Undervalued Hong Kong Crypto ETFs: The Appearance and Undercurrent Behind the Data

Author: Jupiter Zheng, Partner, HashKey Capital Secondary Fund

On May 24, the U.S. Securities and Exchange Commission (SEC) officially approved 8 19b-4 forms for Ethereum spot ETFs,

which means that the regulator's position has softened from a hardline stance. The U.S. Ethereum spot ETF seems to be just one step away from its final launch. Market sentiment has also been ignited recently, and the secondary market is even more heated.

At the same time, in sharp contrast, Hong Kong, which launched six Hong Kong crypto asset ETFs covering Bitcoin and Ethereum as early as April 30, has been quite lonely in the past month, and was even criticized for its "disappointing" market data performance.

The market always likes to overestimate the short-term effects of new things and underestimate their long-term influence. This article aims to clarify how Hong Kong's crypto ETFs have performed in the past month? What are the incentives behind it, and what variables the market has ignored, and what path it may take next?

"Downturn" and variables in the data

On April 30, six virtual asset spot ETFs, including Bosera HashKey Bitcoin ETF (3008.HK), Bosera HashKey Ethereum ETF (3009.HK), Huaxia Bitcoin ETF (3042.HK), Huaxia Ethereum ETF (3046.HK), Harvest Bitcoin Spot ETF (3439.HK) and Harvest Ethereum Spot ETF (3179.HK), were officially listed on the Hong Kong Stock Exchange and opened for trading.

If we look at the opening data, the issuance scale of the three Bitcoin spot ETFs on the first day of April 30 reached US$248 million (Ethereum spot ETF was US$45 million), which is actually far more than the initial issuance scale of the US Bitcoin spot ETF on January 10, which was about US$125 million (excluding Grayscale), which also shows that the market has high expectations for the subsequent performance of Hong Kong crypto ETFs.

The market's criticism of these six Hong Kong crypto ETFs is mainly focused on their "low" trading volume relative to US crypto ETFs: on the first day of listing, the total trading volume of the six Hong Kong crypto ETFs was HK$87.58 million (about US$11.2 million), of which the trading volume of the three Bitcoin ETFs was HK$67.5 million, which is less than 1% of the total trading volume of the US Bitcoin spot ETF on the first day (US$4.6 billion).

The trading volume then continued to decline, even falling below $1 million on May 23.

However, it is worth noting that the trading volume of Hong Kong crypto ETFs has shown a clear inverted trend with the asset management scale: as of May 23, 2024, the total asset management scale of the six Hong Kong virtual asset spot ETFs exceeded $300 million, of which the Bitcoin spot ETF held a total of 3,660 BTC and a total net asset of $254 million; the Ethereum spot ETF held a total of 13,380 ETH and a total net asset of $50.83 million, both of which increased slightly compared to the first day.

Although in terms of absolute size, the scale of US$250 million is still far less than the US Bitcoin spot ETF of about US$57.3 billion, this actually ignores the objective "difference in pool size" between the Hong Kong ETF market and the US ETF market - the total volume of the Hong Kong ETF market is only US$50 billion, while the size of the US ETF market is as high as US$8.5 trillion, a difference of about 170 times.

Therefore, in terms of relative proportion, the $250 million Bitcoin spot ETF accounts for 0.5% of the Hong Kong ETF market, while $57.3 billion accounts for 0.67% of the US ETF market. In fact, there is not an order of magnitude difference between the two. At the same time, this is the performance of less than a month after its launch, which also indirectly shows that the Hong Kong crypto ETF has an equally huge impact on the local financial market in Hong Kong.

If you look closely at the changes in the internal data of Hong Kong crypto ETFs in the past month, China Asset Management, Harvest Asset Management, and Bosera HashKey also show a trend of some rising and some falling:

The BTC and ETH holdings of China Asset Management and Harvest Asset Management have both declined significantly, while Bosera HashKey has a good momentum, with a total asset management scale of over US$100 million, exceeding 33% of the total, an increase of US$30 million from the first day - Bosera HashKey currently ranks first in ETH holdings, and BTC is second only to China Asset Management, and the gap has rapidly narrowed from the initial thousands to less than 500.

"Sweet Troubles" Behind the Unexpected Approval

The data will not lie. Behind the inverted trend of Hong Kong's crypto ETF trading volume and scale, there is actually a "structural" undercurrent - the stakeholders are polishing the process and unblocking the blockages.

If you look back at the pace of this round of Hong Kong regulators approving and launching 6 crypto ETFs in one go, you will find that the most important market feedback is "reasonable, unexpected":

• It is reasonable that since 2022, the Hong Kong government has taken great strides to embrace virtual assets and Web3 After that, a series of relevant policies and regulatory frameworks were steadily advancing, including the long-awaited crypto asset ETF, so all stakeholders had already begun intensive preparations; the unexpected thing was that the judgment of all parties on the approval of ETFs was mostly concentrated in the third quarter or the second half of the year, so they had been gradually polishing the operation process, technical docking and other issues, but the Hong Kong government unexpectedly accelerated in April, and the approval progress greatly exceeded market expectations, forcing all parties to focus on material submission and other work first, and the original deployment plan was not suitable. In short, this led to the stakeholders putting the application work in advance, and the problems in the dimensions of operation, channels, products, etc. that were originally prepared to be polished have not been completely solved, so they can only be put on after the ETF is launched for "make-up lessons", which has caused some obvious "sweet troubles".

