Spot Bitcoin ETF: BlackRock vs. the SEC

The SEC is reviewing ten 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 at first but later the court ordered the SEC to review it again. This is seen as a big win, though the SEC could still reject it.

• BlackRock is another strong candidate, as its ETF bid 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 nine other spot Bitcoin ETFs. The first deadline is in January 2024, while the decision on BlackRock should come no later than mid-March 2024.
• An approval could trigger a rally in the short term and a supply shock with a bigger rally in the mid-term. However, according to JP Morgan, it won’t be a game-changer for the crypto market.
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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 $1.07 billion under management as of October 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:

Grayscale GBTC is winning against the SEC

Grayscale Bitcoin Trust (GBTC) is actually bigger than any existing crypto ETF and approved by the SEC.  As of October 2023, it has $21 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; only accredited.institutional investors can buy in.
• Grayscale charges a 2% fee – much higher than ETFs.
• A trust doesn’t have a redemption program: it can create new shares, but it never destroys them. When investors purchase shares, GBTC doesn’t buy more of the underlying asset - it adds a premium to the price. When investors sell shares, it results in a discount relative to the spot price. As of October 2023, GBTC is trading at a -17% discount relative to spot.

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Grayscale also offers a similar product for Ethereum - ETHE, with a $5.3 billion capitalization and a 2.50% management fee.

Grayscale vs. SEC: a victory for GBTC (so far)

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” and citing “unfair discrimination” against spot BTC ETFs, since it had already approved futures ETFs.

On August 29, the District of Columbia Court of Appeals overturned the SEC’s decision. Note: this wasn’t a court order to accept Grayscale application - just to review it again. Nonetheless, the price of BTC went up 6%.

The SEC had until October 13 to appeal the decision - but it didn’t. So, on October 19, Grayscale filed an updated ETF application. And on October 23, the court issued a formal mandate for the SEC to review the ETF filing. The Commission can still reject it, of course, but it will have to provide a new reason.

Once again, there was excitement in the market following the court order. Bitcoin went up to $35,000, and ProShares’ futures ETF BITO saw its second-biggest trading week since Week 1 (back in 2021), with $1.7 billion. GBTC’s weekly volume reached $800 million.

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.

Commissioner Gary Gensler is on something of a personal crusade against crypto. Speaking at the Securities Enforcement Forum in October, he once again said that the crypto industry is rife with “fraud, scams, bankruptcies, and money laundering”.

At the same time, Gensler 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.

Re-filing and SEC delays

Initially, the SEC rejected BlackRock’s filing, saying it wasn’t clear enough. The company 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).

The SEC has 45 days from the publication date to either approve a bid or delay the review. The total review period shouldn’t exceed 240 days.

As expected, in September the SEC postponed the decision till October 19 - only to delay it again, at the end of September. The Commission will probably drag it out until the final deadline in mid-March 2024.

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

Cointelegraph makes a mistake and BTC goes up $2,000

On October 16, Cointelegraph tweeted exciting news: BlackRock’s Bitcoin ETF has been approved! Immediately, the price of Bitcoin shot up from $27,700 to $29,400. Unfortunately, the rumor was false. Cointelegraph published a lengthy explanation with a screenshot from a Telegram channel where the employee had gotten the fake news.  

The incident shows how much the community is looking forward to an ETF approval. It also reportedly led to $100 million in liquidations. Morale: verify everything, even if it’s tweeted by a trusted account like Cointelegraph.

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 in the short term. In a blog post, Glassnode co-founders Yann Allemann and Jan Happel write that any approvals could trigger a “buy the rumor, sell the news” event. So don’t rush to sell your house and buy Bitcoin if it happens.

With time, the market could face a supply shock as ETF issuers will have to keep buying BTC to back new shares. While the market will absorb the first few waves of this demand, the supply of BTC won’t increase fast enough; it’s already as low as it was in 2018.  

How much could the price go up? 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.  

BlackRock investor Anthony Scaramucci even believes that institutional demand for ETFs could reach $100 billion and that the market cap of Bitcoin could go up 11x to $600 trillion. This would take the price to $330,000.

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 nine more ETF filings. All of them have tried before and got rejected.

• Grayscale: the bid to convert the GBTC trust into a spot ETF as we’ve discussed in this article.
• Ark Investment Management together with 21 Shares: run by Cathie Wood, who believes that BTC will hit $1 million by 2030. The decision is due on January 10, 2024.
• Global X: the firm plans to work with Coinbase on surveillance sharing. Here, too, the decision deadline is January 10.
• Fidelity: an asset manager with $11 billion AUM.
• WisdomTree: the third attempt by the global ETF management company with $97 billion AUM
• 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
• Bitwise Asset Management: the industry’s largest crypto index fund manager filed a BTC ETF application in August, withdrew it a month later, then re-filed in late September with 40 pages of new text after Grayscale’s win over the SEC.
• Hashdex: a Brazilian asset management firm that seeks to convert its existing futures ETF.

To this we should add BlackRock’s bid to convert its ETHE trust into a spot Ethereum ETF, filed in October.

For now, we just have to wait for January and the decisions on Ark Investment and Global X. We’ll keep updating this article, so follow Pontem on Telegram, Twitter, and Discord and stay tuned!

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