Unchained - Why the SEC May Want Cash Creation of Spot Bitcoin ETFs - Ep. 582

Starting point is 00:00:00 A lot of issuers don't want to do this. Most of them, they deal specifically with in-kind because they don't really want to have to be going into markets and buying and selling this stuff and what have you, right? So it's going to be more onus on the issuer to operate these. So there might be some issuers out there that as I hinted at the beginning that are like, well, we were going to do this if we could do in-kind. But if we have to hire people to make sure that we're trading and buying and selling the Bitcoin directly, we might not want to do that. Hi, everyone. Welcome to Unchained. You're a new one. hype resource for all things crypto. I'm your host Laura Shin, author of The Cryptopians. I started

Starting point is 00:00:35 covering crypto eight years ago and as the senior editor of Forbes was the first mainstream reader reporter to cover cryptocurrency full-time. This is the December 15th, 2023 episode of Unchained. This episode is brought to you by Uniswap. From their self-custodied wallet to zero gas swaps, Uniswap is building products for safe and seamless swapping across DFI. Visit app.uniswap.org to get started. Arbitrum's leading layer two scaling solution offers you ultra-cheap and lightning-fast transactions, all with security rooted on Ethereum. Visit arbitram.io today. VaultCraft is your no-code defy toolkit for customizing non-custodial automated yield products on any EVM chain. Join the referral program today and start earning rewards. Learn more at

Starting point is 00:01:23 volcraft.io. Today's guest is James Seifert, research analyst at Bloomberg and intelligence. Welcome, James. Hi, Laura. Thanks for having me. Happy to be here again. It hasn't been that long. This is a very intense time for you, I imagine. And also just for the crypto community in general, particularly the Bitcoin community, we're most likely less than a month away from the launch of swap Bitcoin ETFs at this point. And yet it sort of feels like cram time before finals, at least for the potential issuers in the SEC. We're seeing there's like multiple meetings, happening all in one week. There's like these changes being made. So what information can you glean about what's going on? Yeah. So I mean, there's a lot of like, to be honest, there's a lot of bad

Starting point is 00:02:10 takes I've seen on on Twitter and other places about what's going on. They're like, why would they be meeting this much if they're going to approve them? Look, our view, one thing I will say is you said we could see one list within a month. I, I were very confident we seen one approved. That might not mean they list partially because all these meetings means that the SEC and these issuers are like going over finer details, likely like pushing and arguing for different things. The main thing is this in-kind versus cash create redeem model, which we can get into, but there's also likely like a lot of other things. I wouldn't be surprised if we see a notice that like another issue or met with the SEC today or yesterday that hasn't dropped in the SEC website. Everything I'm hearing is there's a

Starting point is 00:02:48 lot of people meeting with the SEC over this week, over the last few weeks. And my view is it's a positive thing because they would not be down in the weeds going over this minutia if like they weren't willing to spend significant time because they want to get these things ready. Yeah. And so I should say, first of all, we're recording on Thursday at 11 a.m., which is why James is saying we might see more news about meetings and other stuff before this episode goes out. But one other thing is that, so just to clarify for me, because you're recognizing that there's a gap in my knowledge, So the approval would happen by January 10th at the latest is your best guess. And then so how long of a delay is it until launches or listening?

Starting point is 00:03:29 Yeah. So the dates that I'm looking at are January 8th, January 10th. That's when I think we'll see these approval orders if Eric Beltutis and I are correct in our call, which obviously I hope we are. So that's under the 19B4 process. And then there's this other process, the S1, which is what a lot of these meetings are about, It's about like the language in these documents, what it says about risk disclosures and how these funds are going to operate. There are no real true deadlines on that. Now, it would be very abnormal if it was like months between the 19B4 approval and the S1 approval.

Starting point is 00:03:58 My base case is I think that they could get approved around the same time. Like the SEC is working in conjunction, both divisions that would be approving these things. But it wouldn't be out of the question to see like a few days or weeks between seeing those approval orders and ultimately these funds listing on an exchange. So there's no set like, oh, we get approval and then like we have two days and these things are going to list. It could happen anywhere from like a day or two to like a couple weeks in my view. I lean towards thinking we'll have them like you hinted that. I think they'll be listed in mid-January potentially, maybe even earlier. But there's no way to know at this point when that will be. Okay. But will it be the same thing where all the approvals happen on the same day and then all the

Starting point is 00:04:37 listings happen on the same day? So I think, yes, I think all the approvals are going to happen in the same day. That's a stance we've had for a long time. that's what happened with the Ethereum future CTFs. I think that's what the SEC's goal is. The listings will almost be up to the issuers, right? Have the issuers got all their plumbing set up? Do they have all their third parties lined up and ready to go for this approval, which there's no way for me to know for certain.

