The arrival of Bitcoin spot ETF is unstoppable

After the SEC rejected several Bitcoin spot ETF applications in recent years, in August this year, the SEC and Grayscale lost the case of GBTC being rejected for conversion to Bitcoin spot ETF. At the same time, BlackRock, the world's largest asset management institution, and several other institutions simultaneously submitted applications for Bitcoin spot ETFs to the SEC. Bitcoin spot ETFs are coming unstoppably.

What is Bitcoin Spot ETF

Cryptocurrency exchange-traded funds (ETFs) are exchange-traded funds that track the price of one or more crypto assets by investing in crypto assets or related instruments. The widely discussed Bitcoin ETF is an ETF that tracks the price of Bitcoin, which mainly includes Bitcoin futures ETFs and Bitcoin spot ETFs. The main difference is that the underlying asset corresponding to the Bitcoin futures ETF shares purchased by investors is the Bitcoin futures contract, while the underlying asset corresponding to the Bitcoin spot ETF shares is Bitcoin.

The biggest feature of ETFs compared to ordinary public funds is that they can trade fund shares on traditional stock exchanges like stocks, which means that if the Bitcoin spot ETF is approved, investors do not need to go through complicated processes - such as downloading wallet plug-ins, creating public and private key pairs, or trading through centralized exchanges - but directly purchase ETF shares to directly enjoy the yield of Bitcoin. These processes are not difficult for familiar people, but there are still barriers for investors who have no knowledge of crypto assets. Bitcoin spot ETFs lower this threshold and give these investors, especially institutional investors, familiar financial instruments and a sense of security with legal protection.

How does a Bitcoin ETF work? Taking a Bitcoin spot ETF as an example, first, the issuer will purchase Bitcoin assets, either directly from Bitcoin holders or through centralized exchanges. These assets are stored in Bitcoin wallets with multiple protection measures, such as cold wallets. Secondly, the issuer creates fund shares, and the value of these shares closely follows the price fluctuations of Bitcoin. In this process, authorized participants are responsible for the creation and redemption of fund shares. They are usually large financial institutions and often act as secondary market market makers. Investors can buy or sell fund shares on traditional stock exchanges, just like trading stocks. In addition, authorized traders also need to arbitrage price differences when there is a premium or discount on fund shares to ensure that the price of fund shares is consistent with the cost of Bitcoin.

The first Bitcoin ETF was the ProShares Bitcoin Strategy ETF (BITO), a Bitcoin futures ETF that was traded on the Chicago Mercantile Exchange in October 2021. However, the SEC has not yet approved any Bitcoin spot ETF.

The first financial instrument to create shares with Bitcoin as the benchmark was the Grayscale Bitcoin Trust (GBTC), which debuted in 2013 and was officially publicly traded in 2015. In January 2020, GBTC was approved for registration by the SEC, becoming the first crypto asset investment tool that meets SEC standards. However, GBTC is not an exchange-traded fund, but a closed-end fund that is traded through an over-the-counter exchange. Although GBTC fund shares allow investors to obtain Bitcoin returns without directly holding Bitcoin, as a closed-end fund, the price of GBTC fund shares depends on the supply and demand relationship in the secondary market, and does not correspond to the fund's holdings of Bitcoin. Therefore, there is often a price difference between the value of GBTC shares and the value of Bitcoin holdings.

GBTC has been actively communicating with the SEC, hoping to convert to a Bitcoin spot ETF, but it has not been approved. It was not until August 2023 that things took a turn for the better. The Washington, D.C. Circuit Court of Appeals ruled that the SEC's rejection of GBTC's application to convert to an ETF was wrong and the SEC needed to review the application, and the SEC did not appeal the ruling. Such a ruling does not mean that the SEC must approve GBTC's application, but it sends extremely positive news to the market.

SEC Approval Process

Simply put, an institution submits relevant materials for an ETF application to the SEC. After confirmation, the SEC publishes the 19b-4 document in the Federal Register. The SEC will then enter a 240-day approval process and publicly respond to the application results on the 45th, 90th, 180th or 240th day, or announce a postponement to the next date.

