Investors Await Approval of Bitcoin ETF
Investors are eagerly anticipating the potential approval of a spot bitcoin exchange-traded fund (ETF) by the United States Securities and Exchange Commission (SEC). The excitement began in early June when the investment giant BlackRock submitted a filing for the product and gained further momentum after a court decision mandated the SEC reconsider its rejection of Grayscale’s proposal to transform its Bitcoin Trust (GBTC) into a spot ETF.
Challenges with Unregulated Bitcoin Trading
The SEC’s objection to ETFs is related to the fact that Bitcoin (BTC) is traded in unregulated venues around the world, which poses a challenge in preventing fraud and price manipulation.
Surveillance-Sharing Agreements (SSA) as a Solution?
One attempt to address the issue has included surveillance-sharing agreements (SSA) with some cryptocurrency exchanges. In theory, this would allow the identification of bad actors who attempt to manipulate the market. Critics question the efficacy of these SSAs given they cannot cover the entire market. ETFs are based on precedent decisions that allowed spot commodity ETFs based on the relevance of the underlying commodity futures markets.
Price Formation and Manipulation Risks
The SEC has established that the futures should lead the spot in price formation in order to be considered a “regulated market of significant size.” Yet, even if price discovery is led by the futures market, there are still some cases where manipulation in the spot markets can spread to the ETF. The devil is in the details, and more specifically, in the price source for the net asset value (NAV) calculation and in the creations and redemptions method (in-cash or in-kind).
The Impact of Manipulation on In-Kind Creations and Redemptions
If the creations and redemptions are in-kind, there is a straightforward arbitrage that acts like communicating vessels between the ETF and the unregulated spot markets. The manipulation in the spot market spreads to the ETF, at least in part.
The Arbitrage Possibility with Cash Creations and Redemptions
In a case where the creations and redemptions are in cash and the NAV is calculated with commodity prices derived from the unregulated spot markets, a very similar arbitrage is possible. The trade is basically the same as with in-kind creation and the consequences are similar.
Shielding the ETF from Manipulation
The use of spot prices derived from the futures curve for calculating NAV, coupled with in-cash creations and redemptions, emerges as the most promising alternative. The pipes connecting the spot price and the ETF price are obstructed, making it more difficult for manipulators to affect the ETF.
Establishing a Robust Link between ETF and Futures Market
On the flip side, this setup facilitates a straightforward arbitrage path between the ETF and futures. An arbitrageur can execute a trade in the opposite position with perfect hedging on futures, establishing a robust link between the ETF and the futures market.
A Good Development for Traditional Markets and Crypto Industry
A spot Bitcoin ETF in the U.S. would be a good development for both traditional markets and the crypto industry. It has the potential to be truly great for investors by providing attention to detail and keeping manipulators away.
About João Marco Braga da Cunha
João Marco Braga da Cunha is the portfolio manager at Hashdex. He obtained a master of science in economics from Fundação Getulio Vargas before obtaining a doctorate in electrical and electronics engineering from the Pontifical Catholic University of Rio de Janeiro.
Hot Take: The Potential of a Bitcoin ETF
A potential approval of a spot bitcoin exchange-traded fund (ETF) by the SEC is eagerly awaited by investors. The SEC’s objection to ETFs is due to the unregulated nature of Bitcoin trading, which poses challenges in preventing fraud and manipulation. Surveillance-sharing agreements (SSA) have been proposed as a solution, but their efficacy is questioned. Price formation and manipulation risks remain a concern, especially with in-kind creations and redemptions. To shield the ETF from manipulation, using spot prices derived from the futures curve for calculating NAV, coupled with in-cash creations and redemptions, appears to be the most promising alternative. This setup also establishes a robust link between the ETF and the futures market, making it resistant to manipulation. Overall, a Bitcoin ETF would be a positive development for traditional markets and the crypto industry.
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