Starting point is 00:04:59 I can guarantee you that many do, like they will, just knowing how things work, but maybe some of these issuers are deciding there's too many horses in this race or it's too much work because the SEC seems to not be allowing in kind. There's all these different reasons. But so, like, theoretically, the SEC is going to say, if you're ready, you can go. And then it's going to be up to the issuers and their partners to make sure they're ready to operationally ready to launch these things. Okay. So now let's talk about the main sticking point, at least, you know, from all of us, T. Leaf observers, what we're

Starting point is 00:05:28 reading into this. The main sticking point at this point is whether or not there's something called in-kind creations and redemptions of these spot ETFs versus cash creations and redemption. So can you explain what the difference is between these two things? Yeah. So interrupt me if I say anything this confusing because I'm going to have to go like talk for a while about this to kind of get it because it's very, it's very nuanced, but it actually does mean a lot. At the end of the day, before I even dive into this diatribe, I do want to say like for the most part, when these things list, the average end investor is not going to know the difference between what's going on here. It's going to be very, it's going to be very minute, minute differences here.

Starting point is 00:06:04 So that said, the way that an ETF operates, why most people consider it to be better than mutual funds is more tax efficient. It trades. It's your day. You can put money into it your day. And the ETF doesn't have the massive premiums and discounts that we've seen in GBC and something called closed-in funds because they can create and redeem shares or create and destroy shares on a daily basis. So the way that an ETF normally operates, so we'll just talk Bitcoin, because that's what we're talking about here, the way an in-kind model would work is these market makers, authorized participants, think Wall Street traders, these people would gather up Bitcoin if they're creating shares of the ETF. They would gather up Bitcoin wherever

Starting point is 00:06:40 they get it. They would hand it over to the issuer, the authorized participants, would hand it over to the issuer, and in return, the issuer then create new shares of the ETF. They take delivery of that Bitcoin, and no shares will be created to be traded on exchange. So at all times, you're trading Bitcoin for shares at an ETF, which is an in-kind transaction. It's two things that are for equal value, and the IRS does not consider that to be a taxable event. So all of a sudden, you're creating and redeeming shares, and there's no basic transaction happening. It's just that keeps that premium discount at zero. It keeps the nav in line with the price.

Starting point is 00:07:10 and it also is very taxably efficient. With cash create, it's basically that's how mutual funds work in this day and age, right? All mutual funds for the most part, they pay capital gains at the end of the year. It's very common. ETFs almost never pay capital gains because of that in-kind model. A cash model is where those APs, those market makers, those Wall Street trader type people, they're going to be handing over cash and getting shares of the ETF return, or in the opposite of redeeming, they're going to be handing over the shares and getting cash in return.

Starting point is 00:07:39 So what that means is that the buying and selling of Bitcoin is happening at the issuer level, which again is how all mutual funds work, right? You give cash at the next day they buy the underlying assets for you. But the problem with that is that's a taxable event, right? So with the mutual fund and with these cash creates, which it's not guaranteed that the SEC is not allowing in kind, but that's certainly the tea leave reading that I'm getting. Obviously, we've seen BlackRock and Greyscale and Fidelity and Arc and a bunch of these other issues pushing hard to allow in kind because in my view, it's better for everyone involved

Starting point is 00:08:08 for those reasons I just talked about. But the issue with cash create and redeem is essentially it's a taxable event. So, right? That means that at the fund level, they have some sort of gains that they need to distribute. So typically when a fund distributes an income dividend or a company distributed to stock, it's taxed as income, which was taxed at like your marginal tax rate. But these cap gains distributions are going to be like, oh, the fund earned X amount of profit because the Bitcoin that they sold, they have in the fund at a cost basis of $10,000,

Starting point is 00:08:36 and they just sold it at $40,000. that's a $30,000 gain, and they have to pay capital gains tax on that, which is 15%, 20%, whatever that value is, which is typically lower the marginal tax rate. And what that really means is like, if you're holding the fund, you might get hit with the capital gains distribution that you weren't expecting. Now, that's not the end of the world, right? Like if you own the fund and you want to buy and sell it, or if you own Bitcoin and you want to buy and sell it, you're going to be sitting on embedded gains.

Starting point is 00:09:02 That's basically what's happening here with these funds. And specifically, it matters to gray scale because they've been operating for. for so long. So really all it is is a timing thing. So like with ETF, the big benefit over mutual funds is like you can dictate when you have those capital gains distributions, basically when you recognize those gains. Whereas with this structure with the cash create and redeem, it might force you to recognize those gains earlier than you want to, but it's not like you're losing any money here. You're just going to have to pay taxes on those gains slightly earlier. And theoretically, if you really wanted to, you could reinvest in the fund with those games

Starting point is 00:09:32 or you can put them into another Bitcoin fund or Bitcoin directly or what have you. Okay, but the thing is like I would imagine this just increase the cost and ETFs are kind of known to be a low cost investment vehicle, whereas I would imagine that would just, yeah, increase the base cost. So then they're no longer as inexpensive as they could be. Yeah, so that's true. One of the benefits of the ETF wrapper is like all of that stuff that I talked about happens in the plumbing and with these market makers and traders. and the fact that you're going to have to bring this in-house, which is why a lot of issuers don't want to do this. Most of them, they deal specifically with in-kind because they don't really want to have to be going into markets and buying and selling this stuff and what have you, right?

