Bitcoin (BTC-USD) ETFs (exchange-traded funds) have been hailed as the ultimate Bitcoin adoption hallmark for many years. An ETF is a company, in this case, a trust, holding a certain amount of a particular asset that can be redeemed with its shares. The company’s stock becomes essentially equivalent to holding its underlying assets directly.
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This means that regular investors, including pension funds, corporations, and other large asset holders, can “own” Bitcoin through tools they’re familiar with and for which they already have the infrastructure required.
Large asset holders are often limited to holding only approved types of instruments due to regulations. It is very difficult for them to justify owning Bitcoin directly, but it’s much easier to do so with a Bitcoin ETF.
There were already several ways for traditional investors to gain exposure to Bitcoin, but so far, all of these tools were inadequate. Currently, the most widespread asset is the Grayscale Bitcoin Trust (OTC:GBTC), with a market capitalization of almost $11 billion.
Unfortunately, though, GBTC is a far cry from a true ETF. A key defining feature of a workable ETF is the redemption frequency — how often it is possible to exchange shares of the fund for its underlying assets. Most ETFs enable this rebalancing at the end of every trading day. This allows arbitrage traders to come in and sell shares if they’re priced too high or buy them back if they are too cheap. Overall, an ETF tracks the underlying asset’s price very closely.
The Grayscale Trust doesn’t — its shares are only redeemable with a six-month delay, subjecting arbitrageurs to a significant amount of risk. The collapse of this apparently easy arbitrage was among the largest contributing factors to the demise of Three Arrows Capital, a crypto hedge fund heavily involved in this trade. Because of the inherent risk, GBTC only loosely tracks the price of Bitcoin.
The SEC is Approving ETFs — But of the Wrong Kind
Bitcoin ETF applications in previous years were nearly always rejected by the Securities and Exchange Commission (SEC). The first exception was the ProShares Bitcoin Strategy ETF (NYSEARCA:BITO), an ETF built on Bitcoin Futures contracts approved in 2021.
Unlike spot ETFs directly holding “physical” Bitcoin, a Futures ETF holds Bitcoin derivatives in the form of CME Futures.
While this approach satisfies the SEC because no Bitcoins are ever “touched,” investors in these forms of ETFs are less pleased. Because Futures contracts periodically expire, they need to be rolled into the next period by buying new contracts, which will often trade with a slight deviation from the true market price. Over enough time, these deviations accumulate into losses, with the ProShares ETF underperforming by about 3% so far this year over directly holding BTC.
Thousandth Time the Charm?
The BlackRock news is making waves in the crypto ecosystem, as a true spot ETF is the holy grail of institutional adoption. The question now is, will the SEC approve it?
With the SEC under Chairman Gensler entering a warpath against major exchanges, which includes BlackRock’s expected custody partner Coinbase (NASDAQ:COIN), it seems that the regulator’s answer should be an automatic “no.”
And yet, BlackRock is considered to be the most Washington, DC-connected asset manager in the United States, with many ties to the administration, including hiring former officials or being directly tapped for supporting government initiatives.
It is also worth mentioning that despite the negative rhetoric, Gensler has at least saved Bitcoin. He explicitly confirmed it is a commodity, so the SEC’s crusade against other assets may leave the largest cryptocurrency untouched.
So, it may be that BlackRock leadership knows something that the rest of the market doesn’t: this time, it may be different, and a spot Bitcoin ETF may be on the horizon. But then again, this is a familiar tune — there have been dozens of previous failed applications that seemed quite convincing at the time.
