Grayscale points to a possible loophole with the new bitcoin ETF depository

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Grayscale, manager of the world’s largest cryptocurrency fund, has long been stymied by regulators in its bid to convert its flagship vehicle into an exchange-traded fund.

However, it may have found a ploy to partially circumvent restrictions imposed by the US Securities and Exchange Commission.

Grayscale has filed to launch a US-listed ETF that would invest in part in so-called exchange-traded “spot” bitcoin products that are already up and running in other countries.

These ETPs either invest directly in “physical” bitcoin or synthetically track the price of the cryptocurrency – structures the SEC has so far not allowed.

Instead, the SEC has only allowed bitcoin ETFs that trade in futures contracts listed on the Chicago Mercantile Exchange, which is a regulated venue.

This stance prompted Grayscale to sue the SEC over its refusal to grant $16.9 billion Grayscale Bitcoin Trust (GBTC), a private spot bitcoin trust, to be converted into an ETF. The ruling is expected by the end of the third quarter.

Meanwhile, however, Grayscale has filed to launch a Global Bitcoin Composite ETF, which would invest 40% of its assets in spot bitcoin ETPs listed on “major non-US exchanges,” such as in Canada or Europe.

While there’s no guarantee the application will be approved, analysts believe it has a chance given that the overseas ETPs Grayscale proposes to invest in are regulated securities, just the kind of assets the SEC has insisted crypto ETFs hold. .

“Grayscale’s filing appears intended to push the envelope with the SEC by using the SEC’s own words against it to launch crypto ETFs,” said Bryan Armor, director of passive strategies research, North America at Morningstar.

“It appears that Grayscale is directly challenging the SEC’s past decision to allow bitcoin futures ETFs on the one hand and reject bitcoin spot ETFs on the other,” he added.

Todd Rosenbluth, head of research at VettaFi, a consulting firm, described the filing “as a creative way of Grayscale trying to offer a U.S.-listed product with spot bitcoin exposure.”

“I think there is a greater likelihood of Grayscale getting approval for this ETF than getting the SEC to voluntarily approve a US-listed bitcoin spot ETF, which is what Grayscale wants,” he added.

Rosenbluth believed the filing was “an acceptance of reality that the SEC has no intention of giving [Grayscale] the green light”, to convert GBTC.

A point in Grayscale’s favor in its latest filing is that a large number of US-listed ETFs already hold regulated non-US securities, mostly in the form of stocks and bonds.

Indeed, at least one US ETF already holds foreign-listed spot bitcoin ETFs, which appears to set something of a precedent for the facility.

The $447 million Amplify Transformational Data Sharing ETF (BLOCK) holds positions in four Toronto-listed spot bitcoin ETFs, though they currently make up just 4.3% of its portfolio, with the balance in shares of companies involved in blockchain technology.

Grayscale proposes that its 40% exposure to bitcoin spot ETFs be weighted equally across five underlying funds.

Rosenbluth also noted the “added irony” of Cathie Wood’s Ark Next Generation Internet ETF (ARKW extension) with 6.8% exposure to Grayscale’s GBTC trust, although the SEC believes GBTC’s structure is unsuitable for an ETF. The SEC declined to comment.

Even if Grayscale were to get approval for the Global Bitcoin Composite ETF, it’s far from certain that there would be huge appetite for the fund, anyway.

He proposes that the remaining 60% of the portfolio be invested in shares of bitcoin mining companies. Armor wasn’t convinced there was much demand for such a structure.

“I don’t think investors would benefit from access to a 60/40 portfolio of bitcoin miners and a global spot bitcoin fund of funds,” he said.

“The portfolio is confused and will do a worse job of tracking the spot price of bitcoin than a bitcoin futures ETF, so I’m not sure if this type of product adds any value other than SEC strategy analysis for the approval of bitcoin ETFs.”

Rosenbluth agreed that demand may be lacking, saying “Combining bitcoin with other investments is nothing new but has had limited interest.”

As evidence he cited the Global X Blockchain & Bitcoin Strategy ETF (POINTS), which invests in the Global X Blockchain ETF (BKCH extension) and bitcoin futures, but which contains only $11 million.

Rosenbluth noted that despite a strong rebound for bitcoin and cryptocurrency-related companies after steep losses last year, with the currency itself up 61% this year, “demand for bitcoin-exposed ETFs has been limited.” .

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“Investors appear skeptical that the rally will persist and recall the challenges of 2022,” he added.

For example, although the $1 billion ProShares Bitcoin Strategy ETF (BITO), the largest bitcoin futures ETF, is up 57% year-to-date as of May 12, it had only seen net inflows of $95 million, according to data from VettaFI. That wasn’t far ahead of the $75 million the $120 million ProShares Short Bitcoin ETF strategy attracted (BITI), which takes the opposite bet and is down 44% year-to-date.

BKCH has returned 69% so far this year but has posted net outflows of $2 million. Similarly the Invesco Alerian Galaxy Crypto Economy ETF (SATO) was up 68% “and hasn’t seen any interest from investors,” Rosenbluth added.

Michael Sonnenshein, chief executive officer of Grayscale, was more optimistic, however, arguing that “there is no question as we emerge from the cryptocurrency winter that investor appetite for cryptocurrencies remains healthy. It has certainly not gone unnoticed by the community of cryptocurrencies that cryptocurrencies have achieved some of the highest returns in 2023 to date.”