The race for approval of Bitcoin Exchange-Traded Funds (ETFs) has intensified, with more than a dozen contenders seeking regulatory green lights. However, the road to approval is marred by disputes over share creation and redemption methods. Regulatory bodies and issuers find themselves at odds, each favoring a different approach.
The Redemption Conundrum
Recent reports highlight the growing discord over Bitcoin ETF redemptions. The intricacies of “plumbing mechanics” have taken center stage as issuers and US regulators negotiate the final details, as reported by Bloomberg on December 14.
The US Securities and Exchange Commission (SEC) has openly expressed reservations about broker-dealers handling Bitcoin. This reluctance casts doubt on the regulator’s approval of the conventional “in-kind” redemption method.
Two primary methods govern ETF share creation and redemptions: in-kind and cash.
In-Kind Redemptions: A Favored Choice
In-kind redemptions enable ETF issuers to swap the fund’s underlying assets, typically Bitcoin, with a market maker when creating or redeeming shares. This method grants ETFs the ability to issue creation units to participants without immediate cash transactions. Moreover, it sidesteps taxable events, making it a preferred choice among issuers.
Cash redemptions necessitate fund managers to sell Bitcoin in order to distribute cash to redeeming shareholders. However, this process triggers taxable transactions, leading to potential tax liabilities for investors. Additionally, this approach compromises the typical tax efficiency associated with ETFs.
Cash creation involves participants depositing cash equivalent to the net asset value of the creation units within the ETF. This method offers greater flexibility for participants and aligns with the SEC’s preferences.
The regulatory body’s recent discussions with Bitcoin ETF issuers indicate a potential insistence on cash creations and redemptions as prerequisites for approval. This approach aims to address concerns regarding taxable events and enhance transparency.
Tax Implications and Capital Gains
The prospect of cash redemptions raises concerns about capital gains distributions for remaining holders when the issuer must liquidate Bitcoin to fulfill redemption requests.
In response to the evolving regulatory landscape, some Bitcoin ETF applicants have adjusted their strategies. Notably, Invesco, Galaxy, Valkyrie, and Bitwise have amended their SEC filings to adopt cash creations and redemptions. However, BlackRock has proposed a “revised” in-kind model to the SEC, highlighting the ongoing debate within the industry.
James Seyffart, a Senior ETF analyst, weighed in on the ongoing discussions regarding redemption methods and tax implications. He believes that while these developments may pose inconveniences, they are not as detrimental as some social media discussions suggest. In his view, these changes are unlikely to have a massive negative impact.