Spot bitcoin ETFs are coming, but not as soon as their advocates think

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The approval of a spot bitcoin exchange-traded fund (ETF) is almost certainly a matter of "when" rather than "if." Yet, bitcoin ETF approvals likely won't come as soon as many people in the crypto industry would like to believe. 

Why? Another round of application rejections is likely given the continued lack of clear market structure that led to the downfall of cryptocurrency exchange FTX earlier last year. In other words, the lack of separation of custody and trading will continue to serve as a stumbling block for approval until it is fully addressed. To change that trajectory, ETF applicants will likely need to demonstrate to the Securities and Exchange Commission that their assets will be custodied with one provider — ideally with a qualified custodian — and traded using a different entity. 

So, moving beyond the hype into reality, we won't see a bitcoin ETF approved until this market structure is reflected in the applications submitted to the SEC.

Whichever application is approved first will almost certainly help that firm to gain significant market share of the new product and its associated liquidity, which could total in the hundreds of billions of dollars. So, money managers have a clear and vested interest in getting the initial approval. 

The SEC approved the first bitcoin futures ETF in October 2021, raising hopes for a rapid approval of the related investment vehicle — spot bitcoin ETFs — but a speedy approval didn't take place. Since then, numerous money managers have applied for approval with two of the front-runners — BlackRock and Grayscale Investments — gaining large amounts of the news coverage.

In June 2023, BlackRock, the world's largest money manager with $9T+ in assets under management, submitted an application that changed the trajectory by including a surveillance-sharing agreement with Nasdaq to address SEC concerns. Because of their experience with the ETF product and how they've only had one application rejected, people in the industry are watching to see if their approach works. Since this application was submitted, many other well-known investment management companies have since filed spot bitcoin ETF applications that follow BlackRock's model. 

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Grayscale, the world's largest crypto asset manager by assets under management, is also garnering plenty of attention in the news. After the SEC rejected an application from them for a spot bitcoin ETF because of price discovery issues — and after a court ruled in favor of Grayscale — the SEC has indicated that they will not challenge that court ruling.

Grayscale is taking an uplist approach as they continue to seek approval, which would involve moving their securities listings from an off-brand stock exchange to one in the mainstream: from the OTCQX to the NYSE. The advantage of this strategy: Grayscale gets its spot bitcoin ETF to market more quickly and could help them to gain the bulk of the initial liquidity flowing into the new market product. 

Regardless of which asset management company gains first approval — which, whoever it is, will require the separation of custody and trading functions — a group of investment companies' applications for spot bitcoin ETFs that satisfy this requirement could be approved in rapid succession or even all at once. Predicting how quickly this will occur is a purely speculatory exercise.

Approval for spot bitcoin ETFs will be an important step forward for crypto to become more enmeshed in the mainstream investment ecosystem and to validate crypto's place within the broader financial system. ETFs are popular investment vehicles, more affordable than many other options and less complicated than ETF futures with levels of liquidity that many investors desire — and spot bitcoin ETFs can serve as a seamless and secure entry point for investors who are new to crypto and can create a new way to diversify portfolios. A spot bitcoin ETF will be a security, making it easy to buy and sell without the investor needing to hold the actual bitcoin.

Some investors will likely stick with this connection point to crypto while others will expand their digital asset investments. They may stretch their exposure through spot ethereum ETFs upon their approval along with other digital asset investment opportunities. 

The approval of spot bitcoin ETFs will be a key step forward but it's unlikely that the bigger regulatory picture will be resolved any time soon in the United States. Because bitcoin is the only digital asset considered a commodity at this time, a spot bitcoin ETF won't likely pave a quick path to, say, an ETF basket of crypto assets. But it will be an ideal first step, giving advisors and investors a chance to make the transition into this new asset class — crypto in the form of bitcoin — in a familiar vehicle: ETFs.