Bitcoin ETF Redemption Methods Pose Challenges to Issuers
The Bitcoin ETF race is heating up, and at least twelve issuers are vying for a spot-based product to be approved. However, challenges have arisen with the methods of fund share creation and redemptions, with regulators wanting one method and issuers wanting another.
On December 14, Bloomberg reported that this Bitcoin ETF ‘redemption contention’ creates additional challenges. “Wonky plumbing mechanics are in the zeitgeist as issuers and US regulators hammer out the final details,” it said.
Bitcoin ETF Mechanics
The SEC has publicly expressed reluctance to allow broker-dealers to handle Bitcoin. This makes it unlikely the regulator will approve a Bitcoin ETF with its typical redemption method, called “in-kind.”
There are two methods of ETF share creation and redemptions: cash creation and in-kind.
In-kind redemptions allow the ETF issuer to exchange the fund’s underlying assets. In this case, the underlying asset is Bitcoin with a market maker rather than transacting in cash when creating and redeeming shares.
This allows the ETF to issue creation units to participants without immediately selling the securities for cash. It also avoids taxable events and is favored by issuers.
Cash redemptions require the fund manager to sell the Bitcoin to distribute cash to redeeming shareholders. However, this creates taxable transactions.
Cash creation is when participants deposit cash in the ETF equivalent to the net asset value of the creation units to be created. This method provides more flexibility for the participants and is the one favored by the SEC.
Moreover, the SEC’s focus on redemption models in recent meetings with Bitcoin ETF issuers suggests it could insist on cash creations and redemptions as a requirement for approval.
Furthermore, cash redemptions could also result in tax bills for investors if the fund has to sell Bitcoin to meet redemptions. This would also result in a loss of the typical ETF tax efficiency.
“In the case of outflows when the issuer must raise cash by selling Bitcoin, that could result in capital-gains distributions for remaining holders.”
Issuers Tow the Line
Several Bitcoin ETF applicants have already agreed to cash creations and redemptions.
Invesco, Galaxy, Valkyrie, and Bitwise have recently amended their SEC filings to cash creations. However, BlackRock has proposed a “revised” in-kind model to the SEC.
On December 14, Senior ETF analyst James Seyffart commented on the recent flurry of questions regarding the two methods and tax implications.
“Should be more of an inconvenience than anything for most people,” he said before adding:
“So, while I wouldn’t say its meaningless – it’s also not massively detrimental or horrible as some people on twitter seem to be saying.”