Crypto is coming to the Spyder-verse
It's hard to imagine what the Black Monday stock market crash must have felt like for investors. On October 19, 1987, US equities experienced their biggest-ever selloff with the Dow Jones Industrial Average falling 22.6% — in one day!
Disconcertingly, no one knew why.
Journalists cited a tax change proposed the week before and the worsening international macro outlook. But that was just clutching at straws.
In reality, Black Monday was a trading event. People sold because people were selling.
The selling got disorderly because of "portfolio insurance" that caused waves of program sellin. An onslaught of orders to sell hundreds of stocks, all at once, overwhelmed the stock market's ability to process them.
The SEC's 800-page post-mortem on the crash included a request that someone come up with a way to make program selling less disorderly and equity markets more resilient.
Someone did — in response to Black Monday, Nathan Most invented the ETF.
The origin story
The idea behind the ETF goes back at least as far as the 17th century goldsmiths we discussed yesterday. Instead of lugging gold bars around as an unwieldy means of exchange, you could leave the gold in a warehouse and pay for things with receipts for that gold.
Nathan Most was familiar with the concept of receipts from his time trading vegetable oil futures on the Pacific Stock Exchange: "You don't want to be moving the merchandise back and forth all the time, so you keep it in place and you simply transfer the warehouse receipt."
In commodity markets, "warehouse receipts" serve as proof of ownership of a commodity stored in an approved warehouse. When the seller of a futures contract makes delivery to a buyer, it's the warehouse receipt that changes hands — the underlying commodity remains unmoved in the warehouse.
Nathan Most's idea was simply that stocks, too, could be kept in a warehouse while claims on a basket of those stocks traded freely.
ETFs are essentially warehouse receipts you can trade.
It was a simple, but revolutionary idea that not only made markets less likely to crash inexplicably — it democratized trading, as well.
Retail investors no longer had to wait until after the market-close to trade a mutual fund at its once-a-day pricing.
For the first time, they could trade an index of stocks intraday, just like the professionals.
ETFs went on to turn things that previously traded hardly at all — like gold — into a mainstream investment asset, accessible to all.
It might do the same for crypto.
With great power comes great responsibility
The ETF revolution was far from an overnight success.
Despite the original idea coming from regulators in response to the '87 crash, it nevertheless took five years of lobbying to get those same regulators to approve the first ETF, State Street's SPY — aka, "Spyders."
The Spyders ETF traded a respectable one million shares on its first day of trading in January 1993 — but only because its sponsor offered a market maker a free hat if he printed a large trade.
A few months later, with daily volume falling below 20,000 shares a day, ETFs looked like a failed experiment.
But SPY slowly caught on, seemingly by word of mouth, and eventually sparked a mass migration from mutual funds into ETFs.
Assets under management for SPY alone went from $1 billion in 1996, to $12 billion in 1998, $100 billion in 2007, and nearly $400 billion now.
Today, SPY is the world's most-traded security, turning over about $30 billion worth of shares each day, which adds up to $7.5 trillion of annual volume.
There are ETFs for most everything now, but SPY has reigned as the world's biggest except for one day in 2011 when it was briefly surpassed by the primary gold ETF, GLD.
Crypto believers will soon be able to dream of the day SPY's reign is challenged by a bitcoin ETF.
Are your spydey senses tingling?
The effect of ETFs on bitcoin as a mainstream investment should be less than it was for gold because crypto is already halfway there — bitcoin is easily available on Coinbase and even Fidelity.
But a spot ETF would be significant nonetheless because bitcoin (like gold) only has value to the extent people think it has value — so anything that makes bitcoin's price go up also makes its value go up.
By making Bitcoin more easily accessible, an ETF should make it not just more expensive, but more valuable, too.
Crypto has grander ambitions, of course, like supplanting the entire financial system. Why, for example, should you have to trade warehouse receipts for a basket of stocks when you could put those stocks in a smart contract and trade that directly, no warehouse required?
Putting stocks into smart contracts seems like an even better solution to the issues raised in the 1987 crash that gave birth to ETFs.
As noted yesterday, however, for crypto to achieve its ambitions, it may need an assist from the traditional financial system it hopes to replace.
Will Bitcoin, like ETFs, become a mainstream financial innovation?
That's still TBD, in my opinion.
But having an ETF of its own would help it get there.
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