The cold thinking behind the ETF fever: the game between regulation and the market

With the positive stimulus of Bitcoin ETF, the price of Bitcoin once again broke through a record high. So in the context of the US SEC’s further tightening of encryption supervision, why can futures ETFs be approved for listing? How does it work?

Judging from the statement of the chairman of the SEC, the approval of this ETF is based on the 1940 Investment Company Act, which provides a better investor protection mechanism and regulatory framework.

At the same time, many people in the industry believe that the actual significance of Bitcoin futures ETFs is limited, such as the existence of a certain premium, low price tracking efficiency, and limited position holdings. At the same time, the attractiveness of institutional funds is very limited.

The crypto market is eager for more funds and liquidity, and regulators are trying to improve the investor protection mechanism. Futures ETFs are a temporary compromise between the two parties. In the future, spot ETFs will further become the focus of the game.

Author | Richard Lee

At 9:30 am on October 19th, U.S. Eastern Time, the first Bitcoin ETF in the United States was officially launched on the New York Stock Exchange. The trading volume on the first day was 24.42 million shares, valued at nearly 1 billion U.S. dollars, making it the most popular financial market investment on that day. One of the most popular ETFs.

The “Bitcoin Strategy ETF” was launched by American asset management company ProShares. It was recently approved by the US SEC to go public. It was the first ETF approved in the 8-year history of US Bitcoin ETF applications. This is regarded as a milestone in the field of cryptocurrency, which means that Bitcoin has opened its door to the capital-rich place-the mainstream U.S. market. It also provides institutional investors who suffer from inefficient trust funds and individual investors who are not familiar with cryptocurrencies. A relatively convenient investment tool.

According to the ProShares release note, the ETF trading code is BITO, which is actually a Bitcoin futures ETF, betting on the future price trend of Bitcoin, rather than directly investing in Bitcoin spot. BITO mainly invests in compliant futures contracts traded on the Chicago Mercantile Exchange, with an annual management fee rate of 0.95%. As of October 19, it has held contract positions worth more than US$570 million.

Following BITO, the market expects that more Bitcoin futures ETFs will be approved. The Wall Street Journal quoted analysts as saying that asset management companies Valkyrie Investments, Investco and VanEck are expected to obtain SEC licenses within October, while Ark Investment Management, Galaxy Digital, BlockFi and other institutions may launch similar products before the end of the year.

Affected by this event, the price of Bitcoin has been rising all the way since the beginning of October, and today it broke through a record high of US$67,000. In addition to the cheers of crypto enthusiasts, what other thoughts can this ETF listing event bring to the industry?

Why was approved

Since the Winklevoss brothers, founders of Gemini, submitted their first Bitcoin ETF application in 2013, such applications have been rejected continuously for 8 years. So this time, why can ProShares successfully apply?

As a director of an investment research agency told the Wall Street Journal: “This is made possible because of the public guidance provided by the SEC.”

What the executive said was that SEC Chairman Gary Gensler revealed the regulatory inclination for Bitcoin ETF for the first time at the Appens Security Forum in August this year. In the above forum, GaryGensler hinted for the first time that Bitcoin futures ETFs based on the CME market are more likely to be “released” than spot ETFs.

In an interview with CNBC on the 19th, Gary Gensler further explained the reasons. “For the past four years, Bitcoin futures have been regulated by the United States Commodity Futures Trading Commission (CFTC), a sister institution of the US SEC, and it has also passed the 1940″ The Investment Company Act was incorporated into the jurisdiction of the U.S. SEC.”

It is reported that most of the previously unapproved ETF applications in the United States were submitted in accordance with the Securities Act of 1933 (The Securities Act of 1933). Gary Gensle said that regulators are more likely to see ETF applications filed under the Investment Company Act of 1940 (The Investment Company Act of 1940) because the latter provides better investor protection.

The “Investment Company Act” of 1940 brought mutual fund issuing companies into the jurisdiction. In addition, generally speaking, the Securities Act of 1933 focuses on improving investor transparency, while the Investment Company Act of 1940 focuses on the regulatory framework for retail investment products.

In terms of restrictive measures, Bloomberg quoted lawyers to analyze that the 1940 Act additionally required the fund to establish an independent board of directors and restrict the trading of ETFs by related parties. At the same time, the fund’s board of directors must closely monitor the investment. Wang Wei, partner of Tianyuan Lawyer, told Chain Catcher that the focus of the 1940 Act was to require ETF issuers to regularly disclose information about the fund and its investment objectives, as well as the structure and operation of investment companies.

It is precisely under the disclosure of the above regulatory signals that many institutions such as ProShares submitted applications for Bitcoin futures ETFs in August. Although ProShares compromised at the last minute and deleted spot exposures such as Canadian ETFs and collective investment trust funds, the final approval of BITO still reflects the importance of regulatory certainty to the industry.

It is worth noting that while SEC Chairman Gary Gensler has further contracted encryption regulatory policies and criticized DeFi and the stablecoin industry, he has actively “released” Bitcoin ETFs, which further reflects Gary Gensler’s encryption regulatory philosophy, which is to promote regulatory-compliant encryption. Products are incorporated into the existing financial system, while promoting policies to strictly control high-risk non-compliant products, and establishing a clear regulatory mechanism for crypto products that have been in a gray area for a long time.

