KEYTAKEAWAYS
- Bitcoin ETFs simplify investment, attracting new capital, aiding mainstream acceptance, and boosting cryptocurrency industry visibility.
- Institutional entry necessitates secure custody solutions, enhancing Bitcoin's security infrastructure and challenging existing operational models.
- Bitcoin's ETF approval marks a pivotal shift, fostering industry standardization, regulatory clarity, and public recognition of Bitcoin's technical merits and scarcity.
CONTENT
*This article was originally published in Chinese and on the Blog- Code and law.
WHAT IS A BITCOIN ETF? HOW IS IT DIFFERENT FROM BITCOIN FUTURES ETF?
Before understanding Bitcoin ETFs, it’s essential to grasp what ETFs are. ETF, or Exchange-Traded Fund, typically refers to a pooled investment vehicle that invests or replicates a basket of assets or stock indices. Investors commonly buy and sell ETFs to invest in various types of assets such as stocks, bonds, commodities, currencies, real estate, and more. For example, one well-known ETF in the United States is QQQ, established by Invesco PowerShares in 1999. QQQ tracks the NASDAQ-100 Index, primarily focusing on technology stocks. With assets exceeding $210 billion, it ranks among the top five ETFs globally. Instead of individually investing in shares of 101 companies, investors can pool their funds through the ETF and have Invesco PowerShares allocate the money into the technology companies, enjoying the associated appreciation benefits.
The most significant impact in the ETF realm occurred when the U.S. Securities and Exchange Commission approved the issuance of 11 Bitcoin spot ETFs on January 11th. This signifies that Bitcoin can now be held through ETF investments, marking a milestone for the cryptocurrency industry as it enters a more mature market environment.
However, the most recent Bitcoin ETF approved by the U.S. Securities and Exchange Commission (the “SEC”) differs from previously approved Bitcoin futures. The main difference lies in the fact that the approved Bitcoin ETF allows investors to truly hold Bitcoin. In contrast, previous Bitcoin futures contracts did not involve actual ownership of Bitcoin; they were simply agreements to buy or sell Bitcoin contracts at a predetermined price and date in the future.
For the past decade, the SEC has consistently refused to approve physically settled Bitcoin ETFs. The reasons behind this refusal include concerns about Bitcoin’s liquidity, potential market manipulation in the cryptocurrency market, and the perception that Bitcoin’s volatility is too intense for ordinary investors. For example, Bitcoin surged to nearly $20,000 in 2018, then plummeted to a low of around $4,000. In 2021, it surged by 60%, reaching over $50,000 during the NFT craze, only to fall back to around $20,000 as the NFT hype subsided.
Despite the SEC’s approval, according to subsequent interviews with SEC Chairman Gary Gensler, the main reason for approving the Bitcoin ETF this time was the SEC’s defeat in court in 2023 regarding its rejection of Grayscale’s application for a physically settled Bitcoin exchange-traded fund (ETF). This forced the SEC to approve approximately a dozen similar proposals on January 11, 2024. Gensler also emphasized that the approval does not mean the SEC has endorsed Bitcoin. It was a decision made reluctantly to comply with the court ruling, and he reiterated warnings to investors, stating that Bitcoin remains a speculative and volatile asset used for illicit activities, including ransomware, money laundering, evading sanctions, and financing terrorism. Investors should be cautious and mindful of their risks when investing in Bitcoin.
3 MAJOR IMPACTS OF ETF ADOPTION
Investors anticipate that the rise of Bitcoin spot ETFs will bring billions of dollars in investment to Bitcoin, because ETF investment is simpler, with lower barriers to entry, making it easier to attract a large amount of new money into this market. This article believes that it will have at least the following three effects:
1. Entry into the mainstream financial market:
With the endorsement of financial institutions such as BlackRock and Fidelity, Bitcoin will transition from a speculative tool to a strategic investment component in diversified portfolios. The entry of large financial institutions into Bitcoin will contribute to its mainstream adoption and bring in significant investment. Furthermore, with the increasing demand for Bitcoin, its price will rise, making it the biggest advertisement for the entire cryptocurrency industry. Companies and entrepreneurs in the cryptocurrency and blockchain space may also benefit from increased profits, investment capital, and attention. Additionally, when reputable financial institutions introduce new products, there will be certain requirements and standards for these products. These requirements will further eliminate the impression of fraud associated with the cryptocurrency industry and make cryptocurrency-related payments and transactions more convenient.
2. Increased demand for secure custody:
With the entry of financial institutions and Bitcoin’s mainstream adoption, there will also be a growing demand for “secure custody.” Financial institutions are responsible for managing large sums of investors’ funds, and thus, secure custody measures will be crucial for safeguarding these cryptocurrency assets. On the other hand, in the operational models of financial institutions assisting with investments, funds are often entrusted to qualified third-party custody institutions. The advantage of this model is that in the event of financial insolvency or closure of the financial institution, client assets can be separated from the bankruptcy estate and protected from being seized. Such a model may also challenge the current operational model of some cryptocurrency businesses, which combine trading, custody, and investment operations. This trend is expected to drive developments in both “asset custody” and “technical security custody.”
3. Transformation and expansion of Bitcoin’s perception:
The third point is considered the most important transformation in this article. Despite ongoing criticisms of Bitcoin, with some arguing it lacks intrinsic value and citing its volatility and liquidity issues, Bitcoin has seen increasing adoption since its inception in 2008. Today, even corporations and countries like MicroStrategy and El Salvador view it as a significant asset, with El Salvador even adopting Bitcoin as legal tender. While the introduction of Bitcoin ETFs may initially draw attention to it as an investable asset, investing in Bitcoin may further guide investors to understand the principles behind Bitcoin and its significance. This includes Bitcoin’s technical security, immutability, decentralized network model, and most importantly, its scarcity. As awareness of these aspects continues to grow, Bitcoin may become a digital equivalent of gold in terms of value storage. This is due to its widespread recognition and acceptance, especially in a world where tensions between major powers like the U.S. and China are evident, and geopolitical issues in regions like East Asia and Southeast Asia add additional risk to assets and economic environments. Given the unpredictability of the economic environment amidst technological advancements like AI disrupting many existing production models, the trend of rapid change appears unstoppable. Therefore, Bitcoin, with its better portability compared to gold, seems to be an emerging asset capable of withstanding the impacts of significant environmental changes.
LEGAL ISSUES RELATED TO BITCOIN ETFS
Since the Bitcoin ETF has already been approved by the SEC for issuance, investing in and trading this ETF legally falls under a type of security. This will prompt financial regulatory authorities in various countries to further consider whether to approve domestic financial institutions’ applications for Bitcoin ETFs. This discussion can be broken down into several aspects, as follows:
- Issuance of ETF: Can local financial institutions issue their own Bitcoin ETF locally, following the example of the United States?
- Sale of ETF: Can local financial institutions sell ETFs issued abroad within the local jurisdiction, such as Bitcoin ETFs from the United States?
- Assistance with Trading Overseas ETFs: Can financial institutions facilitate the buying and selling of overseas Bitcoin ETFs?
- Derivative Instruments: Can local financial institutions track the 11 ETFs from the United States and issue their own ETF based on them through derivatives?
According to the typical approval process of general financial regulations, regarding the issuance aspect, we usually need to consider what the “underlying assets” that the ETF needs to track are. Assuming that according to the laws of a specific country, the objects that ETFs need to track are limited to “securities” or “commodities,” then the question arises whether Bitcoin itself could be considered a security or commodity. If not, then local operators cannot issue ETFs. However, if it is considered not a security but possibly a commodity, then it needs to be further considered whether this “digital asset” falls under the definition of a commodity under the laws of that country.
On the other hand, regarding the sale of overseas ETFs, it typically also requires approval from the financial regulatory authority of that country before they can be sold; otherwise, it would be considered illegal. Furthermore, if financial institutions cannot issue or sell Bitcoin ETFs themselves, whether they can act on behalf of clients to execute buy or sell orders linked to Bitcoin ETFs is a more detailed operational aspect. Financial regulatory authorities may also consider factors such as the high volatility and risk of Bitcoin prices and, for the purpose of protecting investors, may require operators not to assist with buy orders.
Moreover, if financial institutions are not allowed to issue Bitcoin ETFs, can they issue funds linked to ETFs in the form of funds linked to funds? Although this may seem legally plausible as a type of security, in practice, it should still be consulted with the local regulatory authority.
Regardless of whether issuance or sale is possible in specific country, after the precedent of Bitcoin ETF approval in the United States, we can anticipate that in the future, financial institutions in various regions such as Asia, Europe, and South America may also seek to enter the market and further bring Bitcoin into the public eye.
CONCLUSION – RECOGNIZING NEW CHANGES
The approval of this BTC ETF is considered to have a significant impact on the cryptocurrency industry. Not only are mainstream financial institutions gradually entering this industry, but it will also lead to further standardization of the industry and a more comprehensive regulatory environment, such as implementing asset segregation management and emphasizing the security of asset custody. Financial institutions in regions outside the United States will also begin to explore and participate in this emerging commodity.
After the approval for financial institutions in the United States to issue Bitcoin ETFs, besides bringing in a large amount of capital into Bitcoin and enabling the general public to easily purchase Bitcoin, thereby promoting the price increase of Bitcoin and other cryptocurrencies (as we have recently seen Bitcoin rise to around $50,000), perhaps the more important aspect is that with the increasing participation of legal and compliant institutions, the technical characteristics of Bitcoin itself and its inherent scarcity are more likely to be recognized by the public. This may lead to a change in awareness, continuing Satoshi Nakamoto’s experiment with digital gold since 2008. Can Bitcoin become a reliable asset for us to counter the unstable world in the future? Let’s continue to watch and see.
