BlackRock and Grayscale recently met with the Securities and Exchange Commission (SEC), presumably to discuss the approval requirements for their spot Bitcoin ETF applications.
Coinbase, which offers both Bitcoin custody and Bitcoin brokerage products, has emerged as the proposed custodian for the Bitcoin assets of several ETF applicants. Mike Belshe, CEO of BitGo, recently raised concerns about Coinbase’s dual role as an exchange and custodian. Although his position is clearly aligned with his self-interest, since BitGo is a custodian that does not operate an exchange, Belshe warned that Coinbase’s dual role might lead to the SEC rejecting those applications.
Despite these concerns, analysts are confident that the SEC will approve some applications by January 10th, which is the deadline for the ARK 21Shares application (BlackRock’s is March 15th). The SEC might even approve all applicants in one fell swoop, assuming the spot ETFs share the same structure.
Many presume that Bitcoin’s exchange rate with the dollar will rise significantly alongside the anticipated approval of spot Bitcoin ETFs. Analysts estimate that tens of billions of dollars will flow annually into Bitcoin ETFs, originating from broker-dealers, banks, and registered investment advisers (RIA).
Yet, uncertainty remains about the way spot Bitcoin ETFs will work. The central question is whether the SEC will permit ETF issuers to offer in-kind redemptions.
With in-kind redemptions, shareholders can redeem shares for Bitcoin. This would allow issuers to compete directly with established exchanges and platforms whose users often take custody of their Bitcoin after purchasing it. In-kind redemption would broaden the appeal of spot Bitcoin ETFs, and allow purchasers to benefit from one of Bitcoin’s most powerful properties – self-custody.
Most spot Bitcoin ETF applicants want to offer in-kind instead of in-cash redemptions (selling shares for cash) as it allows them to pursue a larger market. However, ETF analysts recently stated that the SEC is likely advising firms to amend their applications to do in-cash rather than in-kind redemptions.
A cash redemption structure requires fewer steps and partners for issuers during the redemption lifecycle, which is likely why the SEC prefers it over in-kind. In-cash redemptions also keep more users within traditional finance’s confines and reduce the number of individuals who take custody of their Bitcoin. The SEC may prefer this structure to prevent value from exiting the traditional financial system, which aligns with their role in overseeing conventional markets.
Interestingly, the SEC posted a memorandum outlining its November 20th meeting with BlackRock regarding the firm’s proposed spot ETF. The memorandum included two slides that BlackRock presented to the agency. The slides detail an in-kind and an in-cash redemption model, indicating that BlackRock, arguably the most influential spot ETF applicant, and the SEC have not agreed on a redemption structure.
On November 28th, the SEC posted another BlackRock meeting memorandum in which a revised in-kind model was presented, indicating ongoing negotiations between the parties. Since then, other issuers have also met with the SEC. On December 7th, Fidelity met with the agency and shared detailed in-kind creation and redemption models.
Still, even if the SEC forces applicants to use an in-cash model for faster approval, they could transition to an in-kind model later if regulators approve it.
Today, the most common “redeemable” ETF products are those for precious metals. Physical gold trusts, for example, allow shareholders to exchange shares for physical gold once they reach a certain threshold. Yet, that threshold is quite high. For the Sprott Physical Gold Trust, shareholders must own an amount equivalent to one London Good Delivery bar (roughly 400 ounces of gold, which today costs about $800,000) to qualify for a redemption request.
Bitcoin’s digital nature makes it significantly easier to transport than gold, so the redemption thresholds for spot ETFs would not need to be as high. However, if those thresholds exceeded a few hundred dollars, it would prevent many consumers from redeeming their shares for Bitcoin.
The recent introduction of spot Bitcoin ETFs demonstrates the growing integration of Bitcoin with traditional finance. In-kind vs. in-cash redemption is one of the questions that traditional financial players and regulators must resolve to bring such products to market. Although the SEC’s decisions will shape the spot ETF’s immediate future, over the long term, new models must be developed to align such financial products with consumer desires and regulatory requirements while allowing individuals and the economy at large to benefit from the custody innovations Bitcoin enables.
This is a guest post by David Waugh. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
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