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Bitcoin ETFs are finally coming to the U.S. in 2024 and, by all indictions, the first ones will hit the market sometime in mid- to late-January. But now that the long-standing issues of if and when are resolved, the hot question surrounding Bitcoin ETFs is how exactly they will work—and, for now, the SEC is insisting on a process that doesn’t make a ton of sense and will ultimately result in retail investors paying for added complication. More specifically, the agency wants to bar the would-be ETF issuers from using Bitcoin for in-kind redemptions, and instead carry out these transactions with cash.
To understand what this means, it’s helpful to know how ETFs work. Remember that most ETFs contain a basket of percentages from other companies and the issuer relies on wealthy partners, the market makers, to ensure that the ETF percentage is worth it. It reflects the cost of the underlying percentages. This happens through an arbitrage formula that allows market makers to equip themselves with a basket of percentages and redeem them for new percentages in the ETF, which they can then sell at a profit. Or conversely, arbitrageurs can enter with percentages into the ETF and ask for the underlying securities in return. In either case, trades result in a closer alignment of the ETF’s inventory value with the underlying asset. It’s a clever formula that has made ETFs affordable and very popular. .
Unfortunately, when it comes to Bitcoin ETFs, the SEC allegedly insists that those transactions (those in which market makers exchange the underlying asset for new percentages or vice versa) be done in money and not “in kind. “Also make sure that the percentage value of the ETF largely follows the underlying asset (Bitcoin in this case), but it will also be more expensive.
This is possibly not due to tax implications (as Grayscale helpfully pointed out to Bloomberg Intelligence following an erroneous report last week) but rather the fact that ETF issuers will have to spend coins to exchange Bitcoin for coins and vice versa. It would be easier to let the parties transact in Bitcoin, but here we are. In any case, it will be retail 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. In fact, when it approved a gold ETF in 2014 (a new concept at the time), the SEC issued an explanatory letter detailing how the ETF’s issuer and its constituents would conduct in-kind transactions in gold bullion. This is evidently less expensive and more effective than requiring a gold ETF issuer to buy or sell new bullion with each swap. So why not do the same with Bitcoin, or at least allow refunds in cash and in kind?It is said that this is what Fidelity and BlackRock are asking for: corporations that hide the corporations.
The most charitable explanation is that the SEC views Bitcoin as a new asset that can simply be hoarded, and the company needs to minimize the possibility of doing harm in the form of proprietary trading through market makers and ETF issuers. The chances of such manipulation diminishing seem unlikely: recall that a federal appeals court rejected this argument when it forced the SEC to block the blocking of Bitcoin ETFs.
There is also another possible explanation for the SEC’s resolution to block in-kind purchases, which originates from the fact that, in the words of a Washington D. C. source, “Chairman Gensler hates to lose. “It’s conceivable that the company’s director, hurt by his defeat in court, would allow Bitcoin ETFs, but on terms that will make them more expensive and less attractive to buy. It’s an odd position for a company president who claims his most sensible priority is to take care of the little one.
Jeff John Robertsjeff. roberts@fortune. com@jeffjohnroberts
This story appears in Fortune. com
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