Future Future The New Era of Regulatory Compliance for Cryptocurrency ETFs

Revolutionizing Cryptocurrency ETFs Navigating the Future Era of Regulatory Compliance

Author: Dr. Yi, Okeychain Special Researcher, Senior practitioner in traditional financial institutions, with more than ten years of experience in macroeconomic research and nearly ten years of experience in alternative asset investment research.

Abstract: Since the market plunged into a deep bearish trend in 2022, various types of news have struggled to make a ripple, even the management scale of Bitcoin futures ETF has stopped growing. However, the news of BlackRock’s application for the issuance of a Bitcoin spot ETF has caused a stir in the market, sparking ongoing discussions on the topic. Investors frequently refer to the development history of gold ETFs and imagine the enormous potential growth that a Bitcoin spot ETF approval could bring to the industry. On the other hand, the weight of Bitcoin in the upcoming 2024 U.S. presidential election has become increasingly significant, prompting a softening in the Republican Party’s stance in order to win the votes of the crypto community. Meanwhile, the future of cryptocurrency spot ETFs is worth watching, as well-known asset management giants have quietly submitted applications for Ethereum spot ETFs, and players can also focus some of their attention on its progress.

1. Take history as a lesson to know the rise and fall – tracing the development of gold ETFs

• Bitcoin’s Bull Run Unveiling the Forces Behind the Rally and Setting Sights on BTC Price Targets
• Cryptocurrency Market is Rising Is the Golden October Coming?
• Chainalysis Report Overview of the Cryptocurrency Market in North America and the State of Stablecoins

Recently, under the market’s eager anticipation for a Bitcoin spot ETF, the current situation of a Bitcoin futures ETF seems somewhat bleak. The SEC has approved seven Bitcoin futures ETFs based on CME contracts, giving them a significant advantage. However, issues such as slippage caused by roll costs, transaction fees, and futures premiums have resulted in high holding costs, leading to slow growth in management scale. As of now, the total AUM is still just over $1 billion.

Source: USA Today, Okeychain Research Institute

In contrast, Bitcoin spot ETFs do not have the aforementioned drawbacks. On June 15, 2023, the world’s largest asset management firm, BlackRock, submitted an application for a Bitcoin spot ETF called iShares to the SEC. With an AUM of nearly $10 trillion, its 576 ETF applications, which were approved 575 times, renewed hopes for the approval of a Bitcoin spot ETF. Subsequently, numerous TradFi giants followed suit, including Wisdom Tree, Invesco, Galaxy, and others.

However, the SEC deemed that BlackRock did not meet the sufficient application requirements and did not disclose the cryptocurrency exchanges that have signed the “Surveillance Sharing Agreement (SSA),” thus rejecting its initial application.

Afterwards, BlackRock designated Coinbase as an SSA partner and resubmitted the application in response to the SEC’s comments.

Source: CCData, Okeychain Research Institute

According to the SEC’s response deadline, the final deadline for their response to iShares’ application is March 9, 2024.

Source: GSR, Eureka Cloud Chain Research Institute

The outcome of iShares is still uncertain, but BlackRock’s CEO has referred to Bitcoin as the digital gold of the 21st century. Therefore, looking back at the history of gold ETFs can provide some valuable insights.

Drawing a parallel to the transformative impact of gold ETFs on the gold market, a Bitcoin spot ETF could potentially trigger a market revolution. On November 18, 2004, the first gold ETF, SPDR Gold Trust ETF (GLD), was listed on the NYSE by State Street Bank. This ETF significantly reduced the investment threshold for the gold market and solved storage and transportation issues. History may not repeat itself, but it might rhyme, and a Bitcoin spot ETF could potentially bring about a similar revolution. Investors can hold Bitcoin long-term through ETFs without worrying about private keys and custody.

From a price performance perspective, gold ETFs attracted a large number of new investors and incremental capital, driving the rapid growth of the gold price. From the listing of GLD until mid-2011, gold was in a sustained upward trend, peaking in August at around $1,900 per ounce, a surge of over 300% from about $450 per ounce. The compound annual growth rate was approximately 8%. In the past five years and at the end of 2020, GLD experienced a 45% decline before returning to the previous high. This demonstrates that easier market access and more transparent market mechanisms attract more investors and contribute to overall steady price growth.

