On August 30, 2023, the US Securities and Exchange Commission (SEC) delayed a verdict on investment giant BlackRock’s bitcoin spot Exchange Traded Fund (ETF) application, along with seven other firms’ applications. The delay is part of the ongoing seismic shift in global finance as crypto moves closer to traditional finance’s (TradFi) regulatory playbook.
This post covers some factors affecting the SEC’s decision and some background information. If you are wondering why the BlackRock/SEC tussle matters, or even what the hey is an ETF, this post is for you.
Factors Influencing the SEC’s BlackRock Delay
Even though the SEC has approved a few bitcoin futures ETFs, they have denied dozens of bitcoin spot ETF applications in the past. (If that’s confusing to you, don’t worry; we cover the different kinds of ETFs later in the post).
As such, no one was surprised at the delay, including those closest to the process. The SEC points to concerns about volatility and inadequate levels of trading surveillance that could lead to potential market manipulation.
The agency is also concerned that bitcoin trades on non-regulated cryptocurrency exchanges. It’s an interesting point, given that the SEC’s mission is to “protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”
All other currency ETFs deal with regulated currencies. The SEC cannot carry out its mission as long as bitcoin remains unregulated.
Another factor influencing the delay is the SEC is digesting recent input from the courts and other agencies on several fronts.
August – A Big Month for Crypto Regulation Cases
On August 29, a three-judge panel of the District of Columbia Court of Appeals in Washington said the SEC failed to fully explain its reasoning when denying Grayscale’s application to convert the Grayscale Bitcoin Trust into a spot ETF.
Judge Neomi Rao wrote that conditions surrounding futures ETFs were similar enough to spot ETFs that the SEC’s denial of spot ETFs was unwarranted, mainly because the SEC had not sufficiently explained why they rejected Grayscale’s conversion in the first place. The court said that ETFs are similar enough that the SEC needs to treat them consistently and that the SEC should review its decision.
The SEC is also appealing an early August decision from a NY District Court in the SEC’s lawsuit against Ripple. The court found that sales of the XRP cryptocurrency did not constitute securities sales in certain circumstances.
Finally, in mid-August, the US Fed and IRS released proposed rules for crypto taxation that affect the SEC.
Crypto Versions of TradFi Products and Services
As we are seeing, some big TradFi players lumbering into the crypto-verse are causing the regulatory wheels to speed up just a tad. Many of the biggest TradFi companies are positioning to launch crypto versions of their products and services to catch the coming wave of mainstream interest.
In June, Citadel Securities, Fidelity Digital Assets, and Charles Schwab launched EDX Markets, a fully compliant with the SEC crypto exchange for institutional investors. Deutsche Bank has also applied to Germany’s financial regulator to provide crypto custody services.
Some cryptocurrency investors who have not been active in TradFi may not be as familiar with the vehicles of traditional finances. Since ETFs are in the regulatory hot seat at the moment,
let’s take a look.
ETFs, Futures and Spots
An Exchange-Traded Fund (ETF) is a type of investment fund and product traded on an exchange that combines the features of individual stocks and mutual funds. ETFs provide investors access to a diversified portfolio of assets, such as stocks, bonds, commodities, or other financial instruments. The SEC regulates ETFs in the US.
Nate Most invented ETFs as a way to trade a basket of securities as easily as trading a stock. The first SPDR (Standard & Poor’s Depositary Receipts) was introduced in 1993, tracking the S&P 500 index. Since then, the ETF market has grown significantly. Due to its many advantages and flexibility, ETFs have become a favorite tool in modern investment portfolios.
ETFs are a more flexible and cost-effective way to access a diversified portfolio of assets compared to traditional mutual funds and individual stock investing. Some key reasons why investors favor ETFs include:
- Diversification: ETFs allow investors to gain exposure to a diversified portfolio of assets, such as stocks, bonds, commodities, or other securities, with a single investment that helps spread risk and reduce the impact of poor-performing individual assets.
- Liquidity: ETFs are traded on stock exchanges just like individual stocks, providing investors with the ability to enter and exit positions quickly, unlike traditional mutual funds, which typically only trade at the end of the trading day at the net asset value (NAV) price.
- Transparency: Most ETFs disclose their holdings daily, allowing investors to see the fund’s assets.
- Lower Costs: ETFs generally have lower expense ratios than traditional mutual funds because they are typically passively managed, track an index, and have lower operating expenses. Lower costs can lead to higher returns for investors over the long term.
- Tax Efficiency: ETFs are less likely to generate capital gains distributions than actively managed mutual funds, which can lead to tax advantages for investors.
- Flexibility: Investors can use limit orders, stop orders, and other trading strategies to buy or sell ETFs.
- Intraday Trading: Investors can trade ETFs throughout the trading day at market prices, taking advantage of short-term trading opportunities and trading strategies.
- Accessibility: ETFs provide access to a wide range of asset classes and markets, including international markets, commodities, and niche sectors, which may not be easily accessible to individual investors through other means.
A futures-based ETF uses futures contracts as its underlying assets to track the performance of a specific index, commodity, or asset class. Commodity examples include gold, oil, and even carbon credits.
As you might expect, with bitcoin futures ETFs, bitcoin futures contracts mirror the cryptocurrency’s price volatility, indirectly following bitcoin’s real-time market value through exchanges like the Chicago Mercantile Exchange.
Futures-based ETFs are popular among investors who want exposure to asset markets without owning or physically storing these assets. However, these ETFs can be complex, usually needing more expertise than just a crystal ball approach to divining the future of the futures markets.
Futures ETFs can also track currencies, leading to one place where TradFi meets crypto, specifically bitcoin. Futures-based bitcoin ETFs have been available to investors since the
the ProShares Bitcoin Strategy ETF launched as the first US bitcoin futures ETF on October 19, 2021.
Another type of ETF, a spot ETF, doesn’t use futures contracts. The spot ETF is the kind that BlackRock and other firms want to launch.
What is a Spot ETF?
Spot ETFs provide direct exposure to the actual spot (or asset) market, which can result in a more straightforward and transparent investment experience. They avoid the downside of futures ETFs, such as roll costs or tracking errors. Spot ETFs tend to have lower expenses as they do not incur futures contracts’ trading and management costs.
The SEC can delay its ruling in the BlackRock case for up to 6 months. Grayscale and Ripple take the stance that the courts are stepping in to limit the SEC’s “arbitrary” and “capricious” behavior in the words of one judge.
If court rulings continue to favor the crypto industry, we’ll likely soon see approval for Bitcoin spot EFTs, signaling a significant step for crypto’s inroads into the mainstream financial system.
Do you invest in Bitcoin or other cryptocurrencies? If so, ZenLedger can help you stay organized for tax time. The platform aggregates transactions across exchanges, computes your capital gain or loss, and generates the necessary paperwork. In addition, you can identify opportunities to reduce your tax burden using strategies like tax-loss harvesting.
This material has been prepared for informational purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax, or other advice specific to your particular situation.”