Research on the Operation and Development of Cryptocurrency ETFs

Abstract
As the cryptocurrency market thrives, the tools for cryptocurrency investment are gradually becoming more diversified. Since February, BTC ETFs have been launched on the Toronto Exchange. Numerous ETH ETFs also emerged in April. The cryptocurrency market has witnessed an ETF boom. In order to study the functionality of a cryptocurrency ETF, this report will evaluate its quality of tracking, and measure the liquidity from 24-hour trading volume as well as the Liquidity Ratio. This report compares the Nasdaq100 ETF and Gold ETF in conventional financial markets, which are well developed products, with BTC ETFs and ETH ETFs. It turns out that the latter have competitive liquidity. Future ETF products are expected to compete with each other in terms of tracking performance.

Summary
◆ In terms of BTC ETFs, Purpose was the first to list; 3iQ Coinshares has the highest market value; CI Galaxy does the best in terms of tracking; there are distinct differences in liquidity, and Purpose has the strongest liquidity.

◆ In terms of ETH ETFs, 3iQ Coinshares has the highest market value; Purpose is excellent in terms of tracking; and CI Galaxy has the strongest liquidity.

◆ In terms of tracking performance, The BTC ETF has a higher level of maturity when compared to the ETH ETF; There is a growing consensus in regards to the validity of these underlying assets; ETF products need more time to operate and develop further.

◆ In terms of liquidity, the 24H trading volume of BTC ETFs is generally larger than that of ETH ETFs. There are distinct differences in liquidity. Both of them have high quality products with liquidity LR reaching tens of millions.

◆ ETFs in the conventional financial markets have better performance in tracking and liquidity than cryptocurrency ETFs. There are explicit differences.

◆ There is a narrower gap in the tracking performance of BTC ETFs; Several cryptocurrency ETFs already have the liquidity levels of ETFs with LR that reach tens of millions in the conventional market.

◆ In terms of product maturity: gold ETF > NasdaqETF > BTC ETF > ETH ETF; It is predicted that cryptocurrency ETFs will be dominated by BTC and supplemented by other cryptocurrencies in the future.

◆ The prediction is that cryptocurrency ETFs in the futures market will enhance liquidity. They will focus on the optimization of tracking deviation, and products with better tracking performance will be favored in the market.


1 An Overview of Cryptocurrency Fund
1.1 An Overview of BTC Fund
In the cryptocurrency investment market, institutional investors have a strong preference for Grayscale Trust as the go-to cryptocurrency investment tool. This is due to the convenience in terms of investment, less hassle around regulatory compliance and fewer competitors. DCG, the parent company of Grayscale, has also become an invisible giant in the field of cryptocurrency. As cryptocurrencies have gained in popularity, varieties of funds investing in bitcoin have sprung up in recent years. According to incomplete statistics, there are currently 8 funds holding more than 10,000 BTC in the open market. Among which Grayscale bitcoin Trust (GBTC) has a monopolistic position with more than 650,000 bitcoin, while the total of BTC held by the other 7 funds only accounts for 28% of GBTC’s value.

The list includes two new ETF products launched in the first quarter of this year. In February, the Purpose bitcoin ETF (BTCC), the first BTC ETF in North America, was launched on the Toronto Stock Exchange. It quickly absorbed more than 333 million dollars in market value within two days of issuance and has exceeded 650 million dollars in market value so far. The 3iQ Coinshares bitcoin ETF, which was also launched in March on the Toronto Stock Exchange, is even more popular. BTC holdings are quite similar to that of BTCC, with its market value rocketing to $1.46 billion.

1.1 BTC ETF
1.1.1 An Overview of BTC ETFs
More and more institutions are supporting bitcoin, such as Paypal and Tesla. There is a growing consensus about bitcoin in the market. The progression of BTC is clear, from being a “niche market”, to becoming an “institutional market” and then to a “mass market”. From GBTC, which has a high investment threshold, to the alternatives such as the bitcoin Tracker Fund and Bitwise's Cryptocurrency Index, the bitcoin investment space is expanding.

