BTC ETF redemption method presents challenges for issuers

This article is brief:

• BTC ETF issuers face challenges in fund share creation and redemption methods, with regulators favoring cash creation.

• The SEC’s focus on redemption models suggests that it is likely to stick to cash creation and redemption as a requirement for BTC ETF approval.

• If the fund has to sell BTC to satisfy the redemption, the cash redemption may result in the investor paying taxes, thus losing the typical ETF tax efficiency.

BTC ETF race is heating up, with at least 12 issuers vying for spot product approval. However, challenges have arisen in the approach to the creation and redemption of fund shares, with regulators wanting one option and issuers wanting another.

On December 14, Bloomberg reported that the “redemption scramble” of BTC ETFs poses additional challenges. It said, “As issuers and U.S. regulators hammer out the final details, an unstable pipeline mechanism has become the zeitgeist.” ”

BTC ETF Mechanism

The U.S. Securities and Exchange Commission (SEC) has publicly expressed its reluctance to allow broker-dealers to process BTC. This makes it less likely that regulators will approve BTC ETFs with a typical redemption method, known as “spot”.

There are two ways to create and redeem ETF shares: cash creation and spot creation.

Spot redemptions allow ETF issuers to exchange the underlying assets of the fund. In this case, the underlying asset is the BTC of the market maker, rather than being traded in cash when the shares are created and redeemed.

This allows ETFs to issue start-up units to participants without having to immediately sell securities for cash. It also avoids taxable events and is favored by issuers.

Cash redemptions require the fund manager to sell BTC to distribute cash to redeeming shareholders. However, this creates a taxable transaction.

Cash creation is when a participant deposits cash equivalent to the net asset value of the created unit to be created into an ETF. This approach provides greater flexibility for participants and is favored by the SEC.

In addition, the SEC’s focus on redemption patterns at its recent meeting with BTC ETF issuers suggests that it is likely to stick to cash creation and redemption as a requirement for approval.

In addition, cash redemptions may also result in investors paying taxes if the fund has to sell BTC to satisfy the redemption. This also results in a loss of tax efficiency for typical ETFs.

"In the case of an outflow, the issuer must raise cash through the sale of BTC, which may result in the remaining holders receiving a distribution of capital gains. ”

Issuer tow line

Some BTC ETF applicants have already agreed to cash creation and redemption.

Invesco, Galaxy, Valkyrie, and Bitwise recently amended their SEC filings to cash creation. However, BlackRock has proposed a “revised” spot model to the SEC.