leveraged bets on Bitcoin prices. The underlying underlying of these options will be ETFs.
Heres a simple example:
ETF = 0.001 BTC per share
BTC/USD = $ 100,000 ETF share price = $100
You believe that the price of Bitcoin will increase by 25% by the end of the week, so you purchase a $125 strike price call option. This option is out-of-the-money because the current ETF price is 25% below the current strike price. Volatility is high, but not extreme, so the premium is relatively low at $1. The most you can lose is $1, and if the option goes in-the-money quickly (over $125), you can make more profit from the change in the option premium, whereas if you just bought the option, you can make 25% The profits sell the ETF shares themselves. This is a very crude way of explaining leverage.
In the U.S. capital markets, these avid traders are a serious bunch. With these new highly leveraged ETF options products, they will cause some confusion with Bitcoin’s implied volatility and forward structure.
forward arbitrage
Call option price - Put option price = Long forward contract
As traders buying lottery tickets drive up the price of ETF options, the price of out-of-the-money options will rise. The opportunity this provides can be realized through arbitrage between BTC/USD perpetual contracts (such as those on BitMEX) and ATM forward contracts derived from ETF option prices.
Futures basis = futures price - spot price
I expect the ETF ATM forward basis to trade higher than the BitMEX futures basis. Heres how to trade.
Short the ETF ATM forward by selling the ATM call option and buying the ATM put option.
At the same time, buy the BitMEX Bitcoin/USD fixed-maturity futures contract, whose expiration date is similar to that of ETF options.
Wait for prices to converge towards expiry. This won’t be a perfect arbitrage because BitMEX and the ETF use different trading prices to construct Bitcoin’s spot index price.
Volatility (Vol) Arbitrage
To a large extent, when you trade options, you are trading volatility. Traders who currently trade Bitcoin options on crypto-native non-U.S. exchanges have different preferences for duration and strike price than traders who trade ETF options. I predict that ETF options trading volume will dominate global Bitcoin options flows. Since these two groups of traders, USD-based U.S. traders and non-USD traders, are unable to interact on the same exchanges, arbitrage opportunities will arise.
A direct arbitrage opportunity exists when options with the same maturity and strike price trade at different prices. Additionally, there will be a more general volatility arbitrage opportunity where, outside the United States, certain parts of the ETF options volatility surface differ significantly from the Bitcoin volatility surface. Finding and taking advantage of these opportunities requires more trading experience, but I know there will be many French speculators arbitraging in these markets.
MOC (market to close) flow
The 4pm closing price of the CF benchmark index will become important as ETFs will lead to a surge in trading volumes in US-listed ETF derivatives. The value of a derivative comes from its underlying asset. With billions of dollars in notional amounts coming to options and futures expiring daily, it is critical to align the net asset value (NAV) with the ETFs closing price.
This will produce statistically significant trading action during trading hours around 4 PM ET and other days. Those who are good at processing data sets and have good trading bots will make huge profits by arbitraging these market inefficiencies.
ETF Financing (Creation Loan)
Centralized lending platforms such as Blockfi, Celsius, and Genesis are extremely popular among Bitcoin holders who want to borrow fiat currencies using their Bitcoin as collateral. However, the dream of an end-to-end Bitcoin economy has yet to be realized. Loyal Bitcoin supporters still need fiat currency to pay for daily necessities, using that not-so-clean fiat currency.
All of the centralized lending platforms I just mentioned collapsed, as did many others. Borrowing fiat currencies becomes more difficult and expensive using Bitcoin as collateral. Traditional finance is very accustomed to lending against liquid ETFs. As long as you stake your Bitcoin ETF shares, it will now be possible to obtain large-scale fiat loans at competitive prices. For those who believe in financial freedom, the issue is maintaining control of Bitcoin and taking advantage of this cheaper capital.
The solution to this problem is to exchange Bitcoin for ETFs. Heres how it works.
APs that can borrow money in the interbank market will create ETF shares and hedge Bitcoin/USD price risk. This is creating a lending business. In Delta-One terms, its the buyback value of the ETFs shares.
Here is the process:
Borrow dollars in the interbank market and cash out to create ETF shares.
Sell an ATM call option on the ETF and buy an ATM put option on the ETF to create a synthetic short forward contract.
The act of creating ETF units creates a positive spread, i.e. forward basis > interbank dollar rate.
Lending ETF shares in exchange for Bitcoin collateral.
Lets bring Chad in to discuss what he needs to do with his Bitcoin:
Chad is a holder of 10 Bitcoins and needs USD to pay his AMEX bill, and champagne in those bars is expensive. Chad contacted his friend Jerome, a wily French guy who worked at SocGen, who had been a back-office replacement in a major finance company, had been jailed for aggressive futures trading, but had gotten his job back (you cant in France Fire anyone) and now runs the crypto trading desk. Chad asked Jerome about a Bitcoin to ETF exchange for 30 days. Jerome quoted -0.1%. This means that Chad will exchange 10 Bitcoins for 10,000 shares of the ETF, assuming each share is worth 0.001 Bitcoins, and after 30 days Chad will receive back 9.99 Bitcoins.
Within 30 days of Chad owning 10,000 shares of the ETF instead of 10 Bitcoins, he pledged the ETF shares to his traditional finance stockbroker to obtain a very cheap dollar loan.
Everyone is happy. Chad can continue to show off at the club without having to sell his Bitcoins. And Jerome earns the financing spread.
The ETF financing business will gradually become very important and affect Bitcoin interest rates. As this market develops, I will highlight attractive ETF, physical Bitcoin, and Bitcoin derivatives financing transactions.
Your size is my size
In order for these trading opportunities to persist over an extended period of time and allow arbitrageurs to execute them at sufficient scale, the Bitcoin Spot ETF complex structure would have to trade billions of dollars of shares every day. On Friday, January 12, total daily trading volume reached $3.1 billion. This is very encouraging and as various fund managers begin to activate their vast global distribution networks, trading volumes will only increase. With a liquid way to trade the financial version of Bitcoin within the traditional financial system, money managers would be able to escape the woes of poor returns now being offered in this global inflationary environment.
We are in the early stages of this move toward a period of sustained global inflation. Theres a lot of noise, but over time managers who run stock-bond correlations will realize that things have changed. Below zero interest rates, bonds cease to play a role in a portfolio, especially if inflation persists. The market will slowly realize this and the sell-off from the over $100 trillion bond market will devastate the country. These managers must then find another asset class that does not have a material correlation with stocks or any traditional financial asset class. Bitcoin accomplished this task.
Your Size is My Size
In order for these trading opportunities to persist over an extended period of time and allow arbitrageurs to execute them at sufficient scale, the Bitcoin Spot ETF complex structure would have to trade billions of dollars of shares every day. On Friday, January 12, total daily trading volume reached $3.1 billion. This is very encouraging and as various fund managers begin to activate their vast global distribution networks, trading volumes will only increase. With a liquid way to trade the financial version of Bitcoin within the traditional financial system, money managers would be able to escape the woes of poor returns now being offered in this global inflationary environment.
We are in the early stages of this move toward a period of sustained global inflation. Theres a lot of noise, but over time managers who run stock-bond correlations will realize that things have changed. Below zero interest rates, bonds cease to play a role in a portfolio, especially if inflation persists. The market will slowly realize this and the sell-off from the over $100 trillion bond market will devastate the country. These managers must then find another asset class that does not have a material correlation with stocks or any traditional financial asset class. Bitcoin accomplished this task.
