Recently, the Hong Kong Securities and Futures Commission announced the approval list of several virtual asset spot ETFs, including the Bitcoin and Ethereum spot ETFs under China Asset Management (Hong Kong), Harvest Global, and Bosera International. These ETFs opened for subscription from April 25 to 26 and were listed on the Hong Kong Stock Exchange on April 30.
Although these ETFs have achieved good scale in the subscription phase, the first-day trading volume is far lower than that of their US counterparts. This has led to speculation about the potential impact and market performance of Hong Kong crypto spot ETFs. Here, we will analyze this in depth through the relationship between supply and demand.
Demand side: Mainland Chinese RMB investors are not allowed to buy, and the incremental funds may be limited, resulting in low transaction volume
The Hong Kong cryptocurrency ETF still has strict restrictions on investor qualifications, and mainland investors cannot participate in the transaction. Taking Futu Securities as an example, the account opening party must be a non-mainland & US resident before trading can be carried out. The mainland funds expected by the market to trade through the southbound Hong Kong Stock Connect are currently not allowed, and it is expected to be difficult to open up for a considerable period of time.
In terms of fees, Hong Kong crypto ETFs are not superior. Compared with US ETFs, they are not very attractive to institutions that want to hold for the long term. According to SoSo Value data, of the 11 US Bitcoin spot ETFs, except for Grayscale and Hashdex, the largest ones such as IBIT and CBOE have management fee rates of around 0.25%, while the comprehensive fee rates of Hong Kong's three Bitcoin ETFs are relatively high, with Huaxia 1.99%, Harvest 1.00%, and the lowest Bosera 0.85%. Even with a short-term reduction in management fees, there is still no fee advantage. Under the difference in fees, for institutional investors who are optimistic about the crypto market and want to hold for the long term, the US Bitcoin ETF has a lower holding cost.
In the future, demand-side funds may mainly come from two sources:
1) Hong Kong retail investors. For retail investors with Hong Kong ID cards, the threshold for purchasing Hong Kong crypto ETFs is lower. For example, to purchase the US Bitcoin spot ETF, you need to have a professional investor qualification (PI), and to apply for PI qualification, you need to provide proof of an investment portfolio of 8 million Hong Kong dollars or a total asset of 40 million Hong Kong dollars. This time, the Hong Kong Bitcoin spot ETF allows retail investors to trade, and the trading hours are more in line with the Asian schedule, which is an important increase.
2) Traditional investors who are interested in Ethereum. The Hong Kong Ethereum spot ETF is the first to be launched globally, so investors who have substantial difficulties in holding coins and are optimistic about the prospects of Ethereum may bring incremental growth to the Ethereum ETF.
US Bitcoin spot ETF fee situation (data source: SoSo Value)
Supply side: In-kind subscription and redemption methods increase the supply of ETF shares and increase the initial scale. The biggest difference between Hong Kong crypto spot ETF and US Bitcoin spot ETF is that in addition to cash subscription and redemption (in-cash), an additional in-kind subscription and redemption method has been added. This also directly determines that at the ETF share level, Hong Kong crypto ETF may have more supply parties.
Physical subscription and redemption means that investors can use cryptocurrency (Bitcoin or Ethereum) to exchange instead of cash when subscribing (creating) or redeeming ETF shares. When subscribing, investors provide a certain amount of cryptocurrency to the ETF in exchange for ETF shares; when redeeming, investors return ETF shares in exchange for the corresponding cryptocurrency.
Referring to the comparison of the Hong Kong cryptocurrency subscription process in Figure 2, we can see that there are two major differences between physical subscription and cash subscription:
1) Coin holders can subscribe directly with coins: Some large coin holders, such as miners, can easily convert their coins into ETF shares. In addition to holding ETF shares, they can also support cash redemption and direct sale for cash on the Hong Kong Stock Exchange, which provides a very flexible processing method.
2) For the crypto market, physical subscription does not bring incremental funds into the market, but is just the transfer of cryptocurrencies between different accounts. Cash subscription, on the other hand, brings actual buying to the on-chain crypto assets.
Therefore, the subscribers of Hong Kong crypto ETF shares include both traditional cash subscribers and large currency holders. Although the specific shares of physical subscription and cash subscription have not yet been disclosed by each company, according to OSL's public communication, the first batch of ETF shares subscribed in kind may account for more than 50%, which also explains why the initial fundraising scale of Hong Kong crypto ETF can reach nearly 300 million US dollars, and physical subscription has played an indispensable role. But on another level, these ETF shares subscribed in kind may be converted into selling orders in subsequent secondary market transactions.
Hong Kong Crypto Spot ETF Supply and Demand Influence Mechanism (Data Source: SoSo Value)
The significance of Hong Kong ETFs:
The approval of the Hong Kong Crypto ETF is an important development in the global crypto market. It will not only have a long-term impact on the financial landscape of the Chinese community, but is also an important step in the legalization of cryptocurrencies in the global financial system. At the same time, through the physical subscription and redemption method, the Hong Kong ETF further opens up the channel between crypto assets and traditional finance, providing more possibilities for the realization of crypto assets.
