As Hong Kong Approaches In-Kind Bitcoin ETF, Local Establishment Skeptical

Hong Kong’s incoming in-kind spot Bitcoin ETF supports an entirely different relationship between supply and demand compared to US competitors.

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Mar 29, 2024

Hong Kong is on the verge of approving an in-kind Bitcoin ETF, with a different creation method from the ETF offerings available in the US, even as sectors of the financial establishment espouse non-Bitcoin innovations.

Since the first Bitcoin spot ETFs were approved by the SEC in January 2024, the face of the entire digital asset ecosystem has changed irrevocably. Months of hype served to build up Bitcoin’s value at a steady pace, but the real bonanza only began after the ETF issuers had an opportunity to work out a few kinks. By late February and early March, these financial instruments were breaking records on several metrics of asset performance; these new products had grown even faster than anticipated to become a billion-dollar industry. Naturally, Bitcoin has come along for the ride, enjoying its highest prices ever.

Even though these products have brought such wide profits into the world of Bitcoin and reinvigorated demand at all levels, in some ways this can represent a double-edged sword. At present, all of the ETFs offered by major American financial institutions share one trait, that is actually quite uncommon compared to ETFs centered around other products. Rather than having an in-kind creation mechanism, they are governed by cash transfers. In other words, investors wouldn’t give a sum of Bitcoin to an issuer and come away with an equivalent ETF, they would simply pay with fiat currency. This would doubtlessly make it easier for some investors, especially major institutions, to buy into the Bitcoin ETF, but it doesn’t change a major issue: the Bitcoin has to come from somewhere.

To keep issuing these ETFs, the proprietors have been gobbling up Bitcoin at astronomical rates, outpacing the daily supply produced by all the miners in the world by more than 600%. And this figure is especially concerning, in light of the fact that the halving is set to decimate mining rewards in less than a month. The rapid consumption of all available Bitcoin by these multibillion-dollar firms has sparked fears of a sell-side liquidity crisis, where Bitcoiners wishing to buy in for any reason may find that the exchanges are completely out. Already, leading exchanges have seen their total Bitcoin reserves drop by $10B in 2024 alone. Bitcoin may make a lot of money, but it won’t be possible to use it as a currency if nobody can acquire any.

This takes us to the pending new spot ETF that’s coming in Hong Kong, which has drawn global attention for a variety of reasons, in particular due to its revolutionary structure. The Securities and Futures Commission (SFC) has proposed a version of the ETF that requires a Bitcoin-in ETF-out model. In other words, the issuer will still end up with a supply of Bitcoin that matches up with the number of ETFs they can issue. The similarities will end here, however, as the actual pressures on market demand will be more decentralized: rather than a situation where these billion-dollar firms buy up as much as they can at the lowest possible prices, potential investors will have to actually hold the bitcoin in question first.

This situation could lead to a number of different opportunities to alleviate some of the pressures on the overall supply. Maybe some mining firms will cut out the middleman, and trade their earnings for a wildly profitable investment instead of making bulk sales for cash. Or, whales and other private Bitcoin holders may wish to diversify their portfolios by converting a certain portion into the new instrument. If nothing else, all the billionaire investors, corporate and individual, will need to directly buy Bitcoin themselves if they wish to get in on the opportunity. This multifarious stream of inflows seems to more closely reflect the decentralized nature of the Bitcoin community, even as the actual products bear a large number of similarities. The main question, then, is will anyone bother with the hassle of this new method?

There are several encouraging factors here that make the SFC’s proposal so intriguing to the world market. Since regulators in the region signaled their intention to approve such an ETF in late 2023, anticipation has been building in the market. First of all, a world-class business hub like Hong Kong will have ample investors to keep capital flowing into the project, as the city currently leads the world in the number of high-net-worth individuals. More than 12k residents are in the ultra-wealthy category, with more than $30M in total assets each. Additionally, a particularly important advantage is that ETFs as an asset class have consistently proved to be especially popular in the market, with steady rates of growth.

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Additionally, there are several would-be issuers who seem very eager to establish a branch of this multibillion-dollar industry in Hong Kong. The first application came from Harvest Global Investments mere weeks after the SFC announced that an approval was likely, and new applications from other asset managers are still rolling in in late March. Local media reported that ten different asset managers and other financial institutions have expressed their interest, although these applications have not been formally submitted yet. The attitude of overt regulatory friendliness, led by the long-term goal of making Hong Kong a hub for the digital asset industry, has left the space with an ample range of potential new issuers. There’s ample capital and potential issuers to accept it, and the space has a particular fondness for ETFs. Sounds like a match made in heaven, right?

However, although the legal system and financial establishment has proven itself willing to accommodate the technologies of the broad-spectrum crypto business, Bitcoin itself has seen less attention from certain sectors so far. For example, leading bank HSBC launched a new tokenized product powered by blockchain technology on March 27th, but the actual product is based on gold instead of the digital gold Bitcoin. Similarly, an official from the InvestHK government agency claimed the following day that “old money” would likely prefer to invest in stablecoins based on the Hong Kong dollar. InvestHK has the mandate of encouraging foreign investment into the region, and its Head of Fintech and Financial Services stated in an interview that “When you have the backing of the most reputable regulator — the HKMA — giving you the license, that can actually give a lot of confidence to industry players…I'm not talking about just retail but also institutional investors, because that's where the big money is”.

So, powerful banks are building their blockchains, and foreign investment agencies are trying to push a new stablecoin. The regulatory situation is friendly to Bitcoin, and there are certainly firms willing to back it, but there is also a demonstrable interest in shying away from Bitcoin while nevertheless adopting the technology. There does not yet seem to be a sure guarantee that Bitcoin ETFs will prove popular, other than the fact that Bitcoin and existing ETFs have been performing so stupendously well worldwide. At the very least, we can certainly trust that there will be interest for profit margins on that sort of scale.

More to the point, a big success here could be a proof-of-concept for the entire world. Will an in-kind model have distinct advantages over the cash system that the US has pushed so hard? How will a different relationship between ETF issuers and the Bitcoin supply keep Bitcoin open to everyone? We should all be looking towards the performance of Hong Kong’s in-kind ETF as it comes closer and closer, for it may provide very useful information for Bitcoiners everywhere. If Hong Kong’s in-kind model ends up lessening the demand requirements on the Bitcoin ecosystem while still raking in billions, it might provide an alternative model to markets worldwide. Bitcoin’s decentralized nature has allowed for a great number of small-scale experiments over the years to maximize viability, and this looks like another step on the same path. Most experiments like that, however, haven’t involved the billions that are already circulating through Hong Kong’s financial markets. Bitcoin is entering a new stage of success with these ETFs, but the same core spirit remains, and we can count on it to ensure a prosperous future.

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