With yesterday’s SEC Twitter fiasco and original Bitcoin ETF approvals slated for today, there’s a lot to consider in crypto at the moment.
In today’s edition, we’re giving you insights from Cathy Woods of Ark Invest, and Ophelia Snyder of 21Shares, the two companies which partnered to file for the original Bitcoin ETF which much speculation is based upon.
Stay alert, stay informed ⬇
Background on ETF
The SEC twitter account was supposedly compromised, resulting in a faulty Bitcoin ETF approval tweet
The abrupt approval and the tweet’s removal a few minutes later with Gary Gensler’s confirmation of a compromise led to confusion in the market.
Some have speculated on the market movements in the brief period that ensued following the approval tweet and before Gary Gensler’s tweet.
Background on ARK ETF
Wednesday, January 10th, was the decision date for the SEC to approve or deny ARK Invest and 21Shares partnered product.
It was predicted that the decision on this particular product would be extrapolated to the other ETFs, including Blackrock’s.
Today, it was announced that both
Blackrock initially had announced fees to be set at 0.3%, and has lowered this figure to 0.25%.
Blackrock plans to charge 0.12% for the 1st year of ETF operation, or until $5B in AUM is reached; whichever comes first.
ARK Invest had initially set its fees at 0.25% and has now revised fees to 0.21%.
ARK announced plans to waive fees for the first 6 months, or until $1B in AUM is reached; whichever comes first.
This is an example of prospective ETF providers competing for early marketshare, as they recognize that this sort of capital is likely to remain with chosen providers.
ARK x 21Shares: Joint Product Partnership
Ophelia Snyder, Co-Founder of 21Shares, says that many people are not comfortable with infrastructure related to cryptocurrencies.
ETFs provide access to traditional finance for crypto natives by offering exposure to assets like $BTC and $ETH.
She adds that building infrastructure for launching spot $BTC and other crypto ETFs requires expertise.
Even experienced professionals can find it challenging to navigate platforms like Metamask.
The barrier to entry for most people is high due to technical complexities.
Fiduciary obligations add another layer of complexity for those managing other people’s money.
Ophelia says that different fund structures may not be able to hold certain types of assets or perform tax reporting consistently within their infrastructure.
Crypto is not designed to seamlessly integrate with traditional financial systems, so building additional infrastructure is required.
She adds that repackaging crypto allows it to work within the existing financial infrastructure.
This bridge is necessary to attract investments from big asset managers, pension funds, and other institutional investors who may have structural limitations preventing them from directly accessing these products.
Repackaging makes it easier for new participants to enter the industry.
Cathie says that the complexity of infrastructure in crypto funds is often difficult to explain.
She emphasizes their experience of launching 40 funds and successfully navigating different market conditions.
Traditional firms lack the same level of experience and may face challenges in dealing with the complexities of crypto fund infrastructure.
ETP Vs ETF
Ophelia says that Exchange Traded Products (ETPs) and ETFs have similar operational structures.
Regulatory differences between Europe and America result in slightly different naming conventions for these products.
In Europe, ETFs fall under a specific regulation called UCITS, while in America, they have a different legal setup due to restrictions on including crypto assets within US ETF wrappers.
She adds that despite regulatory differences, ETPs and ETFs fulfill similar functions.
Both types of products have creation/redemption mechanisms.
They are accessible to retail investors and can be used by institutions.
For most people’s purposes, the regulatory distinctions do not significantly impact their understanding or usage of these products.
Ophelia says that during product launches, 21Shares encountered challenges related to blockchain issues.
Hash wars caused disruptions in asset transfers and pricing.
She adds that she had to explain complex concepts like hash wars to market makers who were unfamiliar with them.
Over the years, they have dealt with various issues such as halting blockchains, incorrect transfers, settlement errors, etc.
Her team has battle-tested infrastructure in crypto funds.
They have navigated through market meltdowns and successfully managed migrations from proof of Work to proof of stake on Ethereum.
Liquidity management is a significant topic within ETFs, especially during periods of high volatility.
Existing Products
Traditional asset managers, such as BlackRock and VanEck, are entering the crypto space by filing for $BTC ETFs and offering other crypto-related products.
These asset managers will need to navigate specific issues unique to the crypto industry, such as hash wars, hard forks, Staking, etc.
Ophelia says that 21Shares has been offering crypto-native products like $BTC ETPs and $ETH staked products for a while.
She adds that 21Shares offers a wide range of products including single-asset products like $BTC and staked $ETH.
They also provide index products covering top assets and Staking indexes. Additionally, they offer short positions in large-cap cryptocurrencies.
These products are available across Europe where 21Shares is based.
