Crypto ETF 101

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Today’s installment was written by Bitwise Asset Management, the leader in crypto index funds and most recent firm to file for a Bitcoin ETF.

The crypto industry has dreamed of a bitcoin ETF since at least July 1, 2013, when the initial prospectus for the Winklevoss Bitcoin Trust was filed with the U.S. Securities and Exchange Commission (SEC). Since then, eight other firms --- SolidX (and Van Eck), Grayscale, ProShares, Direxion, GraniteShares, First Trust, REX Shares and, as of January 10, Bitwise --- have submitted filings as well.

To date, all of the filings that have come to a regulatory endpoint have been either denied, delayed indefinitely or withdrawn. That includes the Winkelvoss filing as well as the applications from Grayscale, ProShares, Direxion, GraniteShares, First Trust and Rex Shares. Today, only the Bitwise and SolidX/Van Eck filings are still in process at the SEC with targeted review dates.

We’ve received a lot of questions about our ETF application since we filed, in part because the team here has decades of experience in ETFs: Among our leadership team, John Hyland, Bitwise Global Head of ETFs, was the chief architect of the first crude oil ETF (ticker: USO) and the first natural gas ETF (ticker: UNG), and Matt Hougan, Bitwise Global Head of Research, was the former CEO of leading ETF data and analysis firm

While we can’t comment on the specifics of our filing -- we’re technically under a “quiet period” with the SEC -- we can offer some big-picture thoughts and historical context to inform the outlook for a crypto ETF.

Is The SEC Anti-Crypto?

The biggest misconception we encounter when discussing the outlook for a crypto ETF is the belief that the SEC is fundamentally anti-crypto. This view is driven by the belief that the multi-year delay in approving the first bitcoin ETF is atypical and reflects a dislike of crypto at the commission.

The truth is that every “first” in the ETF industry was preceded by multiple years of struggle. For instance, it took:

  • More than six years between the first filing for a leveraged ETF and the first SEC approval;

  • Nearly six years between the publication of the SEC’s first “conceptual release” on actively managed ETFs and the approval of the first active ETF;

  • Nine years between the launch of the first ETF and the launch of the first fixed-income ETF, despite significant efforts in the interim.

Other waves of innovation, like self-indexing and commodities, though comparatively faster, still took multiple years. The fastest major “first” may have been gold bullion, as it took “only” two years from idea to launch of the first U.S.-listed gold bullion ETF (ticker: GLD). That speed, however, had a cost: According to the Wall Street Journal, the World Gold Council spent $14 million developing the fund. Not to mention that gold is an asset that’s been around for thousands of years, or that a gold bullion ETF launched first in Australia.

Given this historical context, it’s not altogether surprising that the first crypto ETF has taken some time. The SEC wants to give investors access to markets but has to be absolutely sure  that certain criteria are met.

The questions the SEC has asked publicly around custody, pricing, arbitrage and market manipulation in the crypto markets are the right issues to be discussing. These topics have been the source of real challenges over the last few years. We’re optimistic that progress in regulated crypto custody, the massive improvement in and expansion of the crypto market making community, and new data insights will help make approving a product more feasible.

Do We Really Need A Crypto ETF?

There are a significant number of people who question the need for a crypto ETF, wondering why people would want to marry a next-gen financial technology like crypto with legacy financial technologies like ETFs.

The answer is that ETFs are a well-understood construct that is plug-and-play with the existing software platforms, paperwork, processes, and workflows that professional investors and firms use. At a 0.25%-10% allocation, crypto isn’t a deep focus of most investors, and most aren’t going to reinvent the wheel just to access it. They need it to be easy.

We recently commissioned a formal survey of 150 financial advisors, and a strong majority -- 58% -- said that an ETF would be their preferred way to invest. When asked what would make them more comfortable allocating to crypto in client portfolios, 54% said “better regulation” and 35% said “the launch of an ETF.” This holds true for many family offices and institutions as well.

As a parallel, consider GLD (the first and largest gold ETF): Prior to the launch of GLD, there were plenty of ways for investors to buy gold. They could buy it directly from dealers, they could buy futures, or they could buy gold mining stocks. In many ways, it was exactly equivalent to today’s situation with bitcoin, where investors can buy directly on exchanges, can buy futures or can invest indirectly via blockchain equity ETFs.

It’s hard to imagine now, but at the time, many questioned why we needed a gold ETF too. In fact, the primary developers of GLD (the World Gold Council) were so worried about early interest in GLD that they reportedly paid UBS $4 million to support initial sales.

They needn’t have bothered: GLD brought in a record $1 billion in assets in its first three days of trading alone, eventually rising above $100 billion in AUM at its peak.

How Large Could A Crypto ETF Be Out Of The Gate?

There is of course no way to know.

GLD’s skyrocketing adoption was unique. Most new ETFs go much slower: Just five of the 268 ETFs that launched in 2018 closed the year with more than $1 billion in assets, and the median launch had around $10 million at year-end. Many years, there are no new ETFs that top $1 billion in assets.

The day an ETF is listed is just the beginning of the journey for a new fund. While many brokerages will make it possible for self-directed investors to buy it right out of the gate, the vast majority of savings and assets in the US are managed by advisors and professionals. For these investors, listing alone isn’t always enough. When the ETF lists, many investment committees will then begin the process of evaluating it. Research teams, private banks, and platforms will begin the process of considering offering it to clients. Advisors can begin looking at what it could do in portfolios. All of this takes time and support.

A bitcoin ETF would have advantages over many ETFs because it would be completely unique, but, as something new and polarizing, it will face challenges as well.

What’s The Process From Here?

As mentioned, there are two filings with set regulatory review dates currently pending at the SEC: Ours most recently, and one from Solid X/Van Eck. The next step is for the SEC to review and approve, reject, or delay them.

As it happens, this is complicated by the current government shutdown.

For instance, the SEC faces a statutory deadline to issue a final ruling on one aspect of the Solid X/Van Eck filing by February 27. But with 94% of SEC staffers furloughed, the likelihood of giving the filing a complete review is in doubt. Bitwise’s own filing is complicated by the shutdown as well.

The important thing, though, is that the overall crypto ecosystem continues to mature. Each day brings greater regulatory clarity, improving custody options, greater futures trading volume, more established exchanges and trading venues, and more widespread understanding. We’re committed to continuing the work of building that understanding and to expanding access to this new asset class.

It should be an exciting 2019.

— The Team at Bitwise Asset Management

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