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The SEC Ties a Rope to Bitcoin ETFs – and It’s Investors Who Will Pay for It
Bitcoin ETFs will finally arrive in the United States in 2024 and, according to all predictions, the first ones will hit the market between mid and late January. But now that the long-standing issues of if and when will be resolved, the burning question around Bitcoin ETFs is how exactly they will work – and, for now, the SEC is insisting on a process that has no doesn’t make much sense and will end up causing retail investors to pay for additional complications. Specifically, the agency wants to prohibit potential ETF issuers from using Bitcoin for in-kind redemptions and conducting those transactions in cash.
To understand what this means, it helps to know how ETFs work in the first place. Remember that most ETFs hold a basket of shares of different companies and the issuer relies on deep-pocketed partners, market makers, to ensure that the ETF’s share price reflects the value underlying shares. This happens through an arbitrage system that allows market makers to come in with a basket of stocks and buy them back for new shares of the ETF, which they can then sell at a profit. Or conversely, arbitrageurs can show up with shares of the ETF and demand the underlying securities in return. In both cases, the transactions result in the ETF share price being more closely aligned with the underlying asset. It’s a clever system that has made ETFs both inexpensive and very popular.
Unfortunately, when it comes to Bitcoin ETFs, the SEC would insist that these transactions – those in which market makers exchange the underlying asset for new shares or vice versa – be done in cash and not “in-kind” . This will also help ensure that the ETF’s share price closely tracks the underlying asset (Bitcoin in this case), but it will also be more expensive.
This will not be due to tax implications, like Grayscale gently points out to Bloomberg Intelligence following a inaccurate report last week, but because ETF issuers will have to spend money to exchange Bitcoin for cash and vice versa. It would of course be simpler to let parties transact in Bitcoin, but here we are. In all cases, it will be individual investors who will pay the additional transaction costs.
This is an odd move by the SEC, especially since in-kind transactions are the norm with other ETFs. Indeed, when it approved a gold ETF in 2014 – a new concept at the time – the SEC issued a explanatory letter describing how the ETF issuer and its partners would carry out in-kind transactions involving gold bullion. This is obviously cheaper and more efficient than requiring a gold ETF issuer to buy or sell new bars with each redemption. So why not do the same with Bitcoin, or at least allow cash and in-kind redemptions? That’s apparently what Fidelity and BlackRock – companies that aren’t exactly underground corporations – are asking for.
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The most charitable explanation is that the SEC views Bitcoin as a new asset that could be cornered, and the agency wants to minimize the possibility of misdeeds in the form of proprietary trading by market makers and issuers. of ETFs. The chances of such manipulation appearing unlikely, however – recall that a federal appeals court rejected this argument when it forced the SEC to stop blocking Bitcoin ETFs.
There is also another potential explanation for the SEC’s decision to block in-kind buyouts, one that has its roots in the fact that, in the words of one DC insider, “Chairman Gensler hates hates losing.” If so, it’s possible that the agency head, stung by his defeat in court, will allow Bitcoin ETFs, but on terms that will make them more expensive and less attractive to buy. It’s a strange position for an agency president who claims his top priority is taking care of the little guy.
Jeff John Roberts
jeff.roberts@fortune.com
@jeffjohnroberts
This story was originally featured on Fortune.com