Author: PSE Trading Intern @John Hol

In recent years, after the SEC rejected multiple applications for Spot Bitcoin ETFs, in August of this year, the SEC lost a case against Grayscale regarding the conversion of GBTC into a Spot Bitcoin ETF.Meanwhile, BlackRock, the world’s largest asset management firm, and several other institutions simultaneously submitted applications for a Spot Bitcoin ETF to the SEC. The arrival of Spot Bitcoin ETFs seems unstoppable.

What is Spot Bitcoin ETFs

Cryptocurrency Exchange Traded Fund (ETF) refers to an exchange-traded fund that tracks the price of one or more cryptocurrencies through investments in cryptocurrencies or related instruments. The widely discussed Bitcoin ETF is a type of ETF that tracks the price of Bitcoin, including Bitcoin Futures ETFs and Spot Bitcoin ETFs. The main difference lies in the fact that the underlying assets corresponding to the shares of Bitcoin Futures ETF are Bitcoin futures contracts, while the underlying assets corresponding to the shares of Spot Bitcoin ETFs are Bitcoin.

The most significant feature of ETFs compared to regular mutual funds is that they can be traded on traditional stock exchanges like stocks. This means that if a Spot Bitcoin ETF is approved, investors do not need to go through complex processes—such as downloading wallet plugins, creating public and private key pairs, or trading through centralized exchanges. Instead, they can directly purchase ETF shares to gain exposure to Bitcoin. While these processes may not pose a difficulty for individuals familiar with them, but for investors who are entirely unfamiliar with cryptocurrencies, there still exists a barrier. The Spot Bitcoin ETFs, however, reduces this barrier, providing these investors, especially institutional ones, with a familiar financial instrument and a sense of security with legal protection.

In terms of how a Bitcoin ETF operates, taking Bitcoin spot ETF as an example, the issuing institution first acquires Bitcoin assets either by directly purchasing them from Bitcoin holders or through centralized exchanges. These assets are stored in a secure Bitcoin wallet, such as a cold wallet with multiple layers of protection. Subsequently, the issuing institution creates fund shares whose value closely follows the fluctuations in Bitcoin’s price. Authorized Participants, typically large financial institutions, are responsible for creating and redeeming fund shares, often acting as secondary market makers. Investors can buy or sell fund shares on traditional stock exchanges, similar to trading stocks. Additionally, Authorized Participants may engage in arbitrage to ensure the consistency of fund share prices with the cost of Bitcoin when there are premiums or discounts in the fund share market.

The first Bitcoin ETF is the ProShares Bitcoin Strategy ETF (BITO), a Bitcoin Futures ETF, which began trading on the Chicago Mercantile Exchange in October 2021. However, the SEC has not yet approved any Spot Bitcoin ETFs.

The first financial instrument that created shares with Bitcoin as the underlying asset is the Grayscale Bitcoin Trust (GBTC). It made its debut in 2013 and officially began trading in 2015. In January 2020, GBTC received SEC approval for registration, becoming the first cryptocurrency investment tool to meet SEC standards. However, GBTC is not an exchange-traded fund (ETF) but a closed-end fund traded on over-the-counter exchanges. While GBTC shares allow investors to gain exposure to Bitcoin without directly holding Bitcoin, as a closed-end fund, the value of GBTC shares is determined by the supply and demand in the secondary market, not directly corresponding to the value of the backed Bitcoin. Therefore, there is often a premium or discount between the value of GBTC shares and the value of the Bitcoin it holds.

GBTC has been actively engaging with the SEC, seeking approval to convert into a Spot Bitcoin ETF, but it has faced continuous rejections. The turning point came in August 2023 when the Washington, D.C. Circuit Court of Appeals ruled that the SEC’s rejection of GBTC’s conversion to an ETF was wrong. The SEC is now required to reexamine the application, and the SEC has not appealed this ruling. While this decision does not guarantee automatic approval of GBTC’s application by the SEC, it sends an extremely positive message to the market.

