Bitcoin & MicroStrategy: The New Favorite Assets for Hedge Funds

👇1-21) Although Bitcoin ETFs have attracted $38.6 billion in net inflows since their January 2024 launch, our analysis suggests that only $17.5 billion (44%) represents genuine long-only buying. The majority—56%—is likely tied to arbitrage strategies, where short Bitcoin futures positions offset inflows.

Bitcoin ETF Flows (LHS, $ millions) vs. Bitcoin (RHS)

👇2-21) This means that the actual demand for Bitcoin as a long-term asset in multi-asset portfolios is significantly smaller than the media portrays. Rather than reflecting broad-based institutional adoption, the buying and selling of Bitcoin ETFs is primarily driven by funding rates (basis rate opportunities), with many investors focusing on short-term arbitrage rather than long-term capital appreciation.

👇3-21) Rather than wealth and asset managers, the largest holders of BlackRock’s IBIT ETF are hedge funds and trading firms that specialize in exploiting market inefficiencies and capturing yield spreads, rather than taking outright directional risk. Among IBIT’s top holders are hedge funds such as Brevan Howard, Symmetry, DE Shaw, Tudor, and Farallon, alongside market-making and trading firms like Susquehanna and Jane Street.

👇4-21) Similarly, the Fidelity Bitcoin ETF, which has received $12 billion in inflows, counts Millennium, Schonfeld, Capula, DE Shaw, and Bracebridge among its top five holders—further reinforcing the dominance of hedge funds and arbitrage players in the Bitcoin ETF market.

👇5-21) With funding rates and basis spreads currently too low to justify new arbitrage positions, hedge funds and trading firms have stopped adding inflows to Bitcoin ETFs and are actively unwinding existing positions that no longer offer the profitable arbitrage opportunities seen a few months ago.

👇6-21) This hurts market sentiment, as media reports often frame these outflows as bearish signals. However, the unwinding process is actually market-neutral since it involves selling ETFs while simultaneously buying Bitcoin futures, effectively offsetting any directional market impact.

👇7-21) While genuine long-only Bitcoin buying has increased since Trump’s election, funding rates have collapsed as retail trading volumes have declined. This drop was triggered by stronger-than-expected U.S. economic data, reinforcing the Federal Reserve’s hawkish stance at its December FOMC meeting.

Bitcoin (LHS) vs. Perp Funding Rate and BTC Basis Rate (RHS)

👇8-21) We initially expected that rising market activity leading up to Trump’s inauguration might encourage retail investors to increase leverage, boosting funding rates and ETF inflows. However, the sharp decline of the $TRUMP coin—which saw retail investors use it as exit liquidity—combined with a six-month delay to investigate the establishment of a Bitcoin Strategic Reserve has led to a slowdown in market activity. As a result, Bitcoin ETFs are experiencing a monthly net outflow for only the third time in history.

👇9-21) Bitcoin ETF flows peaked in November 2024, with $6.5 billion in net inflows, coinciding with a funding rate of +16.5% (or +13% for the basis rate). In contrast, February's funding rate has dropped to +6.2%, falling below our +10% hurdle rate, dampening ETF inflows.

Bitcoin ETF Flows ($ billions)

👇10-21) November also marked a period when MicroStrategy capitalized on market inefficiencies, selling overvalued shares to less-informed investors. The company raised capital at 2.8x its net asset value (NAV), effectively selling Bitcoin at a +180% premium to the market price.

👇11-21) Like hedge funds engaging in ETF arbitrage, MicroStrategy exploits market mispricing through its share offerings. While many investors perceive MicroStrategy as a higher-beta or leveraged Bitcoin play, the reality is that its convertible debt stands at just $7.3 billion, representing only 10% of its total market cap.

👇12-21) As MicroStrategy's NAV premium has declined, the company has slowed its share issuance, contributing to Bitcoin’s current consolidation phase. Despite this, MicroStrategy shares are trading at $300, while their Bitcoin-backed intrinsic value is estimated at $177—or $158 when factoring in convertible debt. This means the stock remains 70–90% overvalued, with the premium expected to shrink over time gradually and ultimately converge toward a NAV of 1 (down from the current 1.7–1.9 multiple).

👇13-21) Since the launch of Bitcoin Spot ETFs, Bitcoin prices have risen +102%, while MicroStrategy shares have surged +459%. However, this outperformance has steadily declined from a peak of +784%, as investors increasingly recognize the arbitrage at play.

Bitcoin ETF Flows ($ billions)

👇14-21) At its peak, MicroStrategy options traded with an implied volatility of 200% or more, which has since compressed to 80%. Higher volatility increases the likelihood of sharp price jumps, particularly relevant for holders of $7 billion in convertible bonds, as their upside potential depends on significant moves in MicroStrategy’s stock price.

👇15-21) Implied volatility is a key factor for convertible bond buyers because it directly affects the value of the embedded call option within the bond. Since convertible bonds can be exchanged for equity, higher implied volatility increases the likelihood of larger stock price swings, making the conversion option more valuable.

👇16-21) As implied volatility declines, convertible bond appeal diminishes, leading to lower demand. This explains why interest in MicroStrategy’s convertible bonds should also be weak, as their potential upside has become less attractive to investors.

👇17-21) Like Bitcoin ETF buyers, the holders of MicroStrategy convertible bonds are primarily low-risk institutional investors, such as Allianz Global Investors (which owns 25%), Voya Investment, Calamos Investment, and State Street. These convertible bond funds typically employ a hedging strategy, buying the bonds while shorting MicroStrategy shares to neutralize equity conversion risk and capture yield spreads.

👇18-21) If implied volatility rises, the embedded call option gains value, increasing the price of the convertible bonds. Additionally, if realized volatility surpasses implied volatility, arbitrage traders can profitably unwind their hedges.

👇19-21) MicroStrategy’s convertible bonds have an implied volatility of around 60%, which is exceptionally high for the equity-linked market. By contrast, MicroStrategy call options have traded at 200% implied volatility, making the convertible bonds appear attractive for arbitrage, as traders can capitalize on the volatility discrepancy.

👇20-21) As MicroStrategy’s stock price rises and its convertible bonds approach "in the money" status, its delta increases, prompting holders to sell more shares to maintain a market-neutral position. Conversely, when the stock declines, they buy back shares, helping to cushion the drop. This dynamic has contributed to the short interest in MicroStrategy declining from 30 million shares in September to 24 million (*$300 per share = $7.2 billion equivalent to the size of convertible debt with conversion prices of $143 to $232).

👇21-21) With retail buying power fading and no immediate catalysts, Bitcoin remains range-bound, primarily controlled by hedge funds. It has truly evolved into a major hedge fund-driven asset.