Starting point is 00:10:17 So it's going to be more onus on the issuer to operate these. So there might be some issuers out there that, as I hinted at the beginning, that are like, well, we were going to do this if we could do in-kind, but if we have to hire people to make sure that we're trading and buying and selling the Bitcoin directly, we might not want to do that, right? So that's one thing. But it definitely will bring more of the call.

Starting point is 00:10:35 in line with the issuer, it's going to add a little more friction because there's way more steps here. So whereas if you're by if the AP, the authorized participant or market maker, I'll just, I'm going to refer to them as AP and MM. Just think of those as the, the trader people that make this work on the back end for most people. They're handling all of that. Now you're putting it inside the ETF wrapper, which is less tax efficient. And like you said, it might add costs because you have all these extra steps that are being included here that people have to do. So you might end up with like slightly wider spreads and in cash grade versus in kind. But for the most part, like for the end investor, like,

Starting point is 00:11:05 this does not matter. You're talking about like basis points, like one basis point maybe in difference and spreads and different things like that. It's going to be minimal impacts for the average person that are looking for exposure to Bitcoin. That said, the taxable part of this and Cap Gaines distributions, that could matter to some people. But for the most part at the end of the day, this really isn't that big of a deal. It's just something that people should be aware of.

Starting point is 00:11:28 And obviously, people have tons of questions on this. And I will disclaim, like, I'm not a lawyer or tax expert. So don't please do your own resources. This is not investment advice. I'm just trying to explain the structures here. Okay. So in a moment, we're going to discuss a little bit more about this difference between Nkind versus cash creation or redemption.

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Starting point is 00:12:22 Arbitram stands at the forefront of innovation as the premier suite of layer two scaling solutions, bringing you lightning fast transactions at a fraction of the cost, all with security rooted on Ethereum. From Defy to gaming, Arbitrum 1 plus Nova is home to over 500 projects. And with the recent launch of orbit, Arbitrum welcomes you to build your very own tailor-made layer 3, or an orbit chain. Propel your project and community forward by visiting Arbitrum.io today. Back to my conversation with James. One other thing that I wanted to ask, though, was, so you're saying these kind of back-end participants, they'll take all this on, they'll, you know, not only do all the steps of buying in and out of Bitcoin and cash,

Starting point is 00:13:05 but then they'll also, I guess, pay those capital gains. But I guess what I was wondering is I think there's also more risk to them, right? Because if they're constantly having to convert out of U.S. dollars into Bitcoin and vice versa, then they're constantly also losing a little bit of like value because there's, you know, bid-ask spreads, you know, when they're buying or just simply the fact that the Bitcoin price can be quite volatile, that would, you know, they need to like have sort of like trading strategies on the back end to make sure they're not losing money. But obviously they might not do it correctly every time. So they might lose money. And so that's another way the expenses might

Starting point is 00:13:44 trickle out to users. Am I right or wrong? Yeah. So it comes out really in the spread is is what happens essentially because these market makers are very sophisticated. We're talking like Citadel, Susquehanna, Jane Street, Virtue, like massive players in the space. And they are hedging on both sides of the trade. So they're basically trying to get to their neutral exposure. So what they will do if like things are more complicated or more volatile, those spreads will be a little bit wider potentially. So basically they're what they're willing to offer at, buy ad and sell at are going to like expand a tiny bit. So like that might show up a little bit in the ETF. But again, for the most part, like these, this is what they do day in, day out 24-7.

Starting point is 00:14:25 So it's not, that said, with the issuers, if they're the ones that have to buy and sell Bitcoin, they're going to have to figure out a way to do this, whether it's an OTC desk or some exchange, who knows exactly how they're going to do it. But the SEC basically is saying they don't feel comfortable with brokers. Typically the people that are APs in this case are a lot of big banks and brokers that are registered broker dealers. And you've done a lot of coverage on this related to Prometheum and a bunch of other things about like how brokers can't touch this stuff, particularly Bitcoin. And I think it comes back to the SEC basically isn't going to give up on that stance.

Starting point is 00:14:56 So if they do allow in kind, the problem here is that they almost be like, implicitly accepting a loophole to that rule. So basically these brokers would have like subsidiaries and offshore entities that would technically deal in in the Bitcoin and they have offsetting balance sheet positions, which like, yeah, that would work and it would be the most efficient way as things are currently constructed in my opinion. But again, that's like the SEC, almost like green lighting a loophole that like takes everything like more out of their jurisdiction, right? So by forcing it to be cash, the brokers aren't touching the Bitcoin. So the brokers are are under the SEC's jurisdiction. And they've asset management firms who run these ETFs are under

Starting point is 00:15:34 the SEC's jurisdiction. So all of a sudden, everything stays when they leave it in cash under the SEC jurisdiction because they are not allowing brokers to touch this stuff. Oh, okay. Now I understand that. So that's basically the reason why they want to do that. So I don't know for certain that's the reason that they want to do this because they are not telling, as far as I know, there's nothing publicly explaining this. Right. They are not telling issuers as far I'm aware, why they're not doing this, but I'm just trying to read the tea leaves and I've talked to a lot of different people on this. And that's my view, essentially. That's what I think is happening. And to be clear, like, the SEC, they've gone in baby steps this whole way, right? Like, they were, GBT is here.