SEC approval process

To put it simply, an institution submits materials for an ETF application to the SEC, and after confirmation, the SEC publishes a 19b-4 document in the Federal Register.Thereafter, the SEC will 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 been concerned about the lack of regulation of the spot cryptocurrency market, which was the main reason for its rejection of the crypto ETF application. In previous reasons for rejection, the SEC maintained that due to factors such as the lack of regulation and supervision of the cryptocurrency market, the lack of necessary information transparency, and the difficulty in ensuring the security of assets, lead to the “concerns about potential fraud and manipulation”, and emphasized that the market needs adequate information sharing and supervision.

After the SEC lost its lawsuit against Grayscale, the court ruled that the SEC can no longer use “potential fraud and manipulation” as a reason to refuse the approval of the Spot Bitcoin ETFs, but the SEC may still find other reasons to refuse the approval of the Spot Bitcoin ETFs.

Spot Bitcoin ETFs application status

In addition to Grayscale, several institutions applied for Spot Bitcoin ETFs with the SEC in 2023. Examples include iShares Bitcoin Trust by BlackRock, Wise Origin Bitcoin Trust by Fidelity, ARK 21Shares Bitcoin ETF by Ark Invest, and others. It’s noteworthy that many of these institutions are not applying for the first time. After years of negotiations with the SEC, they simultaneously resubmitted Spot Bitcoin ETFs applications almost at the same time this year, including BlackRock, which is applying for the first time. BlackRock, renowned for issuing index-tracking funds, has a dominant market share of nearly 50% in the U.S. ETF market with its flagship product, iShares. The success rate of BlackRock’s ETF applications is close to 100%. This is considered a significant factor in the market’s expectation that Spot Bitcoin ETFs will be approved next year.

Furthermore, institutions led by BlackRock have made significant adjustments to their strategies. To alleviate SEC concerns, institutions like BlackRock have proposed Surveillance-Sharing Agreements, which serve as a method to mitigate market manipulation and fraud risks. Surveillance-Sharing Agreements are agreements between cryptocurrency exchanges and regulatory authorities, allowing both parties to share trade data and information for monitoring transactions. In the event of suspicious trade data or information, this data is simultaneously shared with regulatory authorities, ETF issuers, and cryptocurrency exchanges. Both BlackRock and Ark Invest have chosen Coinbase Custody Trust Company as their Bitcoin custodian and New York Mellon Bank as their cash custodian.

Historically, SEC approvals for Spot Bitcoin ETFs have not been granted in advance, rather, the results are typically disclosed on the final approval date. The nearest final approval date is for the ARK 21Shares Bitcoin ETF, set to be announced on January 10, 2024. BlackRock and several other institutions have final approval dates on March 15, 2024. According to sources cited by Reuters, discussions between the SEC and asset management firms applying for Spot Bitcoin ETFs have delved into critical technical details, including regulatory arrangements, creation and redemption mechanisms. This indicates that the SEC might soon approve these products. We could potentially witness the approval of Spot Bitcoin ETFs as early as January 10th next year.

The market impact of Spot Bitcoin ETFs

Take the gold spot ETF as reference. On March 28, 2003, the first Gold Spot ETF, ETFS Physical Gold, received approval in Australia, followed by the approval of the world’s largest Gold Spot ETF, SPDR Gold Trust, in the United States on November 18, 2004. These events had a profound impact on the global gold market, leading to a significant surge in gold prices from \(332 per ounce to \)1600 per ounce over the subsequent decade.

Before the introduction of Gold Spot ETFs, investors faced challenges in directly investing in gold. Usually, investors could only gain exposure to gold by purchasing gold bars, but the low liquidity and efficiency of this approach discouraged many investors. The approval of Gold Spot ETFs allowed investors to gain exposure to gold without physically holding it, and they could easily trade it like stocks. As a result, numerous asset management institutions incorporated gold into their portfolios through Gold Spot ETFs, injecting substantial liquidity into the gold market and contributing to the rapid rise in gold prices over the following decade.

In a sense, Bitcoin, often referred to as digital gold, shares many similarities with gold. Bitcoin is considered by mainstream financial markets as an asset with hedging, safe-haven, and diversification properties. Therefore, despite its volatility, many asset management institutions are willing to include Bitcoin in their portfolios. However, constrained by regulatory compliance and approval processes, mainstream asset management institutions cannot directly hold Bitcoin. What the market urgently needs is a compliant financial instrument to help investors overcome these challenges, and this is the fundamental reason behind the continuous push for a Spot Bitcoin ETFs.

