IN A BITCOIN FRENZY; LONG BTC MINERS & SHORT BTCBitcoin ("BTC") prices are on a tear. It has rallied +57% since the start of September and is on course to clock fourth sequential month of rising prices. Four forces are driving a blistering rally. Euphoria linked to BTC spot ETF. Bullishness in all “Risk On” assets. Regulatory clarity. BTC halving.
In a BTC rally, portfolio managers can gain exposure to the sector in multiple ways. These include a long position in (a) BTC, (b) BTC Futures, (c) Listed BTC miners’ stocks, (d) Crypto Exchanges, or (e) ETF on Listed BTC Miners (“Miners ETF”).
Each of these presents its own benefits and challenges. This paper summarises the forces driving the bull run and analyses the price behaviour of Miners ETF (represented by Valkyrie Bitcoin Miners ETF “WGMI”) vis-a-vis BTC.
Since June when market caught on to the excitement of a BTC Spot ETF, BTC prices have rallied relative to WGMI.
In the near term, will the ETF catch up with the bull rally in BTC? Has the BTC price rally run ahead of itself?
UNPACKING WGMI ETF
WGMI is an actively managed ETF that invests in listed BTC miners. It is issued by Valkyrie Funds LLC.
The ETF objective is to invest >80% of its net assets in firms that derive >50% of their revenue or profits from BTC mining operations and/or from providing specialized chips, hardware and software or other services supporting BTC mining.
The Fund will not directly invest in BTC. Neither will it indirectly participate in BTC using derivatives or through investments in funds or trusts that hold BTC.
Source: ETFDB and data last updated 7th/December 2023
WGMI was launched in Feb 2022, it has net assets of USD 33 million and an expense ratio of 75 basis points.
In June, when regulatory approval discussions became louder, WGMI rallied relative to BTC. Net fund flows have been positive for much of the year with rising inflows since start of October.
However, since mid-July, while BTC remained resilient, WGMI came off precipitously. WGMI price meltdown stopped in early Oct and has since started rising. Meanwhile, BTC prices have rallied sharply resulting in a WGMI underperforming BTC by 30%.
BTC BULLS IN FULL FORCE
Four forces are driving BTC frenzy.
1. BTC Spot ETF Euphoria
ETF applications were delayed by the SEC and remain pending. Previously anticipated timeline of between 5th and 10th January 2024 remains the expected approval date.
Source: James Seyffart
2. Risk-on Asset Bull Run
When money flows, it flows everywhere. Equity markets have been on an upward trajectory over the past three months on Fed rate cut hopes. BTC is seen as the risk asset of choice rallying the most.
3. Regulatory Clarity
Recently, Sam Bankman-Fried (SBF), former CEO of FTX, and Binance, the world’s largest crypto exchange were both prosecuted. SBF was convicted of fraud and jailed.
Meanwhile, Binance was imposed USD 4.3 billion in penalties on criminal charges related to money laundering and breach of financial sanctions.
In reaction to these developments, JP Morgan's Nikolais Panigirtzoglou said that "We see the prospect of settlement as positive as uncertainty around Binance itself would subside and its trading and BNB Smart Chain business would benefit.
"For crypto investors the prospect of settlement would see the elimination of a potential systemic risk emanating from a hypothetical Binance collapse.", he added.
4. BTC Halving
BTC derives value from its limited supply. Every four years, the number of BTCs minted as a mining reward, halves and will eventually halt, leading to a fixed supply.
BTC halving occurs every 210,000 blocks. As the average block time is ~10 minutes this gives a ballpark range of four years. Next BTC halving is expected on 19th April 2024, with tiny likelihood that it could take place in March or May.
HYPOTHETICAL TRADE SET UP
BTC appreciation due to halving is well known but its effects on miners is counter intuitive. With halving, the block reward for mining BTC i.e. miner revenues are essentially slashed in half.
Although BTC price appreciation helps offset to some degree, it may not be enough if elevated prices cannot be sustained. Macro conditions have shifted. Energy prices are lower positively impacting the miners. Miner margins are likely to be wider.
Large miners are expanding their hash rate at record clip. This is supported by expansion of hash rate as well as consolidation.
Given the frenzied euphoric run up in BTC prices, BTC price may have run ahead of itself. In order to protect long position in Bitcoin miners against downside moves in volatile cryptocurrency prices, investors can hedge a long position in WGMI with a short position in CME Micro BTC futures.
This Relative Value trade captures the alpha from rising stock prices of miners, while remaining agnostic to the price action on BTC itself.
This paper argues for a hypothetical long position in WGMI ETF hedged by a short position using CME Micro Bitcoin Futures expiring in January 2024 (MBTF2024).
A long-short spread requires the notional of each trade leg to be identical. Each lot of Micro Bitcoin Futures provides exposure to 0.10 bitcoin equating to a notional value of USD 4,544. Given WGMI prices as of market close on 8th December was at USD 14.75 per ETF, 308 ETF units are required.
The hypothetical relative value trade then comprises of 308 WGMI units of ETF hedged by one lot of short position in CME Micro Bitcoin Futures with the following hypothetical trade set up:
• Entry: 0.03246% (USD 14.75 divided by USD 45,440)
• Target: 0.045%
• Stop Loss: 0.027%
• Profit at Target: USD 1,755
• Loss at Stop: USD 676
• Reward/Risk: 2.6x
Please note that the above hypothetical P&L doesn’t include transaction and capital costs.
MARKET DATA
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