Starting point is 00:16:14 Then they allow Bitcoin futures ETFs. Now they're getting to spot ETFs. They allowed ETH futures ETFs. But with spot, they're still not comfortable with the brokers actually touching the online Bitcoin. So we're only going to get cash probably to start and then in kind. Now, again, I just want to reiterate, like, I don't think Grace's, scale and BlackRock, we've seen filings from Valkyrie and Vesco and Bitwise specifically that have basically given up. Scott Johnson, one of the guys that covers this pretty well, is he said they bent the knee essentially. So they're kind of like giving up and bending knee to the SEC's desire that this all be cash create. We haven't seen other issuers do that

Starting point is 00:16:49 yet. But based on what we're hearing and what I'm seeing, it's looking like the SEC doesn't want to budge on allowing in kind. But these issuers BlackRock, and I know for fact, grayscale, they're not going to give up on trying to push for like some sort of revised model that will make it better so that we don't have to worry about this cash create and the tax implications and the inefficiencies that we've been talking about. And as far as I understand, correct me if I'm wrong, the issuers all wanted both options. They all wanted to be able to do both cash, creation or redemption as well as in kind. And what my understanding was they wanted to do cash because they wanted banks to also be involved in this process and banks cannot hold crypto.

Starting point is 00:17:29 But then they also wanted, you know, the advantages of the in-kind. And so they kind of wanted optionality. But now they're all being like funneled just toward cash. Is that, am I correct? Yeah. So a lot of the documents still, aside from those three I just mentioned, Bidwise was first to officially do it, I believe. Then Invesco did it yesterday.

Starting point is 00:17:47 And then Valkyry actually dropped the filing today where they went to it. And they all say, like, subject to regulatory approval or changes, basically, they would like to use in-kind as well. But the other ones, they all do, like you said, basically say, like in-kind or cash. That's just typical language for an ETF. For the most part, you can do both. And but like the vast majority of these trades and these transactions happen in-kind because it's so much more efficient from multiple different perspectives. So yes, they both, they want to leave both open. But for the most part, everyone would much prefer all of these transactions happening.

Starting point is 00:18:20 Kind. But obviously, some of these issuers are going to say, we're going to leave the ability open for cash in case, for some reason, something's going on in the markets where we're doing cash is just more efficient. So it's not guaranteed that in-kind is always 100% going to be the most efficient way to do this, particularly if an AP or a marketmaker can't locate enough Bitcoin or something like that. So theoretically, leaving the ability open or release valve to do cash-create or in-kind makes sense. But it's looking like the SEC just is not getting there where they're going allow these issuers to do to do in-kind alongside the cash creates. So one other question is that, you know, as you mentioned, this will affect Grayscale in a very particular way. So can you

Starting point is 00:19:01 describe how it will work for them? Yeah. So all these other issuers besides Grayscale, they'd be starting new funds. So it's not that big of a deal, particularly to even just to be in cash, right? Aside from the fact that the onus will be on the issuer to like actually buy and sell the Bitcoin, for the most part, these issuers, it's probably not a big deal. But for some, it actually does matter. Obviously, I know for a fact, I mentioned them at the front. Like, Grayscale is probably one of the ones leading charge. BlackRock has met with them the most, and you can see, like, they have to publish their

Starting point is 00:19:30 presentation on the SEC website. And they basically, they go going back and they're saying, here's a revised model for in-kind that's like slightly in the middle between cash and in-kind and would satisfy our concerns. So everyone's doing this. And then you have Fidelity and Arc and 21 shares. They all seem to be leaning this way. But it affects gray scale the most because they're an operating vehicle, right? So they've already had Bitcoin.

Starting point is 00:19:55 They have right now 620,000 Bitcoin in that trust roughly. They've seen 640,000 flow in. The problem is those Bitcoin have like a certain cost basis. Now, I will say GBDC is a grant to trust and the tax structure around that is very complicated. I was up late last night trying to like understand exactly what this means at an individual level. And I had to take a step back because it's, It was a little bit much for me, to be honest. But what you need to realize is basically this point Bitcoin has gone in from 2013 until

Starting point is 00:20:24 the fund closed in March of 2021. So all that Bitcoin came in. And so right now the average price, I tried to do this the best I could. And basically the way I did it is I calculated this much money went in on this day. The average price of Bitcoin in this day was this. That means that this many bitcoins went in at this price. So my estimate is that right now the average Bitcoin in GVTC is around $11 to $12,000. dollars like that's the cost basis. So theoretically, if you have to sell that, now what they do

Starting point is 00:20:51 in this instance is they'll sell the higher cost basis stuff first. They don't have to incur any taxable events, particularly while cash is only allowed. But they have some Bitcoin they've taken in over $40,000. They have some they've taken in from 30 to 40, but a bulk of it is under that $20,000 mark. And some of it is even came in below the $1,000 mark because they launched in 2013. So while the money that came in in 2013 and 2015 wasn't that massive of numbers, like, It was a couple million dollars here and there. But Bitcoin was $100 or $1,000 or under $5,000 when that was coming in. So it's a lot of Bitcoin that's stored in there that's giving that exposure.