  Here we have to mention the physical subscription and redemption model (i.e., holding currency subscription and redemption) pioneered by Hong Kong cryptocurrency ETF, which allows investors to directly use Bitcoin and Ethereum to subscribe for ETF shares - investors can directly hold BTC and ETH to subscribe for ETF shares, and support cash redemption. At the same time, cash subscription for ETF shares also supports BTC and ETH redemption. Take 3008.HK and 3009.HK issued by Boshi HashKey as an example, each share of 3008 corresponds to 1/10000 of BTC, and each share of 3009 corresponds to 1/1000 of ETH.

  Participating Securities Dealers: China Merchants Securities International, Mirae Asset Securities, Shengli Securities, Aide Securities

  Market Makers: Eclipse Options (HK) Limited, Jane Street Asia Trading Limited, Optiver Trading Hong Kong Limited, Vivienne Court Trading Pty. Ltd.

  The advantage of this innovative mechanism is that it helps investors achieve two-way circulation of virtual assets and traditional assets, but at the same time it involves multiple stakeholders:

  • Participating Dealers (PDs) are institutions selected by ETF issuers (Bosera HashKey, Huaxia, and Harvest) to assume the responsibility of adding new ETF units in the primary market. Currently, there are Shengli Securities, China Merchants Securities International, Shengli Securities, and Huaying Securities;

  • Brokerages are the main channel for investors to conduct ETF secondary market transactions. Investors can buy and sell ETFs through brokerage accounts like stock transactions Shares;

  • The custodian is responsible for safekeeping the encrypted assets corresponding to the ETF and ensuring the safety of the assets;

  • The market maker provides ETF market making services and is responsible for buying and selling ETF shares in the secondary market to ensure market liquidity;

  Therefore, it is necessary for different institutions such as participating dealers (PD), securities firms, custodians/exchanges, and market makers to cooperate in unblocking the bottlenecks in the entire trading chain.

  

  That is, the docking efficiency of each link has become a major problem that all parties need to work out after the ETF goes online. Take the coin subscription of Bosera HashKey Crypto ETF in the above picture as an example:

  1. Investors need to open an account with PD first;

  2. then submit ETF share creation instructions within the specified time;

  3. then send coins to PD, and the coins will be custodied to HashKey The Hong Kong Central Computing Institute creates ETF shares and sends them to PD, which is then given to brokers through PD;

  4. and ordinary investors need to trade in brokers later;

  This involves the KYC information connection of investors in the process of opening accounts with PD/brokers, the subscription and creation of shares in the primary market, the connection between PD and custodians, the connection between PD and brokers, etc. This is also the main bottleneck at present, so many funds, especially those in the primary market, are still on the sidelines, which can easily lead to a negative feedback vicious cycle, that is, low trading volume → slow entry of arbitrage institutions → continued low trading volume.

  However, everything is slowly being resolved, and the trend of changes in asset management scale in the past month is an obvious example.

  Crypto ETF may still need 2 months to ferment

  Therefore, from this perspective, the actual performance of Hong Kong's crypto ETF still needs time to ferment. If estimated based on the current actual situation, it is expected that it will take at least 1-2 months to polish and sort out the relevant operating processes, channels, technical docking and other details.

  Then let's look forward to what changes may be expected in the Hong Kong crypto ETF market in 2 months?

  First of all, with the optimization of operating processes and technical docking, more and more PDs, securities firms and other roles will enter the market, and their original customer base will naturally become the seed pool of incremental users, achieving a leap in the volume of users covered and funds accessible, which will undoubtedly greatly expand the future imagination of Hong Kong's crypto ETF.

  At the same time, two months later, traditional financial institutions that are now on the sidelines and need more time to evaluate can also launch more derivative products such as leverage, lending, and asset management based on ETF products, realizing financial innovations that were previously difficult to implement directly using Bitcoin physical assets, and meeting the needs of various investors to deploy crypto assets.

  The two can also promote each other and form a positive feedback path - the access of more PDs, brokers and more users will further promote more financial innovations in crypto ETFs, and various structured products and derivatives based on spot ETFs will also bring more possibilities to the Hong Kong market and achieve a virtuous circle.

  At the same time, there is another new and biggest variable that deserves special attention - for institutions, the Hong Kong Ethereum spot ETF has become a time window for "preempting" US ETFs.

  The reason is that although the US SEC has approved 8 19b-4 forms for Ethereum spot ETFs, it is still in the waiting stage of "the shoe finally lands", and the market generally expects that it will take at least 1-2 months before it is officially launched.

  During this window period, those who are interested in Ethereum spot ETFs, especially those who want to ambush the next incremental funds and ETH's large-scale rise in advance, can use the Hong Kong ETF, a safe and compliant cheap channel, to "get ahead" compared to other players and take the lead in laying out this almost clear Alpha opportunity.

  Conclusion

  In "Waiting for Godot", Godot symbolizes hope and a better future. For today's Hong Kong crypto ETFs, the current Godot is the running-in optimization between different institutions in the entire transaction process.

  Behind the inverted trend of trading volume and scale, the various stakeholders are refining the process and clearing the bottlenecks. Two months later may be the key node for Hong Kong ETF to start growing and usher in a real opening.