A Compromise Solution: How Bitcoin Futures ETFs Will Shape the Crypto Market

Bitcoin-ETF has long been the “Holy Grail” for many in the cryptocurrency community. The claim that such a product could be a genuine game-changer was made not only by industry experts but also by analysts at traditional financial institutions.

In October the market finally received the coveted instrument, albeit with the underlying asset as a derivative on digital gold.

ForkLog examined whether to expect a revolution from Bitcoin futures ETFs, why these funds are criticised by experts, and why institutional investors buy their shares.

Denial, Anger, Acceptance

An ETF is an exchange-traded fund whose shares freely trade on an exchange. Unlike mutual funds mutual funds and other investment funds, you can perform the same operations as with securities, buying and selling shares at any time during the trading session.

This product provides investors with the ability to redeem funds instantly and excludes brokers from managing the fund. The latter helps lower client costs, as the management company retains only a fraction of a percent of the asset base for itself.

The crypto community had waited nearly eight years for a Bitcoin ETF. The first application for creating such a product filed by the Winklevoss twins Tyler and Cameron Winklevoss in 2013, but the SEC rejected it.

In February 2021, asset-management company Hashdex from Brazil launched an exchange-traded fund on the Bermuda Stock Exchange based on the Nasdaq cryptocurrency index NCI. In the following months such vehicles appeared in Brazil and Canada, but all eyes were on when the regulator of the world’s largest economy — the United States — would approve an ETF.

The SEC had long resisted launching exchange-traded funds on the basis of digital assets. In July 2018, after again denying the Winklevoss twins, the agency published a document detailing its decision.

The regulator gave three key arguments:

• cryptocurrency derivatives markets do not have sufficient liquidity;
• there are no qualified custodial services in the United States;
• the industry lacks a culture of compliance necessary to prevent fraudulent actions and manipulation.

Since then, the situation has significantly changed, and the SEC’s theses have to some extent lost relevance. Agree even some agency officials, notably Commissioner Hester Peirce, who has repeatedly called the agency’s requirements “overstated.”

First, a regulated market for crypto derivatives had matured — by September 2021, despite overall negative momentum, open interest in Bitcoin futures on the CME reached 36,740 BTC (~$1.53 bln at the rate then), and for microfutures — 2,561 BTC (~$106.5 mln).

Second, several services oriented toward providing custodial facilities for institutional participants emerged, such as Gemini Custody, Anchorage, Coinbase Custody, Bakkt and others. All of them undergo security audits and possess the licenses required to operate in the United States.

The spot price of Bitcoin is heavily influenced by operations taking place in markets outside the SEC’s jurisdiction. In this respect, little has changed since 2018.

Regulation of industry participants in the United States has certainly tightened. Thus, last year U.S. residents were required to report to the Internal Revenue Service (IRS) any transactions with digital assets, and in 2021 authorities unveiled a high-profile infrastructure plan envisaging even greater control over cryptocurrency transactions.

Approving a Bitcoin ETF in the United States seemed a natural step, especially given rising institutional interest from traditional finance circles.

With the appointment of a new head of the SEC, who called Bitcoin a “catalyst for change,” these sentiments only intensified. In the end the regulator did allow the widely anticipated product, albeit not exactly in the form the community had hoped for.

Two Acts by Crypto Professors

In April the SEC appointed the former chair of the CFTC Gary Gensler as head. In that role he was known for a hard line on regulation, though many expected the Commission to be more lenient toward the digital asset industry under his leadership.

Much of this optimism rested on the fact that, unlike Jay Clayton, Gensler understands the underlying blockchain technology. He previously worked at MIT, where he taught a course on the potential uses of distributed ledgers and Bitcoin in the modern financial system.

Nevertheless, as early as 2018 the official stated that trading Ethereum and XRP tokens could violate U.S. law. A year later, on a panel discussion with Commissioner Peirce, he confirmed his commitment to strict regulation and said that a rollback of oversight would be an undesirable scenario.

Already in his role as SEC chair, Gensler made it clear that investors’ interests are a priority. This is echoed in his August statement regarding potential crypto ETF approvals — applications should be filed under the 1940s laws, as they provide stronger consumer protections.

Until recently most applications for spot Bitcoin ETFs were filed under the Securities Act of 1933. It provides for the registration of ETF issuers with the SEC but does not regulate the precise structure of such products.

The Investment Company Act of 1940, on the other hand, does not directly apply to financial instruments but contains a number of standards, including limits on leverage and rules related to the use of derivatives. It requires the issuer to have an independent board of directors and obliges it to calculate net asset value daily and to guarantee a fair market price for the shares.

WisdomTree’s chief counsel Ryan Luvar noted that these two acts “really focus on different cases.”

“The Securities Act of 1933 focuses on the information the fund discloses in its prospectus, and the Investment Company Act of 1940 focuses on how the fund operates and is governed. In this way, SEC staff can come for an inspection and determine whether the fund is operating and whether supervision of the entire list of statutory requirements is being observed,” he explained.

Luvar also stressed that the SEC is unlikely to approve spot Bitcoin ETFs in the near future, because the regulator is unsettled by the current pricing mechanism.