Source: Crypto Goose, Eureka Cloud Chain Research Institute

Based on the growth rate of assets under management (AUM), a Bitcoin spot ETF may set a new record. The first gold ETF surpassed $1 billion in AUM within 3 days and maintained that record for 18 years. Another ETF that achieved this milestone in a short time frame was BITO, a Bitcoin futures ETF launched by ProShares in 2021, which attracted $1 billion in liquidity within 2 days. Given the numerous advantages of a Bitcoin spot ETF, it is highly likely to surpass the record set by BITO.

Source: Bloomberg, Eureka Cloud Chain Research Institute

The increase in funds will also lead to a stronger Bitcoin price. As more funds flow into ETFs, net buyers will provide strong momentum for Bitcoin’s price growth. This relationship becomes especially significant during extreme flows. Massive inflows will boost the market, while sustained outflows will have a negative impact.

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Source: K33 Research, Grayscale, Bloomberg, ByteTree, EuLink Research Institute

2. Hidden Political Variable – US Presidential Election

Due to the high regulatory risks faced by Bitcoin spot ETFs, the presidential election will be a major political factor influencing the SEC’s decision. According to the Federal Reserve’s estimate, 8%-11% of Americans use cryptocurrencies, which is enough to influence the election.

Source: Federal Reserve, EuLink Research Institute

Among them, ethnic minorities are key voters in the presidential election. When a candidate’s stance on cryptocurrency policy may directly impact portfolio performance, its importance becomes even more prominent. According to the Plaid report “The Fintech Effect”, 44% of Hispanic Americans and 46% of African Americans believe that cryptocurrency is easier to access than TradFi (traditional finance).

Source: Plaid, EuLink Research Institute

At the same time, comparative data from the Pew Research Center proves that cryptocurrency investment is the only asset class where the per capita quantity for ethnic minority voters exceeds that of white voters.

Source: Pew Research Center, EuLink Research Institute

Furthermore, implementing policies against Bitcoin mining may have a negative impact on the candidates in the 2024 election. A large number of Bitcoin mining machines operate in swing states, accounting for approximately 40.2% of the total hash rate in the United States and serving as crucial voting constituencies. Bitcoin mining companies employ a large number of local voters, increase fiscal tax revenues, and revitalize traditionally backward areas.

Source: Cambridge Digital Assets Programme, EuLink Research Institute

Policies against Bitcoin mining may threaten jobs and revitalization in many swing states, potentially facing resistance from key electoral districts.

It is worth noting that the population structure of swing states is also changing. States like Georgia and North Carolina are experiencing continuous influxes of international immigrants, mainly of Latin American descent. The combination of mining towns and ethnic minority investment preferences may have a significant probability of influencing the outcome of the election, thereby affecting the SEC’s decision on Bitcoin spot ETFs.

Source: Tsinghua University Institute of International Relations, EuLink Research Institute

Since taking office in January 2021, the Biden administration has maintained a tough policy stance on cryptocurrencies and proposed a 30% digital asset mining energy tax on Bitcoin mining farms, without applying the same standards to other similar data centers.

From the perspective of game theory, very few American voters will vote in support of a candidate solely because they oppose Bitcoin, after all, Bitcoin does not affect the majority of people. However, there may be a group of American citizens who support Bitcoin and will vote for a candidate based solely on their endorsement of Bitcoin.

Compared to the continuous crackdown on cryptocurrencies by the Democratic Party, the Republican Party’s attitude change is particularly evident. Former Republican SEC Chairman Jay Clayton, who once sued Ripple, now believes that the agency is involved in excessive regulation and should approve a Bitcoin spot ETF.

Generally speaking, about six months after a new president takes office, a new SEC commission team will be formed, just like the one led by Biden and the current SEC Chairman Gary Gensler. Therefore, the Democratic Party currently holds the majority of seats on the SEC commission team.

To eliminate the partisan divide within the SEC, the political stances of the commissioners must be equal. Former SEC lawyer John Reed Stark predicts that if the Republican Party were to win, Gary Gensler would most likely step down early and be replaced by the most senior official in the current team, Hester Pierce, as acting chairman, in order to achieve a balance between the two parties within the SEC.

It is worth mentioning that Hester Pierce is also known as the “Crypto Mama.” She has advocated for the United States to adopt the European regulatory framework MiCA as an execution model and has opposed several actions taken by the SEC against the crypto industry. If she were to become the acting chairman of the SEC, it is expected that regulatory enforcement against the industry, while not completely halted, will be significantly reduced.