Starting point is 00:21:25 So Grayscale GBTC has taken in $7.4-ish billion in its lifetime. Currently, it's a $27 billion fund because all those Bitcoin it took in early are now massively appreciated, which is obviously good for anyone who's been invested in this thing for a long time. But it's no different than if you had held Bitcoin yourself because you're sitting on those. So if you need to sell that, you're going to have to pay. capital gains the IRS, and that's basically the same position that GBTC is in. So if we see a ton of money pouring out of GBTC, the trust itself is going to have to sell Bitcoin and then basically say, we sold, our cost basis was X, we sold at Y, we have to pay capital gains tax on that

Starting point is 00:22:02 percentage. But really what they do is they distribute those capital gains in a basis. It's kind of like a dividend, but it's a capital gains distribution. And then individually those people would theoretically pay whatever their capital gains tax rate is, which again should be lower than like a regular income tax rate, at least in the U.S. Okay, okay. But so investors in GPTC then I guess would have an incentive to keep their money in that vehicle rather than switching to a different ETF provider if that's, if it ends up being cash creation. Yeah.

Starting point is 00:22:33 So I can't talk like I don't want to talk about like individuals, but I will say this, this is the thing, right? So if you've held GBTC for a long time and you're thinking about switching to another ETF, no matter what you're doing, you will have to sell for a profit. incur capital gains, right? So you need to decide, are you going to just eat that whole lump sum and sell out of this thing and pay capital gains, or would you rather sit in it and possibly get a capital gains distribution at the end of the year, what have you, depending on how flows go? I mean, if GPDC doesn't see really much in the way of outflows at all, then this isn't

Starting point is 00:23:03 much of an issue, especially if basically GPDC gets to be in kind. The other thing I would say is like, Grayskill has not given up on in kind yet. All their documents, all their filings say specifically in kind and they don't say they're going to cash. So I I'm assuming that if the SEC really puts the, puts the hammer down and says like absolutely not, you have to be cash only, that Grayscale would still convert to an ETF. But as of right now, all their documents, everything they've said, the presentations they've given the SEC over the recent months, they're still pushing for in kind. It's just that if they do ultimately decide to convert to an ETF and uplist the New York Stock Exchange, this is a this is what would happen essentially. But again,

Starting point is 00:23:43 And if you're holding it already, like you need to decide no matter what, just like if you're holding any asset, if you're going to sell it and try to trade it, you still are going to have to pay on those gains no matter what you do. This would just be like if you don't want to sell, you might have to basically recognize those gains a little bit earlier. Like if you didn't want to sell for five years or six years, you might have to. So you might get a capital gains distribution of like however depending on how much you hold some number. And basically you're recognizing that gain and then you can reinvest those assets either in GBC or some other some other investment or do whatever you want with it really. Right, right. Yeah, that's what I meant that if in-kind is allowed, then they wouldn't have to pay until later, but now they will have to pay no matter what if everything is forced to be cash. Yeah, so the benefit of in-kind and ETFs is basically like you don't, it doesn't matter what anybody else does. So in mutual funds, if you're in there and some, the fund is, I don't know, we'll say $10 billion. And some one person has $1 billion in there and they take it all out. technically that that like capital you'll end up with the distribution that's just holding it even

Starting point is 00:24:49 though you didn't sell. It's an inefficient way of doing taxes, really, as far as we're concerned, as far as anyone should really be concerned, right? With an ETF, because of the in-kind model, the actual trust and fund is not generating those gains. So basically, you only have to worry about your gains paying those taxes on those gains when you decide to sell. That's the inefficient part here, right?

Starting point is 00:25:09 So like you're kind of being forced to recognize those gains earlier than you otherwise would, but it's still gains that you were going to have to pay no matter what, whether you were, whether you stayed in the fund or like, depending on when you left, really. So an ETF that allows in kind, basically you control when you recognize those gains. This with cash, particularly if you see a bunch of outflows, you might be forced to recognize gains that you would have to pay tax us on. Right, right. Yeah. And I could see that maybe changing people's minds, like if they were planning to leave to another issuer or whatever. But anyway, but one other question. So, but then Gray scale would also incur taxes when they end up listing. Is that what you? No, because it should

Starting point is 00:25:48 be a pass-through entity. So essentially it would just go. So gray scale itself isn't going to like, well, actually, I don't know for certain. But this is basically just how the trust is going to operate. So they'll rather than get like what's called like a regular income distribution, like it comes in. And if you look at your your tax documents, it says income, this will come in and it will say like the distributions we're talking about here. We'll say capital gains distribution. And it should be long-term gains. So long-term gains specifically are tax lower if you held it for over a year, that will come through. And there's a different tax rate for that. So basically, all it's saying is we're recognizing that you made certain amounts of gains and we're distributing those assets as a

Starting point is 00:26:24 cash dividend or cash distribution. And that distribution is capital gains, which you have to pay capital gains taxes on. Okay. And then you also talked about how this would affect BlackRock in a specific way in the Black Rock private trust. Can you talk a little bit about that? Yeah. So this is This is more in the weeds and stuff that we've been talking about. I've been looking at. BlackRock, as you know and many people are aware, they had a partnership with Coinbase back in August of 2022, alongside that they announced that they were launching a private trust for institutions and high net worth individuals that want access to Bitcoin and basically BlackRock

