Taming the Beast

The arrival of Bitcoin ETFs is a mark of respectability. It was the federal government that gave the stamp of approval to crypto with its massive fiscal stimulus in 2020/21.

On 10th January, the SEC approved the conversion of Grayscale Bitcoin Trust into an ETF, allowing crypto assets into the US regulated arena for the first time. A more grudging approval from the SEC’s Gary Gensler is hard to imagine. His statement acknowledges he was dragged by court rulings into reluctant approval of crypto ETFs. Grayscale converted to an ETF the following day. Other bitcoin ETFs were launched shortly afterwards, with several billion inflows within the next six trading days.

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Respectability remains a challenge. The behaviour of Bitcoin (and the new ETFs) since 11th January will hardly mollify the SEC. As Reuters reports, hedge funds dumped approximately $5 billion worth of the Grayscale Trust/ETF securities immediately following its approval, a volume nearly 12 times the average daily volume of the prior 3 months. The deluge caused both the fund and Bitcoin to lose 14% in the week following its conversion. But the selloff was actually less abrupt than TSLA over the same period (-20% since 11th January at pixel time). Perhaps the SEC should show as much concern for TSLA as Bitcoin ETFs.

For the bumpy start to approved ETF trading is an anomaly. Simple analysis shows Bitcoin prices have behaved more-or-less in line with conventional securities for several years. And despite occasional, and dramatic, deviations in correlation, Bitcoin mostly tracked wider asset markets (with high beta).

Even so, the earlier colossal price volatility of Bitcoin need explanation. Let’s try first to explain the early ‘Wild Days’, then the move to respectability.

A reasonable measure of how assets are judged within the financial world is to compare mutual and conditional variance of a market with the wider securities universe. The ratio of conditional to mutual variance is the ‘Information Ratio’. The higher the ratio, the greater the idiosyncratic ‘information’ or variance in a market. A low ‘Information Ratio’ signals widespread acceptance in the financial universe.

The ‘Information Ratio’ of Bitcoin was ‘mad, bad and dangerous to know’ until COVID19 struck. Since 2020, or thereabouts, BTC has become better behaved, with an average Information Ratio between 7-11. And in the last twelve months, the mean Information Ratio was 2.8, which is less than Natural Gas (6.1) and close to Crude Oil (2.7). The institutionalisation of Bitcoin has been in train for years. Bitcoin has become so well-behaved as almost to pass for a high-beta stock, such as AMZN or TSLA.

What caused Bitcoin to move from anarchic behaviour and behave like an acceptable investment products? Probably time and familiarity played a part. And an important specific catalyst was US fiscal policy around COVID19.

The March 2020 Coronavirus Aid, Relief and Economy Security Act (“CARES Act”) gave $1,200 per tax filer and $500 per child. That didn’t have much impact on Bitcoin. But later targeted fiscal spending which made a huge impact. The Consolidated Appropriations Act of 2021 delivered $300 per week unemployment benefit boost and $600 per tax filer and child. And the American Rescue Plan of the Biden administration delivered payments of $1,400 for each tax filer and each child. The combination of these two stimulus packages coming close together amounted to ~15% of GDP. Part of the sudden extra money was used by ordinary households to play in crypto markets. It also prompted institutional asset managers to take notice of potential source of fee income. The background was set for the move to ETF respectability. It was just a matter of time, and court-led directions.

Government policy usually has unintended consequences. And large fiscal policy has large unintended consequences. One of the less important unintended consequences of recent fiscal policy was to make crypto respectable. Gary Gensler doesn’t acknowledge it was his own political masters who pushed crypto assets in his direction, but they did. He may not like it, but Bitcoin-for-the-masses was an invention of the Federal government.

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