Exchange-traded funds are among the simplest and most popular financial instruments. If many retail investors only trade one instrument, it is probably an ETF. Various companies have been pitching the idea of a Bitcoin ETF to the US Securities and Exchange Commission for several years without success.
The SEC’s objection in the past has been that cryptoassets traded on exchanges that the SEC does not yet regulate are vulnerable to manipulation. To give the SEC credit, that is most likely true. Solidus Labs research found that of all crypto transactions in 30,000 liquidity pools since September 2020, about 13% were wash trading. According to the report’s authors, the figure for the overall market could be “an order of magnitude higher.”
The tricky thing for the SEC, however, is that there is actually an ETF for Bitcoin futures. Bitcoin futures are contracts to buy Bitcoin on a specific date. Since these contracts pay out the value of Bitcoin at maturity, a rolling stock of Bitcoin futures should roughly reflect the price of Bitcoin. Since the futures market is regulated by the Commodities and Futures Trading Commission and Bitcoin futures are traded on the Chicago Mercantile Exchange, the SEC is happy to support an ETF.
Even though the futures market may not be manipulated, the underlying asset is still Bitcoin, which the SEC says is vulnerable to manipulation. A court ruled that this distinction was arbitrary and capricious, and it now seems more likely than ever that the SEC will have to license BlackRock, GrayScale, or one of the other applications the SEC is currently working on.
While it appears that the SEC is in no rush to approve the applications it has received, Bitcoin ETFs appear to be inevitable. This is good news for Bitcoin holders. Given the convenience and popularity of the ETF format, Bitcoin ETFs could significantly increase the amount of money committed to Bitcoin. The simple fact that BlackRock is pursuing an application suggests that there is significant demand for the instrument. Accordingly, the price of Bitcoin increases after the announcement of positive news such as the recent court ruling.
In other financial markets, companies are working to develop tokenized versions of ETFs. The idea is that by creating a blockchain token that represents a share of an ETF or other financial asset, it can be traded more efficiently.
Tokenization is unlikely to play a major role for small investors. It doesn’t matter whether their broker (or their broker’s custodian) owns a blockchain token or is recorded as the owner of an asset on a central ledger somewhere. But it could lower their fees. If tokenization is able to reduce the risks and costs of settlement by reducing the number of failed trades and the capital required to offset the risks, the fees charged to the consumer should also be lower.
There are challenges – developing the infrastructure required to seamlessly interact with blockchain tokens and adequately manage risk is not easy. Tokenized assets have so far been relatively few and far between. For all its shortcomings, the crypto asset market is a place where investors can take their first steps by holding and exchanging blockchain tokens, interacting with decentralized financial protocols, and building expertise and technical capacity.
But Bitcoin ETFs are pushing market participants in the other direction. They offer investors the opportunity to immerse themselves in the volatile world of cryptoassets without facing the challenges of interacting with the digital asset ecosystem.
Cryptocurrencies may yet carve out an important economic niche, but whether they do or not, the spread of distributed ledger technology is likely to continue. It is entirely possible that DLT will become the foundation of our financial system, but cryptocurrencies themselves remain curiosities and collectibles.
Bitcoin ETFs provide exposure to the asset class’s performance, but slow progress in realizing the technology’s potential.
Lewis McLellan is Editor of the Digital Monetary Institute, OMFIF.
This topic is further explored in the OMFIF report “Digital Assets: Building the Markets of the Future.” Register for the opening on September 28th.
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