Spot Bitcoin ETF: BlackRock vs. the SEC

The SEC is reviewing seven Bitcoin ETF bids, including one from BlackRock, the world’s largest asset management firm. Many think that this could be the first successful bid, making a spot Bitcoin ETF a reality. But how does a spot crypto ETF work, and why is BlackRock’s filing different from the rest?

TL;DR

• An exchange-traded fund (ETF) is an investment product that tracks the price of another asset or basket of assets. It’s often cheaper and easier to buy an ETF than the underlying asset.
• Bitcoin ETFs come in two types: spot and futures. Spot ETFs allow you to invest in BTC at the current price and hold real bitcoins in reserve. Futures ETFs hold only futures contracts and track the spot price less accurately.
• Futures Bitcoin ETFs have been around in the US for years, and other countries (Canada, Germany, etc.) have spot ETFs. But the SEC has not approved any spot Bitcoin ETFs in the US.
• The most famous exchange-traded product for Bitcoin, Grayscale GBTC, does provide exposure to spot BTC, but it’s a trust (a different kind of exchange-traded product) rather than an ETF. Grayscale’s filing to convert GBTC into an ETF was rejected.
• The latest bid by BlackRock, however, could be the best crypto ETF bid yet, because it features a surveillance-sharing agreement with Nasdaq as a way to prevent the “manipulative acts” that the SEC is so concerned about.BlackRock is the world’s biggest asset management firm, with $8.6 trillion under management.
• The SEC is reviewing six other spot Bitcoin ETFs. The first deadline is in early September, though many expect  the SEC to postpone the decision.
• An approval could trigger a rally, but, according to JP Morgan, it won’t be a game-changer for the crypto market.

What is an ETF?

ETF stands for “exchange-traded fund”. It’s an investment asset (a security) that tracks the price of some other asset or basket of securities. An ETF can track just about anything: gold, corporate stocks, baskets of fiat currencies, stock indexes, cryptocurrency, grain, oil, market volatility,etc. There is even an ETF (VICE) that tracks a basket of stocks linked to bad habits: tobacco, gambling, and alcohol.

Globally, exchange-traded funds have almost $10 trillion in assets under management (AUM). But why do people buy ETFs? Usually because it’s easier, cheaper, or safer than buying the underlying asset.

1) Easier to diversify. The most popular ETFs track the S&P 500 index, which includes 500 companies. It would be a huge task to invest in all of them directly, while the ETF makes it simple to diversify your portfolio.

2) Easier/lower taxes.ETFs are usually more tax-efficient than buying primary assets. They also simplify your return, by consolidating many investments into just security. This is especially true for cryptocurrencies, where capital gains for different transactions need to be reported separately.

3) Lower processing costs. If you buy physical gold, you need to transport it, store it, secure it,  etc. A gold ETF gives you immediate exposure without high processing or storage costs. ETFs do charge a management fee, which is usually quite low (0.5-1%).

An ETF will normally hold the underlying asset in the quantity that corresponds to the investments in the fund. For example, if a gold ETF has $1 billion under management, it needs to own at least $1 billion of actual gold, parked in secure storage with a reliable custodian.

As fresh investor capital flows into the fund, it needs to acquire more of the tracked asset. When investors leave the fund, selling shares, the underlying assets are also sold. This is called the creation/redemption mechanism.

Spot and futures cryptocurrency ETF: the differences

There are two different types of Bitcoin ETFs: spot and futures.

1) A spot ETF allows holders to invest in BTC at its spot price. True, you are buying ETF shares rather than actual BTC, but you are still getting direct exposure to Bitcoin.  To do this, the fund needs to hold actual cryptocurrency. This is a problem in the US, where the SEC has been extremely skeptical of cryptocurrency investing.

2) A futures ETF doesn’t hold  Bitcoin; only futures contracts for Bitcoin. A futures contract obliges two parties to buy and sell an asset at a specific price on a specific date in the future. This price can differ a lot from the spot price, making at a crucial method for investors seeking to hedge their risk or increase profits. At the end of each month, these contracts expire and are normally traded for new ones.

Futures are a derivative: when you trade a Bitcoin futures contract, no actual Bitcoin is exchanged. . In the US, BTC futures are regulated by the Commodity Futures Trading Commission (CFTC) and not the SEC; they are traded freely on the Chicago Mercantile Exchange (CME).

