CME report highlights some interesting facts about trader positioning.
Updates to ETFs in the application process indicate the final decision will likely come down to the final few days.
Hash rate surges to new high driven by plain old simple favorable economics.
CME Futures Paint and Interesting Picture About Positioning
The CME Commitment of Traders report, the weekly report published by the CME, contains a wealth of information about trader positioning and investment sentiment. The most recent report highlights some important information about asset managers, hedge funds and CTAs (commodity trading advisors).
The first important observation is the long position by asset managers, which is the largest on record. Asset managers include mostly futures-based ETFs, the largest of which is the ProShares Bitcoin Strategy ETF (BITO). This is not a fundamental active investment view expressed by ETF managers, rather it is an expression of investor demand for these ETFs, who are buying shares on the open market which results in the purchase of the underlying bitcoin futures. Please note that there is virtually no short position expressed by this trader type.
The second important observation is the positioning by traders in the Leveraged category, which we think of as hedge funds and CTAs. The long open interest position is likely represented by CTAs, which employ trend following strategies. This number peaked on June 27th at 6,145 contracts in the wake of the BlackRock ETF filing. While the Leveraged category long open interest is well off the highs, it is still elevated compared to historical standards. The short side of the Leveraged category traders is likely represented by hedge funds engaged in the basis trade, where they are short futures, which are trading at a premium to spot, and long spot as a hedge. While the basis has come in quite a bit from the highs we pointed out a couple of weeks ago, it still remains elevated compared to historical levels, resulting in a healthy short position.
ETFs Likely Going Down to the Wire
The past two weeks have seen a flurry of behind-the-scenes activities on the ETF front. While the SEC has yet to approve or deny a spot ETF, several signs are pointing to the decision coming down to the final wire. At a high level, the agency is continuing conversations with a number of the issuers about the mechanics of their ETFs and the details disclosed in the registration statements. At contention appears to be the share create and redeem function, with most issuers having an “in-kind” methodology in their registration statement, but with Grayscale having an additional “cash” methodology. This week, we saw numerous updates to bitcoin ETF applications. The Franklin Bitcoin ETF updated its prospectus to include a cash methodology, in addition to its existing in-kind methodology. Blackrock proposed an updated in-kind redemption methodology for the iShares Bitcoin Trust, after what reads as pushback from the agency staff.
We also saw the delay in the decision for the Franklin Bitcoin ETF as well as the Hashdex Bitcoin ETF conversion application. These delays came well ahead of their next deadlines on January 1, 2024. Given that these delays also institute a 35-day public comment and rebuttal process, this puts the SEC’s likely final decision date after that, in the last few days of the final response window, January 8th -10th.
Financial markets reflect this possibility, as well, as implied by options markets. Forward volatility for at-the-money options trading on Deribit show a marked jump for December expiry (48.1%) vs January (63.7%). If the observed premium in January forward volatility was assigned to a single day's event, such as an ETF decision, the implied one-day spot price move is near 12.5%.
Hash Rate Zooms to New Highs as Foundry is Overtaken by AntPool
Bitcoin’s hash rate continues to hit new highs, breaking 490 EH/s and rising over 100% year to date. Amid the flurry of hash rate additions, which have been seen at every major pool this year, AntPool has supplanted Foundry USA as the largest bitcoin mining pool. Over the past 7 days, AntPool accounted for 28% of the blocks mined while Foundry USA accounted for 27% of the blocks mined according to data from Luxor. At the beginning of the year, Foundry USA accounted for 32% of the network hash rate and AntPool at about 20%.
What has been driving the surge in network hash rate? While social media has concocted some truly fantastical theories involving ETFs, the reality is that pure and simple economics have been driving hash rate additions. Right now, the breakeven prices (assuming $0.05 kWh electricity and 2% pool fees) on the latest generation Bitmain S21 (200 Th – 17.5 J/Th/s) is $11,600. While those might not be in broad circulation yet, S19 XP (140 Th – 21.5 J/Th/s) breakevens are around $14,200. Even S17+ (72 Th/s – 40 J/Th/s) that were launched in December 2019 are profitable at current prices ($26.5K breakeven).
These breakevens govern shut down conditions, the marginal cost of production, so it makes sense why miners would keep existing rigs on. But what about capacity additions? There the math is a bit more complicated. Using the $4,900 list price for the S21, assuming a 4-year life, 10% incremental overhead costs to install the rig, and assuming current prices and hash rate as well as previous power and pool fees, one would calculate a 15.2% IRR on that investment. For previous generation S19 XPs, the IRR drops to a level below a reasonable cost of capital, but the math may be more compelling for miners with access to cheap power ($0.02 - $0.03 electricity) or discounted rig pricing. List rig price implies $36/Th, while Luxor reports S19 XPs are currently selling 37% below that price ($23/Th). In addition, there may be unique economic cases (extremely low cost or no cost power, access to deeply discounted mining rigs, including the rig manufacturers themselves) or non-economical motivations (social, political) that have been encouraging hash rate growth.
We will also use this opportunity to remind investors that it is bitcoin’s price that sets the network hash rate, not the other way around. This is one of the longest standing misbeliefs about bitcoin, one that goes back to the very first way that bitcoin was priced on the Bitcoin Talk message boards – the cost of electricity to produce a bitcoin. This idea has been disproven in the academic literature (here and here), and we suggest that valuation methodologies or principles based on this misbelief be forgotten.
Market Update
Bitcoin continued to rally again this week, up another 1.2%, bringing the 2023 annual return to 128.0%. The subject of a spot ETF continues to dominate questions from investors, with the process entering in the final phase. Equities were subdued this week, with the S&P 500 down 0.1% and the Nasdaq Composite down 0.3%. Bonds rallied this week as forward rate expectations decline. Investment grade corporate bonds rallied 1.0%, high yield corporate bonds rose 0.8%, and long term US Treasuries climbed 0.8%. Gold rallied 2.2% and oil price fell 1.9%.
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