The SEC has long been concerned about the lack of regulation in the cryptocurrency market, which is the main reason for its rejection of crypto asset ETF applications. In previous rejections, the SEC insisted that the lack of regulation and supervision in the cryptocurrency market, the lack of necessary information transparency, and the difficulty in ensuring asset security led to "concerns about potential fraud and manipulation" and emphasized that the market needs adequate information sharing and supervision.

After the SEC lost the lawsuit against Grayscale, the court ruled that the SEC could no longer use "potential fraud and manipulation" as a reason to reject the approval of the Bitcoin spot ETF, but the SEC may still find other reasons to reject the approval of the Bitcoin spot ETF.

Application Status of Bitcoin Spot ETF

In addition to Grayscale, which has been applying, several institutions have applied to the SEC for Bitcoin spot ETFs in 2023. For example, iShares Bitcoin Trust applied by BlackRock, Wise Origin Bitcoin Trust applied by Fidelity, ARK 21Shares Bitcoin ETF applied by Ark Invest, and so on. It is worth noting that most of these institutions are not applying to the SEC for the first time. After several years of gaming with the SEC, they submitted Bitcoin spot ETF applications to the SEC again at almost the same time this year, including BlackRock, which applied for the first time. BlackRock is famous for issuing index tracking funds. Its flagship product iShares has a market share of nearly 50% in the US ETF market, and its success rate in applying for ETFs is close to 100%. This is also an important factor in the market's belief that the Bitcoin spot ETF will pass next year.

Moreover, these institutions represented by BlackRock have fully adjusted their strategies. In order to alleviate the concerns of the SEC, BlackRock and other institutions have proposed surveillance-sharing agreements, which is a way to mitigate the risks of market manipulation and fraud. The surveillance-sharing agreement is an agreement between cryptocurrency exchanges and market regulators, which allows both parties to share transaction data and information to monitor transactions. If suspicious transaction data or information appears, this information will be pushed to regulators, ETF issuers and cryptocurrency exchanges at the same time. Both BlackRock and Ark Invest have chosen Coinbase Custody Trust Company as their Bitcoin custodian and Bank of New York Mellon as their cash custodian.

In the past, the SEC usually does not approve Bitcoin spot ETFs in advance, and chooses to announce the results on the final approval date. The closest to the final approval date is the ARK 21Shares Bitcoin ETF applied by Ark Invest, which will give the result on January 10, 2024. The final approval date of BlackRock and several other institutions is March 15, 2024. According to Reuters, citing sources, the discussions between the SEC and asset management institutions applying for Bitcoin spot ETFs have gone deep into key technical details, including regulatory arrangements, subscription and redemption mechanisms. This suggests that the SEC may approve these products soon. We may see the Bitcoin spot ETF pass as early as January 10 next year.

Market Impact of Bitcoin Spot ETF

Taking gold spot ETF as an example, on March 28, 2003, the first gold spot ETF, ETFS Physical Gold, was approved in Australia. Then on November 18, 2004, the world's largest gold spot ETF, SPDR Gold Trust, was approved in the United States. This had a huge impact on the global gold market. In the following ten years, the price of gold rose from US$332/ounce to US$1,600/ounce.

Before the launch of gold spot ETFs, it was difficult for investors to invest in gold directly. Investors could only gain exposure to gold by purchasing gold bars, but such low liquidity and efficiency discouraged many investors. The introduction of gold spot ETFs allows investors to gain exposure to gold without holding gold, and can trade it as easily as stocks. Through gold spot ETFs, many asset management institutions have included gold in their asset portfolios, which has injected huge liquidity into the gold market and led to a rapid rise in gold prices in the following decade.

In a sense, Bitcoin, known as digital gold, has many similarities with gold. Bitcoin is regarded by the mainstream financial market as an asset with hedging properties, safe-haven properties and diversification. Therefore, even considering its volatility, a large number of asset management institutions are willing to include Bitcoin in their asset portfolios. However, due to the restrictions of compliance and approval processes, mainstream asset management institutions cannot directly hold Bitcoin. What the market urgently needs is a compliant financial tool to help investors overcome these difficulties, which is also the essential reason why Bitcoin spot ETFs have been promoted.