Starting point is 00:26:56 is going to offer this private trust. Now, it's not a mutual funder in ETF, so we don't know what the assets are in that trust. But what we do know is that there's likely significant assets in there. And we were estimating a couple hundred million dollars were in there. hundreds of millions we were thinking. And one of our theories was that BlackRock was just going to move that Bitcoin basically into the ETF when the ETF launches, so almost seed it. And then basically the ETF would get a jumpstart and have however many assets that private trust had because there's

Starting point is 00:27:22 not really a huge benefit to just leaving in the private trust for these issuers. It will probably be way cheaper, even the much sure, I don't know what, we don't know what BlackRock's fees are. We don't know really any information on this thing, but it would probably be more efficient to be an ETF for most people, right? So our theory was they're going to take those Bitcoin and just import them into the ETF. And they can't do that in cash create because you can't just take the Bitcoin and then put the Bitcoin in a creation into the ETF because you can only do cash create. So it's likely that those private trust assets are just going to sit in that private trust until the SEC gets comfortable within kind. So our theory was basically Blackark was going to use

Starting point is 00:27:56 that trust and those assets they already have to kind of perk up their their ETF, make it look more competitive. It will be more competitive. I mean, if you come to market and all of a sudden you have hundreds of millions of dollars in your in your ETF and your name. is BlackRock, it will have meaning. So it kind of almost like might be leveling the playing field. That said, there's no way to know from our point of view that 100% this was BlackRock's plan, but if I were BlackRock, that's what I would have been doing. And it's looking like, and based on the fact that they're one of the ones leading the charge on Inkind, again, I will go back and say, in kind is better for everyone involved at the end of the day as far as I'm

Starting point is 00:28:30 concerned, except for the SEC, it seems. But BlackRock has been pushing the charge here. And I think personally that maybe one of the reasons is possibly this. Meanwhile, we have a bunch of issuers who are also applying for an Ethereum ETF, which obviously that would not be until, you know, sometime in the spring or later. But what's happening there? You know, what timeline would you expect there to be some kind of approval? And we're also seeing some kind of objections in the press to the notion of an Ethereum METF concerns about the staking model.

Starting point is 00:28:59 So I just want to hear your thoughts on, yeah, where that all is going. Yeah, so there's a bunch of issues that. filed. It's basically in the same process that the spot Bitcoin ETFs are going through. The reason we're looking at January 10th for Spot Bitcoin is because that's Ark and 21 shares first date. Vanek, I believe, is the first one due for a spot Ethereum ETF decision. So the final decision for them is like May 23rd or 24th. So theoretically, it's possible that we see approvals by then. That said, we're nowhere near as confident in that as we are on the Bitcoin side of things. And obviously, a Bitcoin ETF approval would increase our confidence that a Spot Ether

Starting point is 00:29:35 would be happening. So those are the timelines we're watching. The objections we've seen in the press, honestly, a lot of them I don't think are relevant because none of these applications are going to stake the ETH right now. So the objections about East staking might have more to do with the fact that the SEC might use that to call it a security and then say they can't allow an ETF, but not that like the SEC can't allow it because the trust documents in this case would just basically, they don't say that they're going to stake the E's. So if it's just going to be holding ETH, it's going to be the same thing as Bitcoin, essentially. Now, obviously, a lot of people, particularly Bitcoin Maxis, will argue that this is a security.

Starting point is 00:30:12 My view is that the SEC has pretty much implicitly accepted Ethereum as a commodity at this point. So when the CME listed Ethereum futures, there's this whole process. And essentially, like, the way futures lists, we have the CME Bitcoin futures, we have the CME Ether futures, and then there's variations. There's micro versions of that. When you do that, you have to register and you file a document, and it basically says, we're registering these as this type of futures. And the most common ones are commodity futures or standard futures.

Starting point is 00:30:39 Another one is securities futures, which it basically means it's a futures on a security, and that's duly covered by CFTC and SEC. So anytime anyone registers the futures, they could register for both. And the SEC could object and have said, no, this should be registered as securities futures because Ethereum is a security. But all three or four registration documents, they haven't done that for Ethereum. So that was one thing why I was thinking the SEC might be getting more comfortable Ethereum because they're not pushing back on these things. And to go take a step back, we actually

Starting point is 00:31:07 just saw a lawsuit that went to the same court that Grayscale won with some of the same judges where basically they decided the SEC was arbitrary and capricious in allowing something, basically it's based on volatility. We don't need to get in the nuance. But essentially, the ruling was the SEC gave a letter that said, these are not securities futures. They can operate as commodities futures, which have a little bit, they're more cost efficient and can be more competitive. And the SEC said, no, these are security futures. You act capriciously and arbitriciously, and you can't do this. Right.