The first bitcoin ETF was issued in February with BTCC on the Toronto Stock Exchange (TSX) and it has led the way in the development of ETF products. According to the TSX official website, there are currently nine bitcoin ETFs on the exchange. So far, there have been two main seasons of issuance: From mid-to-late February till early March, and in mid-to-late April.

BTCC issued by Purpose is the first BTC ETF in North America, absorbing liquidity as soon as it was listed. BTCQ and BTCQ.U, the ETF launched by 3iQ together with Coinshares in mid-to-late March, came from behind to become the BTC ETF with the highest TSX market value.

As the world's largest financial market, the United States has never stopped its innovation in the field of cryptocurrencies. Due to strict market regulations, the attempts to issue a spot bitcoin ETF in the United States have failed. With a growing consensus around the legitimacy of cryptocurrencies, as well has the new head of SEC, Gary Gensler having vast experience in blockchain technology, advocates of cryptocurrencies are looking forward to the new U.S. regulatory landscape and more favorable decisions for cryptocurrencies. In the past six months, there have been 8 ETF applications from US institutions to the SEC.

1.1.2 The BTC ETF Net Value
After the worldwide outbreak of the COVID-19 pandemic in 2020 and the consequent impact it had on global economies, bitcoin has performed incredibly well. This is partly due to the massive issuance of currency from central banks around the world. Adoption has increased at a rapid rate and there has been a long-term Bullish trend for bitcoin. From the beginning of 2021 to mid-April in 2021, there was the largest price increase, which was in the range of about 92.6 percent. Given the net value trend, the net value of each ETF is roughly in line with the price of BTC, and the overall fluctuation performance has been consistent.

1.1.3 BTC ETF and BTC Net Value Tracking Performance
From the perspective of conventional finance, the quality of an ETF is measured through tracking the underlying asset. This is reflected in the difference between the net growth rate of ETFs and the price of the underlying asset, or the change in the price index.

As can be seen from the chart below, since the listing of ETFs, the growth rate of the ETF net value has been within the variation range of BTC, and the fluctuation is smaller than that of BTC. At the initial stage when ETFs launched, Ninepoint's BITC.U and Evolve's EBIT.U had more dramatic fluctuations than the price variation range of BTC. Since mid-April, there has been a fluctuation retracement of Bitcoin price. BTCX.B and BTCX.U of CI Galaxy have a relatively average tolerance to fluctuations. The growth rate in net value is greater than the BTC Price variation rate most of the time.

There was a high degree of deviation after the ETFs listing in late April. The tracking intensity of BTC ETFs was weak. Initially, it may have been caused by the market fluctuation due to the newly listed products gaining various levels of popularity. At the later stage, the main reason is that the price of BTC itself was in decline. In the intermediate period, the price of BTC has risen steadily, and the tracking effect of ETFs is also fine, with the tracking deviation remaining in the range of [-5%, 5%].

By calculating the standard deviation of ETF tracking dispersion, the tracking error can be shown more directly. Statistics show that, although the two ETFs of CI Galaxy did not reach the expected values in the market, their tracking error is the smallest, below 6%, and their tracking performance is relatively stable. Despite the fact that 3iQ Coinshares has a good market value, its performance of price tracking has been less than satisfactory.

1.1.4 BTC ETF Liquidity
Purpose has the largest trading volume, which is less than that of conventional financial market
In addition to the tracking index, liquidity is one of the ways to measure the quality of an ETF. The most direct way to measure liquidity is to observe 24-hour trading volume. In terms of the 24-hour trading volume, Purpose takes the lead, with multiple times the trading volume of other ETFs. But in comparison with conventional financial markets, even Purpose, with the largest trading volume in 24 hours, has an average of less than $13 million. Hence it has not been a big threat to ETFs in the conventional financial market or existing cryptocurrency funds.

