Rediscover the Value of Crypto ETFs in Bear Markets: ETF Trading Volume Reaches $360M in Exchanges

The crypto market has recently entered into a one-sided downtrend. This is reflected in the decline in total market capitalization, according to CoinGecko, has dropped from about $2,310.4 billion at the beginning of the year to about $179.25 billion in late February, a 22% shrink, and on the other hand, it is also reflected in the decline in volatility. The average daily amplitude of BTC, which has the highest market capitalization, is about 4.6%, which is lower than the average daily level of 6.72% last year, and the trend is clear.

Studies point out that investing in ETFs, especially leveraged ETFs, may become a way for investors to obtain high returns. In traditional financial markets, an ETF usually refers to a kind of traded open-ended index fund, where investors can both subscribe or redeem fund shares from the fund management company in real time and, at the same time, buy and sell shares in the secondary market at market prices like closed-end funds, with arbitrage opportunities between market prices and fund NAV(Net Asset Value). After the second half of 2019, ETFs entered the crypto market and have now evolved into three main types, namely index funds launched by large institutions, leveraged index funds launched by exchanges, and leveraged tokens, which trade similarly to traditional ETFs. So, can ETFs in the crypto market withstand the cold winter of the market? This article will analyze the differences between these ETFs, their current trading size, and theoretical expected returns to provide a reference.

Part 1: With more than 600 ETFs, daily trading size of exchange ETFs reaches $360 million

The main players in the crypto market refer to large digital asset managers(Grayscale, Purpose and 3iQ) and exchanges(FTX, MEXC and Binance). For example, the Bitcoin ETFs issued by Grayscale track the CoinDesk Bitcoin Price Index, and 3iQ tracks the MVIS CryptoCompare Institutional Index.

Exchange-issued ETFs, on the other hand, are perpetual leveraged products that magnify the rise and fall of the underlying asset by a multiple, and can be divided into leveraged ETF index funds issued by MEXC and leveraged ETF tokens issued by Binance and FTX according to their implementation. The major difference between the two is whether the corresponding tokens are issued on the chain, and the trading methods of each ETF are also different.

At present, there are as many as 639 types of ETFs available for trading in the market. In comparison, institutional ETFs involve fewer asset classes and have fewer tradable ETF products. Grayscale, which has the largest number of products, has issued 16 ETFs involving 24 assets, including BTC, ETF, AAVE, ADA, LINK, COMP, SOL, etc.; while 3iQ has issued 6 ETFs involving 3 assets, including BTC, ETF and LTC; Purpose has issued 4 ETF products involving 2 assets, including BTC and ETH.

Exchange ETFs involve more diverse assets and have more tradable ETF products. MEXC, which has the most products on the market, issued 386 ETFs involving 172 assets, covering almost all tracks in the cryptocurrency world, such as Ether, Boca, Solana, Avalanche Protocol, Fantom, NFT, Meta-Universe, GameFi, DeFi, Layer2, DAO, etc. FTX issued 187 ETFs involving 47 assets, and Binance issued 40 ETFs involving 2 assets. Binance also issued 40 ETFs involving 20 assets.

Currently, the market size of mainstream ETFs has grown to a significant volume. According to the official data of major institutions, as of February 25, the scale of ETFs managed by the three major institutions reached about $36.973 billion, among which Grayscale alone accounts for over 90%, while the scale of both Purpose and 3iQ has not yet exceeded $2 billion. According to CoinGecko's data, the total daily trading volume of ETFs issued by FTX, MEXC and Binance also reached nearly $360 million, with MEXC having the highest trading volume of about $194 million, accounting for 54%.

Although the current market size of exchange-issued ETFs is still much smaller than that of large institutions, the trend shows that exchange-traded ETFs are growing very fast. According to official data from major institutions and data from glassnode, the capitalization of Grayscal and 3iQ has dropped by 25% and 21% respectively in the last six months. In fact, since Grayscale's OTC price continued to maintain a negative premium level last year, the growth of institutional ETFs has started to decelerate and the size of capital management has been declining, and now even compliant institutional ETFs can hardly continue the myth of Grayscale. While institutional ETFs are weakening, exchange-traded ETFs have been on the upswing. According to CoinGecko, MEXC's ETF daily trading volume has grown by 5,015% and FTX by 492% in the last two years compared to the early 2020s when ETFs were first introduced to the crypto market. The growing trading volume means that the market is maturing and becoming more liquid, which is more positive for the development of ETFs.

Part 2: Institutional ETFs continue to have negative premiums over-the-counter. MEXC's average maximum theoretical return of over 518% at the highest

The average OTC premium of all institutional-issued ETFs experienced a process of first rising and then falling in returns. In 2020, when institutional ETFs just started issuing, the average monthly OTC yield basically remained above 10%, reaching a maximum of 23.51% at one point, which was a very impressive return. After entering 2021, the average OTC yield began to turn from positive to negative, falling all the way to the current -22.63%. However, it is worth noting that the overall average yield is more affected by the negative premium of GBTC issued by Grayscale, while the recent OTC premiums of other ETFs have rebounded, such as QBTC.U's current OTC premium of about -3.33%. However, on the whole, the recent returns of institutional ETFs are still not optimistic, except for early investors who can still get excess returns, the profit opportunities for new investors are not as good as before.

