CryptoETF Shift: Balancing Cash and Kind

It's highly probable that regulatory authorities will compel Bitcoin (BTC) ETF applicants to embrace a "cash-create" model before launching their eagerly anticipated investment products, as suggested by Bloomberg ETF analyst Eric Balchunas. This potential decision could significantly impact the operational costs of each fund, subsequently influencing the fees transferred to customers.

Comparison of In-Kind and In-Cash Models

Over the past month, BlackRock and other applicants have engaged in multiple discussions with the Securities and Exchange Commission (SEC) regarding their "redemption model" – the mechanism governing the alignment of their ETF shares with the value of the fund's underlying BTC.

Sponsors such as BlackRock have advocated for an 'In-Kind' redemption model, where a registered intermediary transfers Bitcoin (BTC) to the ETF issuer when issuing new fund shares to meet market demand. Conversely, the SEC is pushing for a cash-create model, requiring intermediaries to send cash to an ETF issuer, which is then used to purchase the necessary BTC. This additional step aims to prevent intermediary broker-dealers from directly handling actual BTC, a practice frowned upon by regulators.

However, there's a downside. As explained by Balchunas in a Thursday post on X:

"Cash creates are worse for taxes because cash changes hands, whereas in-kind is simply a trade with no cash exchange. Thus, cash-create-only bitcoin ETFs are suboptimal and compromise a significant advantage of the ETF structure."

Early Capital Gains Tax Implications

By conducting cash-to-BTC conversions independently, ETF issuers would be susceptible to capital gains taxes whenever they sell their fund's BTC. According to fellow Bloomberg analyst James Seyffart, this could lead to ETF holders recognizing gains when they might not have needed to otherwise.

"This is how *all* Mutual Funds work because mutual funds operate on cash create and redeem," he explained. "It should be more of an inconvenience than anything for most people."

The potential shift to a cash-create model upon conversion to an ETF could particularly impact the Grayscale Bitcoin Trust (GBTC), as the fund has been holding clients' BTC for years at significantly lower prices than today. Balchunas additionally noted that cash-create ETFs seem to be a "done deal" based on internal discussions and various updated ETF filings from applicants.

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