BTC ETF is just in the bud and unable to effectively promote BTC liquidity in the market

Generally speaking, liquidity is directly proportional to the total value of assets and inversely proportional to the price fluctuations. In view of the quantity index, the greater the turnover is, the stronger the liquidity will be. Given the price index, the smaller the spread is, the stronger the liquidity will be. It will be more persuasive to measure liquidity with the combination of quantitative and price indexes.

In “Measuring market liquidity: An introductory survey”, Alexandros Gabrielsen, Massimiliano Marzo and Paolo Zagaglia (2011) have summarized several methods to measure the liquidity of financial assets, among which the most widely used indicator is LR (Conventional liquidity Ratio). It combines trading volume and spread to measure the liquidity. The higher the indicator value is, the better the liquidity will be.

Taking February 24, 2021 as a point (although the first BTC ETF was listed on February 18, TSX only provides the data of recent 90 days, and the author only obtained the trading volume data after February 24 at the time of writing), this paper analyzes the BTC liquidity within the two months before and after the launch of BTC ETF. The statistics show that LR did not increase significantly after the launch of the first BTC ETF. Its value variation was a continuation of previous upheaval and it has a horizontal price movement at a low level in the following month. After the listing of the new ETF, there is little impact on the BTC LR index.

There are significant differences in the LR liquidity of BTC ETF, and the liquidity of Purpose gains the upper hand
Listed on TSX, Purpose (BTCC.b and BTCC.U) have the best liquidity, and both the ETFs have LR scores of 10 million, far outperforming other ETFs. CI Galaxy is relatively more liquid than the other ETFs, and the ETF products of other companies are very liquid. These two findings are also presented in the 24-hour trading volume index.

1.2 ETH ETF

1.2.1 An Overview of ETH ETF
After BTC, the "king of cryptocurrency" was listed in the form of ETF, many institutions started listing ETH ETF in the Toronto Exchange. On April 20th, TSX launched seven ETFs of three companies including Purpose, CI Galaxy and Evolve. Three days later, 3iQ Coinshares launched two ETFs which turned out to be the ones with the highest market value.

In terms of ETH ETF net value and ETH price trend, there is generally an uptrend followed by a down trend. However, at the points of fluctuations, the variation direction of ETF and ETH is inconsistent, which should be seen on a case-by-case basis from the data of variation rate.

1.2.3 ETH ETF and ETH Net Value Tracking Performance
According to the growth rate of ETH ETF and ETH net value, the inconsistency between ETH ETF and ETH fluctuations at many points can be further proved. As shown from the graphics, the net value fluctuation of ETH ETF is prior to that of ETH fluctuations. This regularity may be abnormal to some extent, which may be caused by high network traction in the ETH ecosystem. Investors focus on layer2, DeFi, NFT and other developments on the Ethereum chain so as to predict and bid on Ethereum price. Since ETH ETF has been listed for just about a month, the product development has just taken shape and is taking time to reflect the true value of the developments on the Ethereum network.

Tracking deviation index shows that from the day of listing to mid-May, the tracking deviation of ETH ETF fluctuates in the range of [-10%, 10%], which is larger than that of BTC ETF. In addition, the tracking deviation degree of these 9 ETFs is basically the same, and their respective features cannot be reflected by the net value tracking degree.

Like BTC ETF, 3iQ ETF still has the worst tracking stability, with tracking deviation errors of more than 13.7%. Purpose has the smallest tracking error, and ETF tracking stability of other companies is basically similar.

BTC ETF tracking deviation error is less than 8.4%, while the minimum tracking deviation error of ETH ETF reaches 12.78%, indicating that BTC ETF is more mature than ETH ETF in general, and there is more stability in tracking the underlying assets.

1.2.4 ETH ETF Liquidity
CI Galaxy has a monopolistic position in the ETH ETF trading volume

According to the trading volume in 24 hours, ETH ETF is not as active as BTC ETF. The two ETFs of CI Galaxy have monopolized the trading volume to some degree. The average trading volume in 24 hours is nearly twice that of Purpose (which ranks second), but the trading volume is still small with only more than $6 million. Within one month after the listing, the trading volume fluctuated greatly within 24 hours, and the overall trading volume at the end of the period did not increase much compared with that at the beginning.