In this situation, 1) the SEC may shift its focus to fraud cases rather than registration violations, such as CEX, proprietary trading firms, or clearing institutions failing to register as cryptocurrency exchange platforms; 2) the potential approval of a Bitcoin spot ETF and other significant regulatory measures that benefit the crypto industry may be taken.

3. One more thing —— Ethereum spot ETF

Over the past week, there have been two significant events in the market that could change the outcome of the Bitcoin spot ETF. On October 14, 2023, the SEC decided not to appeal the court’s support for the ruling on the conversion of GBTC to an ETF, increasing the likelihood of a Bitcoin spot ETF being approved. This news greatly excited the market, and the price of Bitcoin also soared above $27,000. Two days later, another major positive news emerged, with leading media outlet Cointelegraph announcing that the SEC had approved iShares Bitcoin spot ETF on its platform, once again boosting the market, and the price of Bitcoin briefly approached $30,000. On October 24th, Bloomberg’s ETF analyst Eric Balchunas tweeted that the BlackRock Bitcoin spot ETF had been listed on the Depository Trust & Clearing Corporation (DTCC), with the stock code IBTC. This is a step in the listing process and the first Bitcoin spot ETF to be listed on the DTCC. With the news landing, the price of Bitcoin once again rose above $30,000 and briefly approached the $35,000 mark.

Source: TradingView, OK Cloud Chain Research Institute

In addition to the progress of Bitcoin spot ETF, Ethereum, as the second largest cryptocurrency in the industry, also attracts strong interest from traditional financial markets.

Source: Santiment, OK Cloud Chain Research Institute

Now, in addition to Bitcoin spot ETF, investors may also pay attention to the progress of Ethereum spot ETF. On September 7, 2023, Ark Invest and 21Shares teamed up to launch the first Ethereum spot ETF. On October 2 of the same year, Grayscale also applied to convert its Ethereum Trust into a spot ETF. Currently, the trust is the largest Ethereum investment tool in the world, with assets under management of nearly $5 billion, accounting for approximately 2.5% of the total Ethereum circulating supply.

Source: THE BLOCK, OK Cloud Chain Research Institute

Given Ethereum’s staking reward mechanism, it possesses yield attributes and can be classified as a security. Moreover, the SEC has consistently regarded Ethereum as a security. According to the “Parimutuel Rule,” if the SEC approves the Bitcoin spot ETF, it should take the same approach to Ethereum spot ETF. If the SEC considers Ethereum to be a security and applicable to the Howey Test, it has even less reason to reject the Ethereum spot ETF. In summary, purely in terms of probability, the approval likelihood of Ethereum spot ETF is higher than that of Bitcoin spot ETF.

Source: Beaconcha.in, OK Cloud Chain Research Institute

Ethereum’s innovative staking mechanism will spur investor demand, attracting them to participate in liquidity staking to enhance the return of holding ETF. Even when using liquidity staking protocols to lock assets, stakers can still maintain liquidity, and the protocol will provide tradable derivative tokens for investors. In contrast, when investors lock their funds in government bonds, they cannot obtain liquidity. Generally, investors prefer shorter redemption periods, and liquidity staking allows them to participate in staking and earn profits while maintaining liquidity, without locking their funds.

Conclusion – Future Outlook

With the Bitcoin spot ETF approaching, the compliance of the crypto industry may have a breakthrough from 0 to 1. This means that in the future, mainstream cryptocurrencies represented by Bitcoin and Ethereum can become alternative investment directions for mainstream institutions and retail investors, alongside traditional stocks, bonds, and commodities. For digital assets, it may bring more incremental funds, and for traditional financial institutions, it can also provide more investment options in a high-interest-rate environment, undoubtedly a win-win situation.

Looking at the long-term perspective, in the future trend of the integration of the cryptocurrency industry and traditional finance, a thought-provoking question is: will the ultimate form of integration be to dress up cryptocurrencies in a similar way to traditional assets to meet the regulatory requirements of traditional financial institutions? We believe this could be a gradual “convergence” process. On one hand, cryptocurrencies will be accepted by mainstream investors in a more compliant manner. On the other hand, by mapping more real-world assets (RWA) on the blockchain, cryptocurrencies will serve as a complement to traditional commercial banks, injecting more vitality into traditional finance. Although this future has not yet arrived, we believe that it will come one day in the near future.

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