Regulatory

Shifting Tides: International Regulatory Developments in Bitcoin ETFs

By Brian Hunt and Mark Costello
16 November 2021

In this Insight (Part 1 of 2) we review recent international developments which seem to signal the beginning of a shift in how regulators view exchange traded funds which afford access to bitcoin exposure.

Introduction

Bitcoin reached a new all-time high value a day after a bitcoin futures-based exchange traded fund (“ETF”) launched on Wall Street for the first time. The launch marks a milestone for the crypto industry, with the ETF potentially providing access to bitcoin exposure to a whole new category of traditional investor. In addition to Bitcoin Futures ETFs, we also consider developments involving Equity-based Bitcoin ETFs, Bitcoin Exchange Traded Products, and the challenges that are faced by Physical Bitcoin ETFs.

Recent US Approval of Bitcoin Futures ETFs

On 19 October 2021, the ProShares Bitcoin Strategy ETF, a fund tracking the price of bitcoin futures contracts, started trading on the New York Stock Exchange. For the first time, this enabled investors to gain exposure to an index tracking the price of bitcoin futures contracts – financial trading instruments that allow directional bets on the future price of bitcoin. ProShare’s fund became the fastest ETF ever to cross the threshold of over one billion US Dollars in assets, signifying the large appetite of investors for bitcoin exposure through a more traditional vehicle.

Prior to the ETF’s approval, comments from the U.S. Securities Exchange Commission (“SEC”) Chairman Gary Gensler indicated that the SEC would look more favourably on a bitcoin futures ETF. This led to a flurry of bitcoin future ETF applications from money managers including the now SEC approved ETFs managed by ProShares and Valkyrie Digital Assets.

The SEC’s preference for ETFs based on bitcoin futures contracts appears to be driven by the fact that the futures contracts in question are regulated by the Commodity Futures Trading Commission. The futures contracts are also traded on a regulated exchange operated by the CME Group. These factors seem to suggest that the SEC looks more favourably on ETFs tracking the performance of regulated instruments as opposed to physical bitcoin, and particularly so while concerns regarding the risks of fraud and market manipulation in the widely unregulated bitcoin market remain.

US and French Approval of Equity-based Bitcoin ETFs

Prior to the approval of ProShare’s ETF, the SEC also approved the Volt Crypto Industry Revolution and Tech ETF, an equity-based bitcoin-correlated ETF. The Volt ETF offers exposure to the share prices of publicly listed companies whose valuations are heavily correlated to the price of bitcoin[1].

This SEC approval follows the decision of the French regulator to approve the Melanion BTC Equities Universe UCITS ETF which tracks the performance of an index of companies with high revenue exposure to bitcoin.

In approving Melanion’s ETF, French regulators ruled that the ETF met key EU investor protection standards under UCITS. A major benefit of complying with the UCITS standards means that the ETF is available to investors across the EU – a first for a bitcoin-correlated fund.

Bitcoin Exchange Traded Products

There are also a number of exchange-traded products (“ETPs”) listed in Europe tracking the price of bitcoin. However, while they are regulated as securities, they do not comply with the UCITS standard. ETPs can carry steep management fees and suffer from liquidity issues – problems that are less commonly associated with ETFs.

In the US, the SEC has repeatedly rejected bitcoin-related ETP proposals. This has contributed to the Grayscale Bitcoin Trust amassing a high level of investment – $37 billion in assets under management – despite both the fact that the trust has high annual fees and is traded on the over-the-counter market, a less-regulated venue than the country’s national stock exchanges. The Grayscale Bitcoin Trust uses a traditional investment vehicle that allows investors to trade shares in a trust holding bitcoin. Grayscale has recently announced plans to convert its Grayscale Bitcoin Trust into a physically backed bitcoin ETF if and when the SEC becomes more amenable to a physical bitcoin ETF.

Physical Bitcoin ETFs

A physically-backed ETF is seen as the holy grail of bitcoin investment vehicles. The structure of such an ETF holds the underlying assets or securities on which its value is based. Bitcoin investors might therefore be keen for such ETFs to be approved in anticipation of further ensuing price action in the underlying asset. No physically backed bitcoin ETF, whereby bitcoin is actually held by the fund in question, has yet been approved in the U.S.

Physical bitcoin ETFs have however been launched in Canada. The Purpose Bitcoin ETF and the 3iQ CoinShares Bitcoin ETF, both trade on the Toronto Stock Exchange and have proved popular with investors.

In Europe, Jacobi Asset Management has recently won regulatory approval from the Guernsey regulator for its physically-backed bitcoin ETF; however, it is awaiting UK Financial Conduct Authority approval to be listed on the CBOE Europe – a pan-European equities exchange. The fact that Jacobi’s ETF is not UCITS compliant however, means that it will not be available throughout the EU.

EU regulators have interpreted the requirement of the UCITS as prohibiting digital assets from being held directly in a UCITS fund. It therefore appears almost impossible for a physically-backed bitcoin ETF to be granted the UCITS standard.

Conclusion

As the experience in the U.S. has shown, investors appear to have a huge appetite for bitcoin-related investments. Despite this, it appears that regulators in the US and in Europe are still not yet ready to greenlight physical bitcoin ETFs for mainstream access. Fears about market manipulation in the cryptocurrency sector seem to be significant obstacles in the approval of such products.

While regulatory authorities closer to home are right to tread cautiously when it comes to bitcoin-related ETFs, it will be fascinating to see how (and whether) they adapt their thinking on foot of international developments.

For more information on the content of this insight please contact:
Brian Hunt, Partner | E: brian.hunt@rdj.ie | T: +353 1 6054237

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[1] For example, the underlying shares in the ETF include bitcoin mining company Marathon Digital Holdings and the software company MicroStrategy which uses bitcoin as its primary treasury reserve asset.

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