Bitcoin Futures ETFsin the US

There are already BTC futures ETFs in the US. The biggest is ProShares Bitcoin Strategy (BITO). It launched in October 2021 and attracted $1.2 billion in just 3 days – one of the fastest ETF launches in history. BITO trades on NYSE Arca (an ETF subsidiary of the New York Stock Exchange) and has $1.09 billion under management as of July 2023, charging a 0.95% annual management fee.  

The second-biggest Bitcoin futures ETF in the US is the much smaller VanEck Bitcoin Strategy (XBTF), with only $47 million under management (0.65% annual fee); the third is Valkyrie Bitcoin Strategy (BTF) with $31 million (0.95% annual fee).

Are spot BTC ETFs better?

Even though BITO and other futures ETFs are easily accessible, web3  can’t stop talking about the pending Bitcoin ETF applications. Why is ther so much hype about spot funds – and what’s wrong with futures-based funds like BITO?

1) For some, futures ETFs aren’t “real investments in Bitcoin” because they don’t track the real BTC price as closely as spot funds do.

2) A spot-based ETFs can hold BTC indefinitely, while a futures ETF has to sell and rebuy contracts every month. If the new contracts are more expensive, investors incur additional costs: over 5% a year, according to some expert estimates.

3) The CME allows each ETF to hold no more than 4,000 contracts for the nearest expiration date (the end of the current month). To grow beyond this point, an ETF has to buy contracts for the subsequent month, where the settlement price can turn out to be even further from the spot price. A spot ETF, by contrast, can hold as much Bitcoin as it needs.

Spot Bitcoin ETFs in other countries

Many people don’t realizethere are already a lot of spot Bitcoin ETFs trading outside the US. Creating a spot-based crypto ETF depends on the specific regulations for both ETFs and cryptocurrencies in a specific country.

Here are some of the best known crypto ETF products in 2022:

What about GBTC?

Grayscale Bitcoin Trust (GBTC) is actually bigger than any existing crypto ETF and approved by the SEC.  As of July 2023, it has $18.8 billion under management – more than all Bitcoin ETFs put together. This is possible because Grayscale is a trust: a different type of security than an ETF.

Like a spot ETF, GBTC is a publicly-traded investment product that holds physical bitcoins as reserves. But there are differences:

• The minimum investment is $50,000, and only accredited and institutional investors can buy in. Compare this to BITO, where any person with a brokerage account can buy just one $16 share.
• Grayscale charges a 2% fee – much higher than ETFs. A trust doesn’t automatically buy more of the underlying asset when investors purchase shares. Instead, it adds a premium to the share price. Conversely, investors selling their shares results in a discount relative to the spot price. In fact, a trust doesn’t have a redemption program at all: it can create new shares, but it never destroys them.

This creates price discrepancies between GBTC and Bitcoin. It also makes GBTC more expensive for new investors. GBTC used to trade at a 30% premium to Bitcoin, but since February 2021 it’s been trading at a discount – around -27% in July 2023.

In 2022, Grayscale filed to convert the GBTC trust into a proper spot Bitcoin ETF, but the proposal was rejected by the SEC. In response, the asset management firm sued the SEC, calling its decision “capricious and discriminatory”. As of March 2023, the District of Columbia Court of Appeals seemed to be siding with Grayscale, but there is no decision yet.

What does the SEC have against spot Bitcoin ETFs?

Spot ETF investors can sell their shares at any time to get exactly the same price as they would for real BTC, so investing in such products is practically like investing in bitcoin. In theSEC’s view, direct investments in cryptocurrency make users vulnerable to “manipulative acts and practices”.

What is meant by “manipulative”? According to the Commission, crypto exchanges often falsify their trading volumes and don’t share data with regulators. This means an inaccurate representation of BTC liquidity and price, from which the SEC wants to protect American investors.

At the same time, Commissioner Gary Gensler has said he doesn’t have a problem with futures ETFs, as they are “different products and contain different underlying holdings” compared to spot ETFs.

According to ETF Store head Nate Geraci, the SEC is unlikely to approve any spot ETF bids until it has the power to regulate major crypto exchanges. So far it has shut down numerous Bitcoin ETF proposals:

• VanEck, November 2021
• Kryptoin, December 2021
• First Trust & SkyBridge, January 2022
• Fidelity, January 2022
• Global X, March 2022
• NYDIG, March 2022
• Bitwise Asset Management, June 2022
• Wisdom Tree, December 2021 & October 2022
• Grayscale, June 2022 & December 2022
• Ark21Shares, April 2022 and January 2023

However, the SEC is now dealing with its most serious proposal yet from BlackRock, the world’s largest investment management firm.