However, situations of ETFs issued by exchanges are different. If we look at the 10 ETFs with the highest daily trading volume on each exchange, 10 of the 30 ETFs had a positive net value gain so far this year, including 4 by Binance and 3 by FTX and MEXC as of the close of trading on Feb. 23th. The highest net value gain this year is the ETH 5x long ETF (ETF5L/USDT) issued by MEXC, with a 127.20% reach. Other ETFs with higher gains are the ETFs issued by Binance with up to 4x short ETF (ETHDOWN/USDT) and the BTC 5x long ETF (BTC5L/USDT) issued by MEXC, both with an over 50% gain.

In terms of historical returns, the average highest theoretical net value of the 10 ETFs with the highest current trading volume of MEXC has the largest gain of about 518.40%, and the average lowest theoretical net value has the smallest decline of about -96.40%, which is the best average return performance among the three major ETF trading products. The average highest theoretical net value of the 10 ETFs with the highest trading volume of FTX increased by only 182.49%, and the average lowest theoretical net value decreased by about -100%; the average highest theoretical net value of the 10 ETFs with the highest trading volume of Binance increased by the lowest, about 68.80%, and the average lowest theoretical net value decreased by about -99.94%. The average return performance of these two is relatively close.

In a one-sided market, leveraged ETFs outperforms the notional leverage multiple, i.e. the cumulative increase of ETFs that move in the same direction as the underlying spot price will exceed the underlying yield by a certain multiple, while the cumulative decrease of ETFs in the opposite direction will be less than a certain multiple of the underlying yield.

The crypto market over the month has been affected by multiple external factors and started to turn into a one-sided downward trend, which is clearly characterized by the downward movement of coin prices and the accompanying decline in average daily maximum amplitude. Looking at cryptocurrencies ranked 1-10, 45-54 and 90-100 by CoinMarketCap on February 23, the average daily maximum amplitude dropped from 10.24% to 7.32% in each month of the last six months, with a clear downward trend. The total market capitalization of cryptocurrencies fell from $214.53 billion to $1,715.6 billion in the same period, a 20% drop, with the same obvious downward trend. In such a market environment, leveraged ETFs may become an option for investors to gain excess returns.

Part 3: Leveraged ETFs are relatively performing than perpetuals in risk control, while not suitable for long-term holding

ETFs issued by exchanges have certain advantages over other investment products. Firstly, these ETFs are open-ended products that investors can buy and sell freely at any time, making them more liquid than most closed-end ETF funds issued by institutions.

Secondly, these ETFs are leveraged products, so their returns are affected by the leverage multiple, i.e. if the spot price of the corresponding underlying rises or falls by x%, the net value of the corresponding n times leveraged ETF product will rise or fall by nx%. Currently, the theoretical leverage multiples of ETFs launched by the three exchanges range from 2x to 5x. Taking MEXC as an example, 342 out of 386 ETFs are 3x leveraged, another 18 each are 4x leveraged and 5x leveraged, and only 8 are 2x leveraged. However, this is the nominal leverage and the actual leverage will be affected by the rebalancing mechanism.

For risk control purposes, major exchanges will establish their own rebalancing mechanism. For example. MEXC’s rebalancing mechanism includes timed rebalancing and untimed rebalancing, timed rebalancing is essentially an operation to maintain the leverage of the ETF, untimed rebalancing refers to the temporary adjustment when the price of the underlying asset rises or falls by more than a certain margin, the way to achieve the rebalancing mechanism is mainly achieved by risk hedging on multiple other derivatives platforms. Due to the existence of the rebalancing mechanism and the compounding investment mechanism, i.e., the daily profit portion is automatically transferred to the position, which gives ETFs the advantage of low leverage and no position explosion compared to futures, and the advantage of expanding returns compared to spot, especially for over-returning in unilateral upward market.

In addition, leveraged ETFs do not require margin and do not have a strong closing price, which provides higher capital utilization compared to futures. Looking at BTC3L/USDT issued by MEXC, users can open positions in leveraged ETFs as if they were buying or selling spot, without taking up part of the position as margin to raise or lower the forced closing price.

Overall, the risk of leveraged ETFs is more controllable, however, it should still be noted that leveraged ETFs track the daily return of the underlying asset and therefore do not track the cumulative gain or loss over multiple days, and should not be held for a long time. Long-term holding may cause wear and tear on the principal due to repeated ups and downs in the market over multiple days, and may also incur additional wear and tear costs such as daily funding fees and position rebalancing. In addition, investors need to pay attention to the net price when buying and selling leveraged ETFs. Due to the fluctuation of market sentiment, there may be a situation where the market trading price deviates from the NAV for a certain period of time, which may result in a premium. For investors, they should trade opportunistically and be careful not to trade at a price that deviates too much from the NAV.

Cleo Harttman
Market Analyst— Crypto, Blockchain, NFT, and new markets. Bitcoin Advocate.