It is unknown if the listing of ETH ETF has an impact on ETH

After the listing of the first ETH ETF, the LR value of ETH did not present an obvious trend of expansion, and we could also witness a decline in the ETH price after the middle of May. There was a sign of decrease in the LR value oscillation frequency in the following one month compared with that before the listing while the oscillation interval narrowed. However, there was no evidence that this was directly related to the listing of ETH.

ETH ETF liquidity differentiation is less than that of BTC ETF, and CI Galaxy has the strongest liquidity

Like the regularity of the trading volume in 24 hours, in terms of LR index, CI Galaxy (ETHX.B and ETHX.U) has the strongest liquidity, with ETHX.B's LR reaching more than 16 million. The liquidity of Purpose (ETH series) is behind that of ETHX.U, and Evolve (ETHR) has also performed well, of which the overall differentiation is not so obvious as BTC ETF.

2 ETF in the Conventional Market
In order to measure the performance of the cryptocurrency ETFs that have been listed, we compared the development of ETFs in the conventional financial market, taking the Nasdaq100 ETF with similar technological elements and the Gold ETF with single commodity attributes as the reference subjects. The maturity of cryptocurrency ETF can be measured statistically from their tracking performance and liquidity.


2.1.1 The Tracking Performance of Nasdaq100 ETF
According to the ETF ranking list of JustETF, the Nasdaq ETFs with the largest amount of funds in the market include iShares Nasdaq 100 UCITS ETF(ACC) (Nasdaq code: CNDX) and Invesco Nasdaq 100 ETF (SIX symbol: QQQM).

Through the net growth rate of Nasdaq100 ETFs and Nasdaq100 Index, it can be found that there are basically similar variations in QQQM and Nasdaq indicators; while CNDX has a large deviation; there is a lag of 1-3 days in the net value growth variation of CNDX compared with Nasdaq100.

The tracking deviation index shows that CNDX tracking deviation is in the range [-4%,4%], while QQQM is basically in line with Nasdaq100 index, and their tracking deviation errors are just 1.98% and 0.14% respectively, indicating that both products can track the price of the underlying assets in a relatively stable way.

2.1.2 Nasdaq100 ETF Liquidity
The LR liquidity of QQQM is more than ten million, and the LR value of more than ten million may be the criterion for evaluation

By calculating the LR indicators of the two Nasdaq100 ETF from January 4 to May 21, it can be found that the liquidity of the two products are quite different. Considering the lag of several days in the net value variation of CNDX, the Research believes that the liquidity of CNDX may be affected by other factors, so it makes more sense to use QQQM as a liquidity reference. The LR value of QQQM has exceeded 10 million, therefore, the LR liquidity value of 10 million can be initially used as a reference standard to evaluate high-quality ETFs.
According to Investopedia's article "Best Gold ETFs for Q3 2021" on May 13, there are currently eight ETFs specially trading gold in the U.S. (not including leveraged or inverse ETF funds and the funds with assets of less than $50 million under management). There are three of them which are the most representative ETFs, including Goldman Sachs Physical Gold ETF(AAAU), Ishares Gold Trust(IAU)—BlackRock Financial Managent and GraniteSharesGold Trust (BAR).

The trend of net value variation rate shows that the price fluctuation of the three gold ETFs and gold futures is synchronous, and the curves of the three ETFs and gold futures overlap most of the time.

Statistics show that gold ETF follows the price trend of gold futures, and the tracking deviation degree of the three gold ETFs all stays between [-1%, 1%], with a very small fluctuation range, and the tracking deviation degree error of the three is about 0.33%.

The liquidity LR value of gold ETF is more than 50 million dollars
Through the LR calculation of the two Gold ETFs from January 4 to May 21, it can be found that the LR liquidity value of the Gold ETFs exceeds 50 million dollars. With the analysis above, the LR value of $ 10 million can be used as a standard to measure ETF quality.