BlackRock Bitcoin ETF filing

BlackRock has an incredible $8.6 trillion in client assets. It also has an ETF subsidiary called iShares, with $2 trillion under management. iShares offers 800+ ETFs across the globe, including almost 400 in the US.

You can imagine the industry’s excitement when iShares filed a proposal for a spot Bitcoin product called iShares Bitcoin Trust on June 15, 2023. While it has “trust” in the name, it would have a redemption mechanism – a key difference  between an ETF and a trust like Grayscale. So the iShares product can be called a spot ETF.

Coinbase Custody would act as the custodian for the BTC reserves, and Coinbase Inc. would be the trust’s prime broker. However, the SEC recently sued Coinbase, which makes it an imperfect fit for this role. So iShares took  extra steps to describe how iShares Bitcoin Trust would protect investors from those “fraudulent and manipulative practices” that Gary Gensler is so concerned with.

Bitcoin’s spot price will be taken from Chicago Mercantile Exchange’s CF Benchmarks, a fully regulated and transparent source of asset price benchmarks. But the most important detail is that iShares plans to enter a “surveillance-sharing” agreement with the Nasdaq exchange to ensure transparent data. In fact, the SEC has written that an exchange that lists a spot Bitcoin ETF would need such an agreement with a regulated market.

Initially, the SEC rejected the filing, saying it wasn’t clear enough. BlackRock refiled at the start of July, and on July 13, the SEC formally acknowledged the bid. On July 19, the filing appeared in the Federal Register (a daily publication by the US government). From that point, the SEC has 45 days to either approve the bid or extend the review, so the first decision deadline is due in early September. But, the SEC is likely to postpone the decision; the maximum review period is 240 days

BlackRock’s Bitcoin ETF filing is the most serious challenge to the SEC in the Bitcoin ETF field so far. Crypto Twitter is already looking forward to a “battle” between Gary Gensler and BlackRock’s powerful CEO Larry Fink.

What will happen if the BlackRock ETF is approved?

Right before ProShares futures ETF (BITO) started trading in October 2021, the price of Bitcoin hit $60,000. However, it fell back below $40,000 within three months.

If a spot Bitcoin ETF gets approved, it could trigger another BTC rally, at least in the short term.. Expert estimates vary wildly: Morgan Creek Capital’s Mark Yusko expects $55,000, while the investment research firm Fundstra believes $180,000 is in the cards.

Meanwhile, JP Morgan wrote that an approved spot crypto ETF in the US won’t be a “game-changer”. None of the spot ETFs in Canada and Europe have managed to attract $1 billion in capital, and BITO has similar  assets under management to when it launched.

We don’t provide financial or investment advice, but rallies in crypto are often of the “buy the rumor, sell the news” kind: the price tends to go down soon after a much-anticipated event. This could end up being the case with the iShares Bitcoin ETF, too.

Other active spot Bitcoin ETF proposals

BlackRock Bitcoin ETF is the one everyone’s talking about, but the SEC is currently reviewing six more ETF filings. All of them have tried before and got rejected.

• Fidelity: an asset manager with $11 billion AUM
• WisdomTree: the third attempt by the global ETF management company with $97 billion AUM
• Bitwise Asset Management: the industry’s largest crypto index fund manager
• Valkyrie: a digital asset ETF manager that operates Bitcoin Miners ETF (WGMI), among others
• Invesco: an asset management firm with $1.4 trillion AUM that’s part of S&P 500
• Ark Investment Management:run by Cathie Wood, who believes that BTC will hit $1 million by 2030

For now, we just have to wait for September, though it’s likely the SEC will postpone the decision on the BlackRock Bitcoin ETF. The maximum review period is 240 days. We’ll keep updating this article, so follow Pontem on Telegram, Twitter, and Discord and stay tuned!

About Pontem

Pontem Network is a product studio building the first-ever suite of foundational dApps for Aptos. Pontem Wallet, the first wallet for Aptos, is available for Chrome, Mozilla Firefox, Android, and iOS.

Use Pontem Wallet to store and send any tokens on Aptos. The wallet is integrated with our Liquidswap DEX, the first DEX and AMM for Aptos, Topaz and Souffl3 NFT marketplaces, Ditto and Tortuga liquid staking platforms, Argo and Aries lending protocols, and all other major Aptos dApps.

Our other products include the browser code editor Move Playground,  the Move IntelliJ IDE plugin for developers, and the Solidity-to-Move code translator ByteBabel – the first ever implementation of the Ethereum Virtual Machine for Aptos.