Ophelia says that the absence of certain ETP offerings in the US is primarily due to regulatory decisions made by authorities like the SEC.
Europe tends to be more progressive in terms of pushing regulatory boundaries for financial products like ETFs.
She adds that the market structure, social safety net, market size, fragmentation, and retail presence differ between the US and Europe.
These factors influence regulators’ considerations regarding new financial products.
Ophelia says that the US has a different approach to regulations compared to Europe, often being more cautious and slower in adopting new financial products.
The legal system in the US places emphasis on precedent and checks and balances, which affects the pace of regulatory decision-making.
Cathie says that the SEC’s recent denial of regulatory clarity for Coinbase and their stance on existing regulatory structures for crypto indicate a difference in mindset compared to Europe.
She adds that understanding America’s political and legal history helps explain why regulations work differently in the country.
The US has a unique legal framework that evolved over time, resulting in a more cautious approach to regulation.
A lack of appreciation for history within the crypto industry can lead to misunderstandings about regulatory differences between countries.
Cathie says that she thinks Coinbase may take their case regarding regulatory clarity to the Supreme Court.
Recently, Coinbase requested regulatory clarity from the SEC but was denied. They plan to appeal this decision.
She adds that the SEC’s position on existing regulatory structures for crypto echoes past conflicts between different authorities like the CFTC.
Resolving jurisdictional disputes between regulators can take years, as seen in previous cases that went all the way to the Supreme Court.
Cathie sees outsourcing regulatory decisions from agencies to courts as a feature rather than a bug in the US system.
This approach allows for achieving consensus through a regulatory court system.
It aligns with the checks and balances of the executive, judicial, and legislative branches.
She adds that the appointment of Gary Gensler by Joe Biden adds an executive perspective to regulation.
Judicial engagement is crucial, as it provides a balance against regulatory agencies like the SEC.
The involvement of all three branches (executive, judicial, legislative) is positive for normalizing crypto within America.
Cathie says that regulatory arbitrage in other parts of the world has prompted action in the United States.
Concerns about innovation leaving the country have driven regulatory engagement.
Without this spur, the US might still be where it was two years ago.
How Much Interest Is There?
There is a growing interest in Bitcoin ETFs from both crypto natives and institutions.
Institutions like BlackRock, Bitwise, Ark, and 21Shares are motivated to push for the approval of a Bitcoin ETF.
The level of interest on the buy side, particularly from retail investors, is still uncertain.
Cathie says that the probability of a spot $BTC ETF being approved is estimated to be around 95% or higher. The anticipated approval window is in early January, specifically around January 10th.
Portfolio Allocation And Risk
Cathie says that Cambridge Associates suggested that institutions should consider allocating a percentage of their portfolio to $BTC as a new asset class.
The optimal weight of $BTC in an overall portfolio depends on the desired risk-return profile:
To minimize volatility, the recommended allocation is around 2%.
To maximize return per unit of risk (sharp ratio), the recommended allocation is closer to 6%.
Cathie says that over time, institutional adoption of new asset classes tends to start with a small allocation and gradually increase.
Real estate and emerging markets are examples where institutions initially allocated around 1% and eventually increased it to about 5%.
Similar adoption patterns are expected for $BTC as more institutions recognize its low correlation with other assets and potential for diversification.
She says that historical performance data shows that over rolling three, five, and seven-year periods, Bitcoin has been the top-performing asset.
Institutions cannot dismiss $BTC unless they possess unique information that contradicts the data.
The underlying technology of $BTC has proven to be resilient against hacks, with most vulnerabilities found in layer-two solutions rather than the base layer.
Cathie says that the narrative of crypto as an uncorrelated asset class was initially presented to institutions in 2018.
Institutions are driven by the desire for a more performant portfolio over the long term.
Allocating to crypto assets becomes increasingly compelling when considering risk-adjusted returns and potential diversification benefits.
Ophelia says that selling to institutions in Europe follows a consistent pattern. Initial questions are addressed regarding the structure and functioning of the asset.
Testing is conducted, often involving a small allocation. Compliance reviews and further basis point allocations follow this initial phase.
She agrees with Cathie’s prediction that crypto will reach 1% to 5% allocation.
However, they emphasize that reaching this level will take longer than expected due to compliance reviews and additional work involved.
The industry underestimates the magnitude of dealing with trillions of dollars compared to what crypto has experienced before.
A few basis points may seem insignificant, but when applied to trillions, it represents substantial amounts of money.
The industry needs to grasp the scale and liquidity implications at play.
What Makes An ETF So Special?
Cathie says that institutional allocators have been waiting for regulatory approval, specifically from the SEC for a spot $BTC ETF.
