Will ETFs Reduce Bitcoin Volatility?

After a painfully long wait, spot Bitcoin ETFs were OK’s by the US Securities and Exchange Commission. The general expectation has been that by removing the need to get a crypto wallet, worry about blockchain hacking, and own Bitcoin directly, that many more investors would invest in the Bitcoin world. At least at the beginning, this prediction seems to have been shown to be true. If now we are going to see more traditional investors in the Bitcoin arena, will we see Bitcoin trade more like the stock market. In other words, will ETFs reduce Bitcoin volatility?

Bitcoin Volatility

Science Direct published a useful look at Bitcoin volatility and how it relates to the stock market and overall investor sentiment. A brief look at the price of Bitcoin in dollars over the years makes it clear that occasional spikes followed by retreats are the norm for Bitcoin and not rare events. Bitcoin detractors have blamed this volatility on pump and dump cycles, FOMO (fear of missing out), Bitcoin wash trading, and the fact that a handful of Bitcoin “whales” have the capacity to dramatically move the market. It turns out that most of the time Bitcoin tracks with indices like the Nasdaq. Overall investor sentiment, the stock market in general, the VIX options volatility index all move in generally rational ways with Bitcoin or vice versa. Our question is whether or not letting a whole herd of institutional as well as mom and pop investors trade Bitcoin via ETFs is going to make Bitcoin more like stocks in its degree of volatility.

Will ETFs Reduce Bitcoin Volatility?

Outflows from Spot Bitcoin ETFs

Coinbase wrote recently about spot Bitcoin ETF fund flows. Spot Bitcoin ETFs are new and have grown impressively as more and more investors have purchased shares. To the degree that these folks are long term investors we would expect to see these funds grow and grow with few withdrawals. To the extent that traders are going to be using this route to trade Bitcoin, we might expect to see money flowing both in and out of these exchange traded funds. That is what is now happening. Over four days from March 18 to 21 these funds experienced outflows of $836 million. Coinbase speculates that the outflows had to do with the Genesis Global bankruptcy associated liquidations. Alternatively, this could simply have been profit taking by folks who are trading Bitcoin via ETFS instead of directly.

Bitcoin Wash Trading and ETFs

Bitcoin wash trading is quite common. This practice distorts the market, fools naïve traders, and is perfectly legal within the Bitcoin system. However, ETFs trade like stocks and wash trading is not legal in US stock markets. Wash trading is the practice of selling an asset in order to claim a tax loss and then immediately buying it. Then the asset, such as a stock or cryptocurrency, goes back to the price where the person originally purchased it. If they had simply held on to the investment they would neither have lost or gained money. If they are able to claim the loss as a tax deduction, they are actually ahead of the game even though the asset is not trading at the original price. Wash trading will not be an issue in spot Bitcoin ETFs. To the extent that ETFs come to rival direct Bitcoin trading in volume, we might expect Bitcoin to become less volatile.

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