Spot Bitcoin ETFs is poised to become the key bridge connecting mainstream asset management institutions, with a market capitalization of around \(50 trillion, and Bitcoin, which has a market value of less than \)1 trillion. It has the potential to inject trillions of dollars in liquidity into the Bitcoin market. The potential market impact of a Spot Bitcoin ETFs includes:

1. Increase Direct Investment in Bitcoin: Spot Bitcoin ETFs will attract mainstream investors in the financial markets. Historically, Bitcoin has faced barriers to entry due to high learning costs and a lack of financial tools, making it challenging for mainstream asset management industries to find effective investment channels for Bitcoin. Institutional investors, restricted by compliance and approval processes, have been unable to offer direct Bitcoin or other cryptocurrency investment services to their clients. The advent of a Spot Bitcoin ETF sprovides mainstream investors, especially institutional investors, with a familiar financial tool to gain exposure to Bitcoin.

2. Enhance Legal Recognition of Bitcoin: Spot Bitcoin ETFs will further elevate Bitcoin’s position in the mainstream financial system. Traditional asset management institutions often cannot directly hold Bitcoin or buy it from centralized exchanges due to legal considerations. The Spot Bitcoin ETFs can address this issue, as asset management institutions can provide legally protected assets to investors through the ETF. This can promote legal recognition of Bitcoin in mainstream markets and boost confidence in Bitcoin within the mainstream financial sector.

3. Diversify the Asset Management Portfolios: Spot Bitcoin ETFs will offer asset management institutions a more diversified portfolio. Compared to existing Bitcoin Futures ETFs and financial instruments provided by trusts, Spot Bitcoin ETFs can  not only provide direct exposure to Bitcoin but also reduce the spread between the ETF’s share value and the reserved Bitcoin. This represents a better financial tool for asset management institutions looking to participate in the Bitcoin market.

Looking ahead to the future of Bitcoin,

After more than a decade of development, its acceptance in mainstream financial markets continues to rise. With constant push from investors and asset institutions, regulatory bodies, albeit reluctantly, find themselves needing to legally recognize the value of cryptographic assets like Bitcoin. This opens the door for mainstream asset management institutions to enter the world of Bitcoin.

The approval of Spot Bitcoin ETFs is just the beginning of mainstream financial markets venturing into the cryptocurrency market. Since the beginning of this year, global regulatory authorities have been actively establishing regulatory frameworks for the cryptocurrency market. It’s important to note that regulatory actions will not affect the cryptocurrencies’ censorship-resistant nature, which is determined by the decentralization of cryptocurrencies. Instead, regulatory actions can help investors filter out scams disguised beneath the technical facade in the cryptocurrency market and remove barriers for mainstream financial institutions to enter the market, establishing norms.

This year, the European Union has made significant progress in establishing a regulatory framework for the cryptocurrency industry. Since 2018, the European Commission has been working on building a regulatory framework for the cryptocurrency industry. On April 20th of this year, the European Parliament voted to approve MICA (Markets in Crypto-Assets Regulation), currently the most comprehensive regulatory framework for the cryptocurrency industry globally. The EU aims to establish a robust regulatory framework during the regulatory vacuum in the U.S., providing legal certainty for large technology companies and asset management institutions to enter the cryptocurrency market, thereby taking a leading role in globally regulating cryptocurrencies.

Compared to the Spot Bitcoin ETFs, 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 or participate in the cryptocurrency market.

The market generally expects unprecedented gains in the market value of Bitcoin with the launch of the Spot Bitcoin ETFs, Bitcoin halving, and the end of the U.S. Federal Reserve’s interest rate hike cycle. However, from a long-term perspective, this may just be the beginning. The approval of the Spot Bitcoin ETFs will undoubtedly mark a significant turning point in the history of Bitcoin and global finance. In the future, we can expect regulatory frameworks to continue to be established worldwide, deepening the integration of Bitcoin with mainstream financial markets and making it the consensus digital gold for everyone.