big country
Author: David Mann, Head of Products and Capital Markets, Franklin Templeton ETFs
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The “story of the year” for exchange-traded funds (ETFs) in 2024 is the rapid adoption of the nine spot Bitcoin ETFs launched on January 11, 2024. As of the end of February, the total net inflows of these ETFs reached US$1.6 billion, with nominal trading volume of US$45 billion.1 Given that all of these funds hold the same thing (Bitcoin), with many issuers cutting fees to zero and tracking similar benchmarks, investors have turned to measuring statistics related to “liquidity” as a way to differentiate . Not surprisingly, many of the misconceptions about measuring ETF liquidity that I discussed before resurface. I will discuss these issues here, while also acknowledging some issues specific to Bitcoin.
Finally, my son and I discussed the best way to make the Bitcoin ETF spot liquidity story accessible to all readers. Following his instructions, I’ll use the Detroit Lions’ chances of winning the 2025 Super Bowl as the perfect analogy.
My first blog post in 2016 discussed the misunderstanding of using average trading volume as an accurate measure of ETF liquidity. Before discussing volume, I want to clear out some other ETF metrics from the spot Bitcoin ETF comparison board:
- Bid/Ask Spread: According to each ETF’s website, most of the new ETFs trade at a cent spread, meaning the difference between the bid and ask price of a spot Bitcoin ETF share is just 1 cent.
- AUM: I would also remove assets under management (AUM) from the ETF liquidity conversation – AUM is the important consideration related to percentage ownership limits, not the ability to buy and sell Bitcoin or the costs associated with it.
The rest is volume. Average daily trading volume only shows other people’s past trading volume. Importantly, it does not provide any information about the price investors pay for their ETF shares, specifically information related to the fund’s net asset value (NAV).
I also think the trading volumes are particularly misleading given the unique nature of these Bitcoin ETFs, where each of several new funds holding entirely new underlying assets launches on the same day. Typically, for new funds, every dollar traded on an exchange should generate one dollar of primary market activity. I’ve discussed these ratios in the past because typically with new funds, existing shareholders don’t sell shares to new investors. Instead, ETF market makers are selling shares to new investors and need to issue new shares to cover those short positions.
For investors who define liquidity as the ability to enter and exit positions with minimal market impact, I believe metrics such as NAV premium/discount are more relevant than average daily trading volume. This is especially true when comparing multiple ETFs that share the same underlying assets.
The ratio of trading volume to primary market activity for these nine funds is almost three to one. I can speculate as to why. I believe that given the volatility of Bitcoin, intraday trading volume is quite high, with investors buying and selling frequently but ultimately not taking long positions. I also think that as long as there is any premium/discount differential, there will be specialist firms buying/selling all of these funds at the same time. Consider this ETF arbitrage on steroids. If this is indeed happening, then why do ETFs get additional credit for increased trading volume due to increased premiums/discounts?
Back to premiums/discounts. For a true apples-to-apples comparison, I looked at six ETFs using the CME CF Bitcoin Reference Rate – New York variant, as different benchmarks can lead to misleading data. The three largest ETFs, each with more than $1.5 billion in assets under management, have an average daily trading volume of $280 million. The three smallest of these ETFs have a combined average daily trading volume of $10 million. The three funds’ weighted premium/discount to net asset value is 16 basis points.For the bottom three (which includes BCFranklin’s Spot Bitcoin ETF), with a weighted average of 7 basis points.2 By this metric, I think spot Bitcoin funds are seeing lower volume more Liquidity refers to the ability of investors to trade based on the underlying price of Bitcoin.
My son used an NFL analogy to emphasize this point, and rightly so. BTW, I’ve received some unnecessarily harsh feedback from readers: 1) being a Detroit Lions fan, and 2) picking them to win this year’s Super Bowl. Anyway, the day after the Super Bowl, my son was curious about the possibility of the Lions winning the Super Bowl in 2025. I showed him a table that listed the odds for each team in six different sportsbooks. For the Lions, the odds range from 12-to-1 (bet $1 to win $12) to 13.5-1 (bet $1 to win $13.50), depending on the sportsbook.
His next comment was spot on, “Oh, so we should go to the sportsbook with odds of 13.5-1.” While obviously investing has no guaranteed payout (if only!), he didn’t ask me which sportsbook Bet the most, nor ask which sportsbook has the most action on the Detroit Lions. He’s focused on what influences his investment in Detroit winning the Super Bowl. I believe that for ETFs, metrics such as NAV premium/discount are more correlated with liquidity than volume and AUM. I can only hope to see such revelations in the spot ETF Bitcoin world.
What are the risks?
All investments involve risks, including possible loss of principal. The value of investments can fall as well as rise and investors may not get back the full amount invested. Generally speaking, projects that offer higher return potential are associated with a higher degree of risk. Stock prices can sometimes fluctuate rapidly and dramatically due to factors affecting individual companies, specific industries or sectors, or overall market conditions. For actively managed ETFs, there is no guarantee that the manager’s investment decisions will produce the expected results.
ETFs trade like stocks, fluctuate in market value, and may trade above or below the ETF’s net asset value. Brokerage commissions and ETF fees will reduce returns. ETF shares can be bought and sold throughout the day at the market price on the exchange on which they are listed. However, there can be no assurance that an active trading market for the ETF’s shares will develop or be maintained, or that its listing will continue or remain unchanged. While shares of an ETF may be traded in the secondary market, they may not trade readily under all market conditions and may trade at a significant discount during periods of market stress.
1. Source: Bloomberg. As of March 1, 2024.
2. Source: Same as above.
Editor’s note: Summary highlights for this article were selected by Seeking Alpha editors.