Bitcoin spot ETF will become the biggest bridge between mainstream asset management institutions with a scale of about 50 trillion US dollars and Bitcoin with a market value of less than 1 trillion US dollars. It will inject trillions of liquidity into Bitcoin. Bitcoin spot ETF has the following potential market impacts:

1. Increase direct investment in Bitcoin: Bitcoin spot ETFs will attract mainstream investors in the financial market. Bitcoin has always been limited by high learning costs and lack of financial instruments, which makes the mainstream asset management industry lack effective investment channels to invest in Bitcoin. Such institutional investors are unable to provide clients with direct investment services in Bitcoin or other cryptocurrencies due to compliance and approval process restrictions. The arrival of Bitcoin spot ETFs allows mainstream investors, especially institutional investors, to gain exposure to Bitcoin with familiar financial instruments.

2. Improve the legal recognition of Bitcoin: Bitcoin spot ETF will further enhance the status of Bitcoin in the mainstream financial system. Traditional asset management institutions are often unable to directly hold Bitcoin or buy it from centralized exchanges due to legal reasons. Bitcoin spot ETF can solve this problem, because through Bitcoin spot ETF, asset management institutions will be able to provide investors with legally protected assets. This can promote the legal recognition of Bitcoin by the mainstream market and enhance the mainstream market's confidence in Bitcoin.

3. Expand asset management institutions' asset portfolios: Bitcoin spot ETFs will provide asset management institutions with a more diversified asset portfolio. Compared with the financial instruments provided by existing Bitcoin futures ETFs and trust institutions, Bitcoin spot ETFs can provide direct exposure to Bitcoin on the one hand, and reduce the spread between share value and reserve Bitcoin on the other hand. This is a better financial tool for asset management institutions that want to participate in the Bitcoin market.

Looking into the future of Bitcoin

After more than a decade of development, Bitcoin's recognition in the mainstream financial market has continued to increase. Driven by investors and asset management institutions, regulators, although reluctant, still need to recognize the value of crypto assets such as Bitcoin at the legal level, thereby opening the door to Bitcoin for mainstream asset management institutions.

The approval of the Bitcoin spot ETF is only the beginning of mainstream financial markets entering the crypto market. Since this year, global regulators have been actively establishing a regulatory framework for the crypto market. It should be noted that the actions of regulators will not affect the anti-censorship of crypto assets, which is determined by cryptography and the degree of decentralization of crypto assets. On the contrary, the actions of regulators can help investors eliminate scams disguised as technology in the crypto market, and clear obstacles and establish norms for mainstream financial institutions to enter the crypto market.

The EU has made great progress in establishing a regulatory framework for the crypto industry this year. The European Commission has been working on establishing a regulatory framework for the crypto industry since 2018, and voted to pass MICA (Markets in Crypto-Assets Regulation) on April 20 this year, which is currently the most comprehensive regulatory framework for the crypto industry in the world. The EU hopes to take advantage of the regulatory vacuum in the US crypto market to establish a sound regulatory framework and create legal certainty for large technology companies and asset management institutions to enter the crypto market, thereby playing a leading role in regulating cryptocurrencies globally.

Compared to the Bitcoin spot ETF, which aims to create a financial instrument for investing in Bitcoin, MICA is more ambitious. Its goal is to pave the way for all institutions to directly invest in or participate in the crypto market.

The market generally expects that with the launch of the Bitcoin spot ETF and the Bitcoin halving, coupled with the end of the Fed's interest rate hike cycle, the Bitcoin market value will usher in an unprecedented increase. But from a long-term perspective, this may just be the beginning. The approval of the Bitcoin spot ETF will undoubtedly be a major turning point in the history of Bitcoin and even the world's financial history. In the future, we will see the continuous implementation of the global regulatory framework, and Bitcoin will be deeply integrated with the mainstream financial market and become the digital gold that everyone agrees on.