In addition, Simeon Hyman, a global investment strategist at ProShares, also pointed out three advantages of futures ETFs. First, the futures market often leads the spot market in price discovery, but CME Group futures are regulated to provide investors with protection from the market. For the protection of manipulation, the third is that Bitcoin futures are more liquid.

However, futures ETFs based on these considerations have not won most recognition within the crypto industry.

Futures ETFs have limited meaning

According to the prospectus, BITO invests in cash-settled “near-month bitcoin futures”, which refers to futures contracts with the shortest expiration time. Nevertheless, Gu Yanxi, a senior researcher in the encryption field, believes that due to the characteristics of futures ETFs, their approved value is not as good as spot ETFs.

According to his analysis, for the market, futures itself has a leverage attribute, so Bitcoin futures ETFs are equivalent to Bitcoin physical “derivatives”. He believes that the circulation of such products may not be conducive to the stability of the financial market.

On the other hand, investors will also favor ETFs linked to Bitcoin spot. Gu Yanxi said that compared with spot ETFs, futures ETFs have lower market efficiency and higher transaction costs. Futures contracts are often used as speculative tools, and their trading prices are often different from the spot price of Bitcoin. Therefore, the efficiency of price tracking of ETFs based on futures contracts is also low.

The speculative and bullish market sentiment in the crypto field usually pushes the price of bitcoin futures higher, making it higher than the spot price of bitcoin for a long time. This phenomenon is also known as “futures premium.” In the state of futures premium, the ETF manager will implement a “roll” (or “rolling”) operation-continuously selling expired contracts and buying futures contracts with later expirations. Because the rolling costs required for these operations are borne by investors, the return on investment of Bitcoin futures ETFs will also be discounted.

Despite the above-mentioned disadvantages and risks of the first ETF, Gu Yanxi believes that the launch of BITO will still be “very popular” in the long drought.

At the same time, other industry veterans also expressed doubts about BITO’s performance. Juthica Chou, head of over-the-counter options trading at Kraken Digital Asset Exchange, analyzed Bloomberg. Compared with previous years, US individual investors can now easily buy and sell cryptocurrencies on global cryptocurrency exchanges and retail-led platforms such as PayPal and Square. He is not sure whether the issuance of ETFs will trigger a lot of market demand.

Accordingly, traditional financial institutional investors are more interested in Bitcoin futures ETFs.

Gu Yanxi pointed out that many American investors buying Grayscale Trust Funds, MicroStrategy (note: the company buys Bitcoin spot from time to time), and mining company stocks are all trying to indirectly hold Bitcoin, but this type of method is usually It is not convenient.

Take the Grayscale GBTC Bitcoin Trust Fund as an example. The fund holds about 3.5% of the bitcoins in the global circulation market, with assets under management of 40.5 billion U.S. dollars, but its fund shares have a lock-up period of up to 6 months. It is not redeemable and is not an efficient investment tool for institutions.

However, David Nadig, head of research at ETF Trends, also tweeted today that most of the trading volume of ProShares’ Bitcoin futures ETF on the first day are small-volume transactions, which means retail investors, speculators, and high-frequency traders, not Large-scale organization configuration.

The market demand for spot ETFs is solid, but when it will be approved is still unknown

On October 19, Grayscale officially announced that it had submitted an application to the SEC to convert the Bitcoin trust fund into a Bitcoin spot ETF. Grayscale described the move as “a response to the current watershed moment.”

In an official press release, Gray said that the SEC approved the Bitcoin futures ETF, indicating that the regulator is satisfied with Bitcoin as an underlying asset. At the same time, some media believe that this move is also trying to put pressure on the SEC through the Bitcoin spot ETF.

According to Coindesk, one of the main reasons for the SEC’s rejection of Bitcoin spot ETFs lies in concerns about transparency and market manipulation. ETFs may buy Bitcoin from various cryptocurrency exchanges, but not all of these exchanges are regulated by the SEC. It is difficult to predict whether the physical price of Bitcoin will be manipulated.

With the listing of Bitcoin futures ETF, Grayscale faces the threat of customer diversion. Bitcoin trust funds have a disadvantage in terms of pricing, with an annual management fee rate of 2%, more than double that of BITO.

The grayscale application will have a 75-day approval period, after which the SEC will make a tacit approval, rejection or extension decision. Regardless of whether the application can be passed or not, Gu Yanxi pointed out that the market share of Grayscale GBTC and many other bitcoin spot ETF applications waiting for approval indicate that the market has a strong real demand for spot ETFs.

He believes that in addition to protecting investors, another basic function of the SEC is to improve the efficiency of market capital allocation. Therefore, the SEC is unlikely to ignore this market demand for too long. The subsequent SEC should cooperate with various institutions to strengthen market risk. Supervise and then release the Bitcoin spot ETF.

However, due to the aforementioned regulatory signals, before the establishment of an overall regulatory framework for the crypto market, the regulatory authorities are still vigilant about the actual logistics of cryptocurrencies. It is still difficult to predict when the spot ETF will be approved, and the game between the crypto market and supervision may continue to be more intense. Long time.

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