Trust in Gensler’s stance on Bitcoin futures on the CME is likely linked to the fact that the platform is a federally regulated market — under the oversight of the CFTC.

Institutional History

On October 15, 2021 the SEC approved ProShares’ application to launch an ETF based on CME’s Bitcoin futures. The Bitcoin Strategy ETF (BITO) began trading on the New York Stock Exchange on October 19.

The product proved the second-most active debut. On its first day its turnover reached 24.42 million shares, nearly $1 billion, and BITO needed just two days to surpass that milestone.

RECORD BREAKER: $BITO assets up to $1.1b after today, making it the fastest ETF to get to $1b (2 days) breaking GLD’s 18yr old record (3 days), which is poetically apropos. https://t.co/yGXyfwaogD

— Eric Balchunas (@EricBalchunas) October 20, 2021

As of October 27, trading volume of BITO exceeded 100 million shares.

On October 22, trading began on Nasdaq for another Bitcoin futures ETF — from Valkyrie Investments. The instrument showed a more modest debut: its first-day volume reached 3.19 million shares and, after three sessions, 5.74 million shares.

From October 16 to 22, total investments in these two products stood at $1.24 billion, and aggregate inflows into crypto funds peaked at a record $1.47 billion.

After ProShares’ ETF launched, the price of digital gold renewed its historical high above $67,000. Some compared BITO to the first gold ETF in the United States — SPDR Gold Trust (GLD). The instrument was launched in November 2004, and to date its assets under management have surpassed $56 billion.

When GLD was launched, gold traded near $600 per ounce. Since then the price of the precious metal has nearly tripled, while quotes have never fallen back to 2004 levels. Experts reasonably argue that the appearance of ETFs helped drive that shift.

“Now it’s clear that launching ETFs has had a strong impact on the gold market. Today, ETFs are a key part of it,” noted Graeme Takull, head of ETF Securities, in 2013.

There are 35 gold ETFs trading in the United States. The total assets under management of these funds are estimated at $115.23 billion. The popularity of these products stems from a simple fact — they ease access to the precious metal for both institutional and retail investors.

Before the first targeted ETF, investing in gold was considerably more cumbersome — you had to buy bars or coins. Exchange-traded funds allowed ordinary consumers to transact with the asset in the same way they had traded stocks for decades.

Yet with cryptocurrencies those problems do not exist. Billions of dollars in Bitcoin can occupy precisely as much space as a slip of paper with a seed phrase written on it. Digital assets are easy to transport, and retail investors have long had direct access on platforms such as Coinbase and Robinhood.

In an interview with ForkLog, Vladimir Smerkis, co-founder of the Tokenbox.io platform, noted that a Bitcoin futures ETF is largely an institutional instrument.

“I’m one hundred percent sure this is about institutions, because retail in the United States and many European countries already have ways to invest in crypto. ETFs must first appear on the radar of brokers and funds that work with end clients. That will take some time yet.”

A non‑named Financial Times source among Bitcoin fund managers also emphasised that the interest in futures ETFs on digital gold relates to the investment opportunities they provide to traditional market participants.

“It’s about convenience and accessibility. If you think about where your investors hold capital pools — in 401(k) plans and in brokerage accounts — the fact is that ways to access Bitcoin typically lie outside that system,” said the FT source.

He also noted that unlike crypto purists, most investors do not care about controlling private keys. They simply “want to buy a product from a trusted provider.”

Not the Holy Grail, but a Key Milestone

In a recent Yahoo Finance interview, Gensler stated that most cryptocurrencies do not fall under investor-protection laws, making the market susceptible to fraud and price manipulation.

Thank you @YahooFinance & @bcheungz for the discussion today! https://t.co/cGCew94pl5

— Gary Gensler (@GaryGensler) October 25, 2021

According to ETF Store’s Nate Geraci, the comment signals the agency’s unwillingness to approve spot ETFs until a regulatory framework exists, which he believes could take at least a year.

I was thinking second half of 2022, so O/U say July 1st of next year.

But honestly, after hearing those Gensler comments, I just don’t see how that happens. How long will it take for Congress to develop a regulatory framework here?

I’m now starting to think 2023 or beyond.

— Nate Geraci (@NateGeraci) October 25, 2021

According to Kiivkulis, futures ETFs’ lack of yields makes them a “compromise solution,” so the approval of spot funds in the United States is only a matter of time.

“Sooner or later the SEC will approve a spot crypto-ETF. Such ETFs already exist in countries like Brazil and Canada, and the United States cannot delay this for long. Otherwise many American investors will continue to prefer trading on foreign exchanges,” the expert said.

In the short run the introduction of Bitcoin futures ETFs is unlikely to have a material impact on the market. They are young products with limited utility, and substantial liquidity is required for fundamental shifts.

The price rally that many tied directly to the launch of these instruments may have been driven by concerns about potential hyperinflation, as JPMorgan analysts noted.

Nonetheless the long‑term impact of this development could be significant. Retail investors can expect volatility to ease gradually as institutions seek to dampen the adverse effects of large price swings.

Equally important, by approving the instrument the SEC signalled that plans to ban cryptocurrencies are no longer merely words, but actions. Given the Fed’s similar stance and China’s de facto exclusion from the equation, this lends some confidence to the market’s future.

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