By Bradley Duke, Founder and co-CEO, ETC Group.

Bitcoin returned 39.63% in January, its second-best start to a year since 2013.

On a total return basis, as well as a risk-adjusted basis, Bitcoin crushed every other asset into the dust in January 2023.

Bitcoin’s January return of 39.63% was its second-best start to a year since 2013, years before the asset became widely known and at least half a decade before it was widely traded by institutions.

Bitcoin’s stellar performance in January was mirrored by a surge of interest in Bitcoin ETPs over the same period –  according to Bytetree data, global Bitcoin investment products saw a total of 11,301 BTC of net inflows, worth $260m, between 3 January and 3 February.

It is clear that institutional confidence in crypto returned in force in January, followed by a healthy dose of FOMO, or Fear of Missing Out, by retail participants shocked into action by soaring prices.

And ETC Group’s 100% physically backed ETC Group Physical Bitcoin (BTCE) was the biggest winner of the recent pick-up in institutional interest in crypto assets.

A total of 2,044.1 BTC flooded into BTCE in the 30 days to 3 February 2023, the largest amount entering a Bitcoin exchange-traded product in Europe over the period.

That shift spiked the ETP’s total assets under management by $154.8m to $432.1m, making BTCE the largest physically-backed Bitcoin investment product in Europe by AUM.

Synthetic vs Physical

Physical ETPs like BTCE replicate the price performance of Bitcoin by physically holding BTC with a third-party custodian in cold storage. Synthetic ETPs instead rely on derivatives called swap agreements with counterparties — for example, crypto asset lending platforms — to do the same thing.

In the seven days to 3 February, physically-backed Bitcoin ETPs were the biggest winners in terms of inflows, while synthetic ETPs lagged the market.

The two least popular Bitcoin funds in Europe over this period, with net outflows of 38 BTC (€805k) and 26 BTC (€551k) respectively, are both synthetic Bitcoin ETPs: Bitcoin Tracker One and Bitcoin Tracker Euro.

The basis trade is back on

The closest thing to a risk-free trade in Bitcoin — trading the basis with futures — also spurred flows over recent weeks, according to data surveyed by ETC Group.

This popular arbitrage strategy sees traders buy spot Bitcoin (or a highly liquid associated product like BTCE), while simultaneously selling long-dated Bitcoin futures, collecting a ‘risk-free’ premium.

Because of its liquidity profile, BTCE has become the instrument of choice for hedge funds and other institutions making this type of trade.

The latest available data from Deutsche Borse Xetra, one of the seven European stock exchanges on which BTCE trades, shows that the physically-backed Bitcoin ETP was the third-most-traded ETP across December 2022 with an order book turnover more than three times larger than the next crypto product.

Only WisdomTree’s daily leveraged and short Nasdaq funds traded more volume on Xetra across the month.

Crypto ETPs are still opening despite bear market

The number of crypto ETPs rocketed by 50% in 2022, showing a market of growing depth and interest even as the price of Bitcoin dropped by 66% and the total market cap of all crypto assets dived from a high of $3 trillion to under $1 trillion.

A total of 162 crypto ETPs were available as of 31 December 2022, compared to 109 on 1 January 2022. From a market structure perspective, this is one of the most bullish long-term trends to note.

But not every Bitcoin ETP is equal. Far from it. Investors are opening themselves up to potential hidden risks if they buy uncollateralized or synthetic products or those that allow their products to lend out Bitcoin or other crypto assets as part of the package.

Despite the growth of the Bitcoin ETP market, the structure of some of these products exposes investors to concealed risks. These include increased counterparty risk in those products that allow lending or ‘sweating’ of assets, as well as market risk from those products that are synthetic, rather than physically backed.

BTCE’s structure does not allow the fund to lend out its underlying assets, and investors have a legal claim to the Bitcoin backing it, should the issuer go out of business.

BTCE’s structure also differs from Grayscale’s Bitcoin Trust (GBTC) which is a closed-ended fund. Because of this structure, $14.5bn in Bitcoin is unable to leave GBTC, and the SEC has repeatedly denied Grayscale’s attempts to convert the fund into an ETF. As of 6 February 2023, the Net Asset Value (NAV) of GBTC shares is now worth 43.06% less than the Bitcoin in the fund.

By contrast, BTCE and other open-ended funds allow for the creation and redemption of shares which allows Bitcoin to both leave and enter and keeps the NAV tightly tracking the actual price of Bitcoin.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)