In this blog post, BPI intern Zack Cohen breaks down the ongoing saga surrounding the approval of a spot bitcoin ETF.
An Exchange-Traded Fund (ETF) trades like a stock but typically contains a diversified portfolio, including stocks, bonds, or commodities such as gold and oil. Commodity ETFs, considered high-risk, offer investors exposure to commodities without direct ownership but have associated tradeoffs. Take, for example, GLD, the most popular spot-price gold ETF. Until GLD’s launch in 2004, gold could only be traded via bullion or mining stocks, likely limiting the number of potential investors due to custody challenges and indirect exposure to the underlying asset. Within only 72 hours of its launch, GLD had amassed over $1 billion in investment, evidence of significant market demand for a streamlined method of gaining exposure to gold’s spot price. On the other hand, while the ETF provided easier access to gold investment, it also introduced challenges, such as the inability to confirm if shares were backed by physical gold and potential counterparty risks like theft or insolvency. Furthermore, GLD's price often deviates from physical gold prices, indicating a risk to be considered by investors, which is also relevant for discussions on a potential Bitcoin spot ETF.
In the U.S., ETFs are subject to stringent regulations, with oversight from the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 and the Investment Company Act of 1940. In order to list a commodity ETF, firms must apply with the SEC; to date, no firm has received approval from the SEC to create a Bitcoin spot ETF.
Among those vying for approval is Grayscale, a firm currently offering the Grayscale Bitcoin Trust (GBTC) to its investors. Unlike an ETF which offers constant share creations and redemptions, GBTC currently operates as a closed-end fund. This operational nuance is critical as it often leads to a divergence between the share price and the actual market value of the underlying asset, evidenced when GBTC shares experienced a significant trough, trading at a 30 percent discount relative to Bitcoin's spot price. This means that anyone who bought GBTC when it was at par with Bitcoin’s spot price, lost 30 percent of their value as opposed to holding the asset personally.
In October of 2021, Grayscale filed to convert GBTC into a Bitcoin spot ETF, receiving a denial of their application not long after. Grayscale then sued the SEC alleging that the SEC violated a provision of the Administrative Procedure Act (APA) that dealt with treating like cases alike. Ultimately, the Washington D.C. Circuit Court found that “the SEC’s denial of Grayscale’s application for a bitcoin spot ETF was “arbitrary and capricious,” thereby violating requirements of the Administrative Procedure Act (APA).”1 While this decision will not immediately bring forth the first spot Bitcoin ETF, it does mean that the SEC will need to either begin approving applications or find another reason to continue denying them. The specifics of the court's findings and the history of these legal proceedings is further detailed here by BPI’s legal fellow, Zack Shapiro.
The introduction of a Bitcoin ETF has a number of tradeoffs, with the primary benefit being a reduction in complexity for the average investor. By eliminating the technical barriers associated with buying and storing Bitcoin directly, such as navigating digital wallets and managing private keys, a Bitcoin ETF provides a straightforward path for investors to gain exposure to bitcoin’s price without having to handle the asset themselves. This ease of access extends to institutional investors, who can more comfortably enter the Bitcoin market under the regulated and familiar structure of an ETF.
Thus, a spot ETF may drive increased investment in bitcoin, which could improve market stability in turn. Presently, many investors are deterred by Bitcoin’s dramatic price fluctuations. Large volatility swings are commonly caused by an excess of sellers or buyers at any given moment. Assuming a spot ETF drives more investment, the increase in the number of buyers and sellers has the potential to equalize these imbalances over time, reducing sharp price movements and making the asset less daunting for new investors.
While a Bitcoin ETF might stabilize price volatility to some extent and streamline the investment process, it does so by integrating Bitcoin into the very financial system it was conceived outside of. This integration presents a trade-off: it offers increased accessibility and a form of legitimacy within mainstream finance while potentially straying from the roots of what makes Bitcoin unique and valuable. Fundamentally, Bitcoin is different from existing financial instruments because users can custody the asset with little to no trust in others. Thus, in order to gain the core benefits of the technology outside of speculating on its price, users must custody the asset themselves. Not only will investors miss out on one of Bitcoin’s core benefits, but in choosing to outsource their custody, they expose themselves to systemic risks and counterparty uncertainties inherent in the traditional financial sector.
Furthermore, detractors of the technology worry about the message that the acceptance of Bitcoin ETFs sends to the public. By legitimizing it as an investment, traditional investors might interpret this as a seal of approval on Bitcoin's value and stability, potentially overshadowing meaningful uncertainties and risks associated with the technology.
The first application to be filed and accepted by the SEC for review was from Ark and 21Shares on May 15, 2023. In mid-June, an onslaught of additional applications rolled in following breaking news that Blackrock, the world’s largest asset manager, had entered the pool. Upon receipt of these applications, the SEC has a total of four deadlines with which they can approve, deny, or defer the applications, each of which is 45 days after the previous one. However, on the fourth deadline, they are required to either approve or deny the application. Thus 180 days following the filing of the application, the SEC can no longer defer and must come to a decision. This puts Ark and 21Shares deadline for approval on January 10, 2024 and Blackrock’s on March 15, 2024.
It is also important to note that the SEC allows filers to amend their applications as the review process unfolds. Thus onlookers should not be surprised to see applications amended throughout the process as the SEC clarifies its expectations. In mid-October, Blackrock amended their application to reflect their plans to seed the fund with Bitcoin during November. Onlookers should continue to expect to see changes and updates like this as the process nears certain deadlines.
While there is a potential for the SEC to approve or deny applications before these deadlines, it is unlikely that onlookers will see any action until 2024. It is also worth noting that the ruling in the Grayscale Investments v. SEC case has caused analysts at Bloomberg to increase their projected odds of approval from 65% to 75%. They did state that they had factored in a win for Grayscale, but not with the unanimity and vigor expressed in the decision. In this vein, Blackrock has an unprecedentedly high approval rate for ETF filings with a record of 575 approvals for only one rejection.
Just in the past few weeks, Blackrock’s iShares Bitcoin Trust appeared on a list managed by the Depository Trust & Clearing Corporation (DTCC). The DTCC is one of the largest settlers and custodians for US financial instruments, and Blackrock’s listing within their system is evidence of preparations being made for operation of the fund. Blackrock has also recently filed for a Committee on Uniform Securities Identification Procedures number, which is another step in bringing an ETF to market, pending SEC approval.