Bitcoin ETF Issuers and Regulators Clash Over Redemption Methods

The race to launch a Bitcoin exchange-traded fund (ETF) has intensified, with at least twelve issuers competing for regulatory approval. However, challenges have emerged in determining the methods of fund share creation and redemptions, leading to a clash between issuers and regulators.

According to a report by Bloomberg on December 14, there is a notable disagreement over the redemption methods, creating additional hurdles in the approval process. The mechanics of Bitcoin ETFs, particularly how shares are created and redeemed, are becoming a focal point in discussions between issuers and U.S. regulators.

The Securities and Exchange Commission (SEC) has expressed reservations about allowing broker-dealers to handle Bitcoin. This reluctance makes it less likely for the SEC to approve a Bitcoin ETF with the traditional redemption method known as “in-kind.”

There are two primary methods for ETF share creation and redemptions: in-kind and cash. In-kind redemptions involve exchanging the fund’s underlying assets, such as Bitcoin, with a market maker, avoiding immediate sales for cash. This method is favored by issuers as it prevents taxable events.

On the other hand, cash redemptions require the fund manager to sell Bitcoin to distribute cash to redeeming shareholders, resulting in taxable transactions and potentially creating tax bills for investors.

The SEC has shown a preference for cash creations and redemptions, emphasizing its focus on redemption models in recent discussions with Bitcoin ETF issuers. While cash redemptions may align with the SEC’s preferences, they could lead to capital gains distributions for remaining ETF holders, disrupting the typical tax efficiency associated with ETFs.

Several Bitcoin ETF applicants, including Invesco, Galaxy, Valkyrie, and Bitwise, have adjusted their SEC filings to include cash creations and redemptions. In contrast, BlackRock has proposed a “revised” in-kind model to the SEC.

The clash over redemption methods adds complexity to the already intricate process of gaining regulatory approval for a Bitcoin ETF. Analysts believe that while the issue is a point of contention, it may not be a decisive factor and could be viewed as an inconvenience rather than a substantial obstacle.

The battle over redemption methods underscores the challenges and nuances in bringing a Bitcoin ETF to market, as issuers navigate regulatory requirements and seek to strike a balance between operational efficiency and regulatory compliance.