Starting point is 00:31:36 So the court basically threw out the SEC's decision to allow this thing to be a regular futures contract. So now we go back to Ethereum. The SEC is not fighting this. They also now have approved Ethereum futures ETFs, which are squarely in their purview. If they want to go back and call this thing a security, then we'd have to delist every Ethereum futures contract out there. We'd have to delist the Ethereum futures ETFs. And basically, it wouldn't just be the SEC fighting against the industry. It would be the SEC fighting against the industry and the CFTC.

Starting point is 00:32:07 It's sister agency. So that's why I think things are more likely than not. We haven't put out exact odds, but I do think it's likely to happen in 2024. My view, since this summer has basically been, I think Gensler and the SEC are pivoting on Bitcoin and Ethereum. So Bitcoin's on a tier all its own. Gensler will say it's on security, call it a commodity. And then he won't say anything on Ethereum. But he'll call like pretty much everything under everything else under the Sun,

Starting point is 00:32:30 security. So I think he's kind of pivoted on Bitcoin Ethereum. I think it's just not worth their energy to fight this. That said, they could probably pull some rabbits out of their hat to delay this thing further. It's not guaranteed that it's going to happen in May of 24. I know that was a really long-winded answer, but I just want, like, I'm probably going to get a lot of flack for saying that. I got a lot of flack for saying that on Twitter. But my view is basically the SEC has implicitly accepted this thing is not a security at this point. Nothing saying they can't go back and try to fight that again, but I just don't think it's worth their time. It's way easier for them to go back and fight against these other things, being securities, which they have put in these lawsuits

Starting point is 00:33:08 against Coinbase and Crack and other exchanges. Yeah. So who knows where all that will go? Because I do still think Ethereum's a different animal. And so it'll be very interesting to see whether or not applicants want to take advantage of that, but also how institutions will react because they kind of have a choice to like stake and get yields or you know just invest in normal ETF rapper. But anyway, James, this was just jam-packed of information. I really appreciate that you took the time. I know you have a very busy day today. So thank you so much for coming on and chained.

Starting point is 00:33:43 Yeah, thanks for having me, Laura. This was great. Don't forget. Next up is the weekly news recap. Today presented by Megan Christensen, who's a part of the Unchained team. Stick around for this week in crypto after this short break. Defi just got way easier with Volcraft. your no-code toolkit for building, deploying, and monetizing automated yield strategies in a few clicks.

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Starting point is 00:34:52 Download today. 19 plus, Ontario only. If you have questions or concerns about your gambling or the gambling of someone and close to you, please go to conicsonterio.ca. Thanks for tuning in to the weekly news recap. I'm Megan Christensen, producer at Unchained. Thursday morning, the crypto industry was rattled by a significant security incident with the compromise of Ledgers Connect Kit. Hackers injected malicious code into the GitHub library of Ledgers Connect Kit, a key component used for connecting decentralized applications or

Starting point is 00:35:22 DAPs to crypto hardware wallets. This breach affected the front end of multiple. DAPS, leading to the unauthorized draining of $504,000 from the user's wallets by the time of this recording. The exploit caused wider panic and confusion because it was not limited to Ledger wallet users. Ledger's Connect Kit is used by giants in the space, such as Sushi Swap, Lido, Metamask, and Coinbase. Ledger responded promptly by replacing the compromised version with a genuine one and advise users to carefully verify transaction details. Despite the quick response, the potential extent of the breach was significant, with several daps and crypto protocols urging users to refrain from interacting with them until the situation was clarified. At 145, AST on Thursday, the ledger team confirmed on X that the situation was solved.

Starting point is 00:36:14 They wrote, quote, Ledger and Walt Connect can confirm that the malicious code was deactivated. You are now safe to use your Ledger Connect kit. This week, the Financial Accounting Standards Board introduced new rules, potentially solving a big pain point for companies accounting for digital assets like Bitcoin on their balance sheet. These amendments, which became effective after December 15th, 2024, will enable companies to reflect the fair market value of their crypto holdings in their financial statements. This week, the Financial Accounting Standards Board introduced new rules, potentially solving a big pain point for companies accounting for digital assets like Bitcoin

Starting point is 00:36:51 on their balance sheet. These amendments, which become effective after December 15th, 24 will enable companies to reflect the fair market value of the crypto holdings in their financial statements. Previously, firms were required to record losses when digital asset values fell below purchase prices, but cannot report gains on values rose unless the assets were sold. Joe DiPasquale, CEO of Bitbull Capital, praise the update. He told Unchained that the changes would make it, quote, much easier for us to view the actual value of company's crypto holdings. Michael Saylor, chair of Microstrategie, a significant Bitcoin investor also applauded the new guidance. He wrote on X. This upgrade to accounting standards will facilitate the adoption of Bitcoin as a Treasury Reserve asset by corporations worldwide.

Starting point is 00:37:39 On Tuesday, lawyers for FTX objected to a staggering $24 billion tax claim from the IRS. Initially, the IRS had demanded as much as $43 billion, but this figure was later adjusted to $24 billion, a sum FTCS has branded as absurd and meritless. The FDX bankruptcy estate argues that the exchange, which only operated for about three years, never generated income close to the amount claimed by the IRS. Indeed, audit firm Ernst & Young calculated that FTCS recorded over $11 billion in losses from 2020 to 2020. FTCS's legal team is challenging the IRS to justify its calculations, stating that the tax claim significantly exceed any income the exchange could have possibly earned.