Retail investor acceptance by regulatory bodies like the SEC provides confidence for institutions as they prioritize retail investor safety.
Institutions value regulatory “seal of approval” as it signifies legitimacy and reduces uncertainty surrounding new asset classes.
She adds that regulatory approval from the SEC is crucial for institutional investors.
The SEC’s research department is knowledgeable about crypto and provides accurate insights.
Political factors have sometimes clouded the industry’s perception but are not a deterrent for institutions.
Judicial support and legislative movement towards favorable regulations increase confidence. Institutional investors prioritize benchmark-sensitive investments due to their conservative nature.
Ophelia says that asset managers have fiduciary obligations to ensure safe custody of assets and best execution practices.
Learning an entirely new industry and setting up compliance infrastructure is time-consuming.
Reporting taxes on cryptocurrency holdings adds complexity to asset management processes.
Allocating a small percentage of client portfolios to cryptocurrencies requires extensive work that goes beyond their primary responsibilities as allocators or relationship managers.
She adds that traditional financial institutions have existing reporting standards and perform due diligence on known managers they already have relationships with.
They rely on brand names that they trust to vouch for the underlying security and hold fiduciary responsibility for their clients.
This is different from the perspective of a crypto-native audience who may not be aware of these processes.
The Value Of Custody
Ophelia says that traditional financial advisors need infrastructure, such as SEC-approved platforms, to offer investment products safely.
They have a high level of responsibility towards their clients’ investments, unlike individual investors who can take full control themselves (self custody).
The crypto industry sometimes forgets the high bar set for traditional financial advisors in terms of responsibility and client support.
She adds that client service is crucial for traditional financial advisors in helping clients understand investment theses and building suitable portfolios.
Research, client coverage, and support are essential components of providing effective client service.
The crypto industry should recognize the importance of client service as a requirement for traditional financial advisors.
Ophelia says that traditional financial advisors operate on the principle of trusting third parties to manage investments on behalf of clients.
This is different from the desire of some individuals in the crypto industry who prefer to have full control over their investments.
The responsibility and risk associated with managing other people’s money require a high level of trust in professionals.
Cathie says that financial advisors have a significant responsibility towards their clients’ investments, which can impact their entire careers.
They are expected to vet investment structures properly and ensure client funds are secure.
Individuals who entrust their money to financial advisors rely on them for responsible management.
She adds that traditional financial advisors need infrastructure, such as banks before they can effectively manage investments.
They may lack confidence in explaining new investment opportunities to clients without properly understanding themselves.
Learning how to explain new concepts and gaining confidence takes time and experience.
Cathie says that financial advisors sometimes bring along experts or learn from others when they need to explain new investment opportunities to clients.
It can be daunting for advisors who may not initially understand or feel confident about certain investments like $BTC.
Understanding and explaining new investments often requires multiple attempts before becoming comfortable with them.
How Many ETFs Can Get Approved?
Ophelia says that comprehensive crypto regulation in America is still lacking, which affects the approval process.
Each individual product’s characteristics and purpose play a significant role in determining its eligibility for an ETF.
Different tokens are treated differently from a tax and securities perspective.
She adds that transparency in markets and pricing, as well as market infrastructure, are crucial considerations for approving ETFs.
She expects the approval process to be similar to Europe, where each product’s fundamentals and market infrastructure are evaluated.
Ethereum ETF In 2024
Ophelia expresses hope for a change in pattern regarding $ETH ETF applications’ withdrawal requests by the SEC.
Continued engagement from regulators is seen as positive progress towards an $ETH ETF approval.
Concrete predictions regarding an $ETH ETF are dependent on $BTC’s performance, as they are closely related.
Cathie says that it is crucial to communicate with the SEC to prevent being shut down or classified as an investment company.
Cathie says that Michael Saylor has been advised by the SEC and directed to Financial Accounting Standards Board (FASB).
This interaction positively influenced $BTC’s classification as an intangible asset.
Ophelia says that $stETH has become available in Europe and recently expanded into Canada.
While it may seem plausible for staked ETH to be introduced in America, progress within this system requires starting somewhere before further iterations can occur.
Did We Get A Fed Pivot?
Cathie says that Austin Gouby, known for leaning towards easing, has attempted to walk back previous dramatic statements made by the Federal Reserve.
Various indicators, including an inverted yield curve, suggest economic challenges such as a potential recession. Industrial America is experiencing difficulties, while China’s exportation of deflation impacts the United States negatively.
She adds that the Federal Reserve desired 2% inflation but may face negative inflation in 2024.
Negative inflation implies deflation, which can cause profit declines for companies accustomed to pricing power.
Technology companies thrive in a deflationary environment due to learning curves resulting in cost declines passed on as price reductions.
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