The competition for a Bitcoin ETF is intensifying, with a dozen issuers seeking approval for spot-based products. However, complications have emerged regarding the creation and redemption methods of fund shares, as regulators and issuers advocate for different approaches. On December 14, Bloomberg highlighted the additional challenges stemming from this ‘redemption contention,’ noting that intricate mechanics are currently at the forefront of discussions between issuers and US regulators as they finalize the details.
Bitcoin ETF Operational Processes
The SEC has openly expressed hesitancy in permitting broker-dealers to manage Bitcoin, making it improbable for the regulator to endorse a Bitcoin ETF using its conventional “in-kind” redemption method.
There exist two approaches to ETF share creation and redemptions: in-kind and cash.
In in-kind redemptions, the ETF issuer can swap the fund’s underlying assets, such as Bitcoin, with a market maker, avoiding cash transactions during the creation and redemption of shares. This approach allows the ETF to issue creation units without immediate securities sales for cash, preventing taxable events and gaining favor among issuers.
Cash redemptions necessitate the fund manager to sell Bitcoin to distribute cash to redeeming shareholders, resulting in taxable transactions.
Cash creation involves participants depositing cash equivalent to the net asset value of creation units to be established in the ETF. This method offers more flexibility for participants and is the SEC’s preferred approach.
Recent SEC engagements with Bitcoin ETF issuers, emphasizing redemption models, indicate a potential insistence on cash creations and redemptions as prerequisites for approval.
Additionally, cash redemptions might lead to tax liabilities for investors if the fund sells Bitcoin to meet redemptions, diminishing the usual tax efficiency associated with ETFs, as noted by Bloomberg.
Issuers Adhere to Guidelines
Several applicants for Bitcoin ETFs have already embraced the use of cash creations and redemptions. Notably, Invesco, Galaxy, Valkyrie, and Bitwise have modified their SEC filings to incorporate cash creations. In contrast, BlackRock has submitted a “revised” in-kind model for consideration by the SEC.
On December 14, Senior ETF analyst James Seyffart addressed the recent surge in inquiries about the two methods and their associated tax implications. He remarked, “It should be more of an inconvenience than anything for most people,” before adding: