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Rating:Is Larry Creating a Spot Bitcoin ETF ... Or an ETC? Not Rated 5.0 Email Routing List Email & Route  Print Print
Friday, June 16, 2023

Is Larry Creating a Spot Bitcoin ETF ... Or an ETC?

by: Sean Hanna, Editor in Chief

Despite widespread reports that BlackRock [profile] filed for a spot Bitcoin ETF — a product that has never been approved by the SEC — the world's largest asset manager's proposed product does not fit into the traditional '40 Act ETF structure. In fact, the ETF titan appears to have proposed a Bitcoin product that is an "exchange-traded commodity" ("ETC"), a label proposed by the ETF industry's Big Six — including BlackRock — as recently as 2020 in attempt to address naming confusion around which products are ETFs and which aren't.

Laurence D. "Larry" Fink
Chairman, CEO
BlackRock has filed to offer shares in a trust offered under the 1933 Act. If approved, that would make its product similar to that of Grayscale's Bitcoin Trust, which is registered under the 1934 Act. However, BlackRock is borrowing a concept pioneered by ETFs that would make its trust fundamentally different than that run by Grayscale. And, yes, neither of those trusts are technically mutual funds, exchange traded or otherwise.

BlackRock's proposed iShares Bitcoin Trust thus drops some '40 Act investor protections (and perhaps the "ETF" brand, too): it will have no investment advisor, nor an independent board, '40 Act requirements that continue to be highlighted by the SEC folks — including by Gary Gensler himself, the current chair, in remarks last month at the ICI Leadership Summit. Yet BlackRock's proposal also appears to address the SEC's key concern around Bitcoin pricing by taking it out of the equation for the purposes of creation, redemption, and valuation, all of which will be done in Bitcoin, not in dollars.

One clue that BlackRock is doing something different is that it filed an S-1. Mutual funds use an N-1 as their application filing.

The second clue is in the filing itself:
The Trust is not an investment company registered under the United States Investment Company Act of 1940, as amended (the "Investment Company Act"), and the Sponsor is not registered with the Securities and Exchange Commission ("SEC") as an investment adviser and is not subject to regulation by the SEC as such in connection with its activities with respect to the Trust. The Trust is not a commodity pool for purposes of the United States Commodity Exchange Act of 1936, as amended (the "Commodity Exchange Act" or "CEA"), and the Sponsor is not subject to regulation by the U.S. Commodity Futures Trading Commission (the "CFTC") as a commodity pool operator or a commodity trading advisor with respect to the Trust.

O.K., the iShares Bitcoin Trust is most definitely not a traditional ETF or any other kind of '40 Act product, and BlackRock does not want you to be confused about that. Indeed, when BlackRock and the rest of the Big Six proposed the classification system that would label this trust as an ETC, Samara Cohen, now CIO of BlackRock's ETF and index investments (EII), explained the system as a way to help fight investor confusion by increasing transparency via "a shared language."

So why did BlackRock choose this route? BlackRock officials have not commented on their plans, but one possibility is that they may believe the SEC is more likely to approve a trust structure similar to one that already exists. Indeed, the SEC has also approved a similar Delaware Trust offered by Bitwise.

The Delaware trust structure is more palatable to the SEC as it only directly offers shares to accredited investors. Shares are able to be traded to non-accredited investors six months after they are created. The unwieldiness of this structure means that share creation (or redemption) can lag investor demand. And, as there is no way to arbitrage if the trust's NAV drifts from the secondary price, the trusts are vulnerable to discounts or premiums between the NAV and secondary market price for the shares. Both the Grayscale and Bitwise trusts currently trade at steep discounts to their NAVs.

It appears that BlackRock is hoping to avoid this pricing issue by issuing shares to registered broker-dealers that are approved by the trust. It is also planning to issue and redeem shares in "baskets" consisting of 40,000 shares. And, those broker-dealers will buy their basket of shares using bitcoin, not cash. Also, the BlackRock trust will only redeem shares in the form of a basket, not for cash. That means that redeemers will have to take 40,000 shares worth of spot Bitcoin, something non-accredited investors will not be able to do: only B-Ds will be permitted to create and redeem baskets.

This concept should sound familiar as it echoes the strategy that ETFs use to make sure no significant gap opens between their NAV and trading place. In the case of ETFs, buyers of shares are able to purchase and redeem shares either in cash or by delivering a basket of the underlying securities in the ETF's portfolio. That dual way to trade allows institutions to arbitrage away any gap in the two prices.

The basket concept is one that neither Grayscale or Bitwise uses, and it is a twist that could slow any approval by the SEC.

The fact that the trust will only issue shares through the acceptance of a basket of Bitcoin has one other interesting implication: the fund will not be a buyer of Bitcoin. Rather, all of its Bitcoin holdings will stem from accepting baskets of Bitcoin in exchange for shares. This also means that the amount of Bitcoin represented in each share will fall over time as the trust will be a periodic seller of Bitcoin in order to raise funds to pay its expenses.

Assuming the SEC allows the trust to become effective, BlackRock will list the seasoned shares on the Nasdaq, where retail investors will be able to buy and sell them as they would shares in a traditional ETF.

BlackRock's legal team also came up with one more interesting twist that should lower the costs of operating the fund at least a little (and every penny ... err basis point ... counts). The trust is being created as an "emerging growth company" under the Jumpstart Our Business Startups Act (JOBS Act). That means that the trust will face reduced reporting. Congress intended the reduced reporting to entice smaller companies to be able to afford to raise money from the public. BlackRock’s new trust is a small company, even if BlackRock is the world's largest asset manager.

For those into the details, Coinbase Custody Trust Company will be the Bitcoin custodian for the trust and Bank of New York Mellon will custody the trust's cash holdings. The CF Benchmarks Index, from CF Benchmarks Ltd., will be used to determine the trust's NAV.

Editor's Note: A version of this story first appeared on our sister publication CeFiWire. 

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