3 ETF of the Conventional Market VS Cryptocurrency ETF
The development of BTC ETF and ETH ETFs in the cryptocurrency market has been discussed above from the perspectives of ETF net value, tracking deviation index, tracking deviation error, trading volume, and liquidity index LR. The quality of the underlying assets tracked by these ETFs and their own liquidity can be evaluated from these indicators. In addition, it shows the tracking performance and the liquidity of Nasdaq100 ETF and gold ETF in the conventional financial market. By contrasting the data of conventional ETFs and cryptocurrency ETFs, the features are summarized as follows:

◆ ETFs of the conventional financial market perform better than cryptocurrency ETFs in terms of tracking underlying assets and the tracking error, with significant differences between them. The tracking deviation of conventional ETFs is within [-4%,4%], while that of cryptocurrency ETFs is in [-10%,10%]. The tracking deviation error is less than 2% and more than 5.9%, respectively.

◆ In terms of liquidity, the LR value of ETFs in the conventional financial market may be evaluated at the level of more than ten million dollars, while three of the cryptocurrency ETFs reach this level.

◆ In terms of product maturity, gold ETF > NasdaqETF > BTC ETF > ETH ETF.



4 Summary
This paper researches into the current development of cryptocurrency ETFs, mainly focusing on the nine BTC ETFs and nine ETH ETFs listed in the Toronto Exchange, and evaluating the operating performance of existing ETFs from the aspects of tracking performance and liquidity. Meanwhile, the maturity or inadequacy of cryptocurrency ETFs is evaluated from a horizontal comparison with the data of Nasdaq100 ETFs and gold ETFs in the conventional financial market. In terms of product maturity, gold ETF > NasdaqETF > BTC ETF > ETH ETF.

The tracking performance of BTC ETF is stronger than that of ETH ETF, and there is greater consensus on the underlying asset; the product operation time of ETF is longer, and the product form is relatively mature. The 24-hour trading volumes of BTC ETFs are generally larger than ETH ETF, and the liquidity differentiation is more serious. Both of them have high-quality products with liquidity LR value of tens of millions. Conventional financial market ETFs do better than cryptocurrency ETFs in tracking performance and liquidity, and there is a significant gap between the two. The tracking performance of BTC ETF is narrowing the gap, and the BTC ETF with an LR of tens of millions is closely catching up with ETH ETFs in terms of liquidity.

In general, the cryptocurrency ETFs that have been listed are still at their preliminary stage, and there is a big gap in tracking underlying asset and liquidity compared with conventional ETFs. However, as cryptocurrency is accepted by more institutional and individual investors, cryptocurrency related investment products are believed to have a good prospect of development. The Research predicts that in the future, the development of cryptocurrency ETFs will still be supplemented by BTC and other cryptocurrencies. ETF products will focus on the optimization of tracking deviation degree while maintaining liquidity, and make efforts in tracking models, tracking strategies, technical methods and other aspects.

5 Limitations
This report collects data from multiple channels and researches into the development of ETFs by means of data analysis. Possible deficiencies in this process are illustrated as follows:

1. Data incompleteness and inconsistency. Some data websites or official websites that release data only provide a limited amount of data or the data within a specific period of time, therefore, there is some deviation from the ideal data required in the research process, which may affect the results.

2. The insufficiency and obsolescence of indicators. The LR index used to measure liquidity is classical, but the feasibility of the research on cryptocurrency needs to be improved.



Statement
To issue this research report, we hereby make the following statements:
■ This report is a conclusion drawn by internal members with all due effort of survey and objective analysis, aiming at conducting research and analysis on the blockchain industry, which cannot completely predict the impact on price of tokens in relevant projects.
■ This report is not a tool to measure the value of the research object or the value of tokens issued by relevant projects, and the sole basis for investors to make their final investment decision.
■ All the materials of the projects in this report are sourced from reliable and accurate internal channels. Due to artificial or mechanical errors, information prevails when it is acquired in the first place. Internal members have verified the authenticity and accuracy of all the materials, but won’t make any explicit or implicit statement or guarantee.