Starting point is 00:38:23 This development comes as FTX reported recovering $7.3 billion in assets earlier this year, with a plan to refund 90% of creditors' claims if its amended bankruptcy plan is approved by mid-20204. However, the IRS's demands could greatly impact these efforts, potentially delaying the recovery of user funds. Whocoin, a well-known digital asset exchange, has agreed to a significant settlement with the New York Attorney General's office. The exchange will pay $22 million in fines and refunds, as well as sees operating in New York State in order to settle allegations of operating as an unregistered securities trading platform. This amount includes a $5.3 million fine in over $16.7 million in refunds to New York users. The settlement resolves claims that Kukoin acted as an unregistered

Starting point is 00:39:11 securities and commodities broker dealer in the state. The lawsuit filed in March 2020 by Attorney General Letitia James is part of her intensified efforts to regulate the crypto industry. The Martin Act, a New York law aimed at protecting consumers from securities fraud, was cited in the lawsuit against KuKoin. This settlement comes amid a challenging time for digital asset exchanges, following Binance's recent $4.3 billion penalty for violating sanctions laws and operating without a license. Kucoin's CEO assured users of their asset security during the transition, indicating those affected would be notified via email or SMS. Interestingly, despite the legal challenges, Kucoin's native token, KCF, has shown a significant increase in value recently, reflecting a broader surge in the crypto markets. Binance intensified its legal defense against the lawsuit with the SEC.

Starting point is 00:40:04 Despite recently settling with the DOJ, Finance and its former CEO, Cheng Peng Zhao, face ongoing litigation with the SEC. The SEC's lawsuit alleges that Binance violated U.S. securities laws by failing to register as a broker dealer and cites the sale of B&B tokens and BUSD stable coins as examples of unauthorized securities transitions. Binance's legal team has disputed these allegations, challenging the SEC's arguments unquestioning the relevance of the DOJ's settlement, in which Binance pleaded guilty to money laundering and other criminal violations to the current case. Meanwhile, finances blockchain, B&B chain, reported a record high 32.7 million transactions

Starting point is 00:40:44 demonstrating robust activity despite the legal challenges. Meanwhile, the old max applied with the SEC to start an ETF focused on Microstrategy, the largest corporate holder of Bitcoin. This fund aims to generate monthly income by trading derivatives and earning interest on U.S. Treasury security holdings. Bloomberg Senior ETF analyst, Eric Bohunis, however, skepticism about this ETF, suggesting that investors bullish on micro strategy might be better off just buying the stock directly. Also, SEC chair Gary Gensler told CNBC on Thursday that the agency's, quote, new look, end quote, at applications for a spot Bitcoin ETF was influenced by recent court rulings.

Starting point is 00:41:25 One of those was an August decision by the U.S. Court of Appeals for the D.C. Circuit ruling in favor of Grayscale's arguments against the SEC for denying a bid to convert its gray scale Bitcoin trust into a spot ETF. On Wednesday, Bloomberg reported that Sujou, co-founder of the now defunct Three Arrow's Capitol, faced a Singapore court for questioning for the first time about the funds collapsed. The interrogation conducted by Tenio, the appointed liquidator, focused on understanding the failure of 3A.C and tracing its assets. Jews' arrest in September marked a crucial step in addressing creditors' concerns

Starting point is 00:42:03 with liquidators aiming to recover $3.3 billion. Despite his past claims of cooperating good faith, the liquidators have struggled to recover significant assets, reflecting the broader challenges following the dramatic collapse of 3A. Montenegro's high court, as extended the detent, of Terraform Labs co-founder Do Kwan, as reported by Bloomberg. Following requests from the U.S. and South Korea, the court ruled to extend Kwan's custody until February 15th. Both countries are pursuing charges against Kwan related to the

Starting point is 00:42:35 2022 collapse of the algorithmic stablecoin TerraUSD and its entire ecosystem. A decision on Kwan's extradition is pending, with Montenegro's justice minister to determine his fate. Time for fun bits. In the quirky world of crypto, even former presidents are getting in on the action. Donald Trump is back in the spotlight, this time peddling NFTs featuring his infamous mugshot, following two sets of NFTs he issued previously. That's right, you can now own a piece of digital art immortalizing Trump's less than presidential moments. It's a unique blend of politics, art, and blockchain.

Starting point is 00:43:17 A combo you probably didn't see coming. And that's all. Thanks for tuning in. Unchained is produced by me, Laura Shin, with up from Kevin Fuchs, Matt Pilchard, Juan Aranovich, Megan Gavis, Nelson Wong, Shoshak, and Margaret Curia. Thanks for listening.

Starting point is 00:43:35 Unchained is now a part of the Coin Desk Podcast Network. For the latest in digital assets, check out Markets Daily seven days a week with new host, Noel Atchison. Follow the CoinDesk podcast network for some of the best shows in crypto.

Unchained - Why the SEC May Want Cash Creation of Spot Bitcoin ETFs - Ep. 582

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