A spot-based Bitcoin ETF has long been considered a critical ingredient in promoting the wider adoption of the world’s premier cryptocurrency. While the SEC has so far been reluctant to approve a spot Bitcoin ETF, the recently revealed Lummis-Gillibrand crypto bill, formally known as the Lummis-Gillibrand Responsible Financial Innovation Bill, aims to provide a feasible offramp against some of the most vociferous reservations expressed by the SEC so far.
What Does the Lummis-Gillibrand Crypto Bill Offer?
Before going further, let’s take a brief refresher course on this critical piece of legislation. As we had noted in our previous post on this subject, the bill aims to offer an unprecedented level of clarity on the crypto front by simplifying the current regulatory regime, which is based on a confusing amalgam of a number of piecemeal legislative attempts, for Bitcoin and other cryptocurrencies. First, the bill aims to bifurcate the regulatory authority for the crypto sphere, with all tokens that are deemed a security falling under the purview of the SEC, while those that are considered a commodity are now subjected to the regulatory oversight of the CFTC. In order to classify a token as a security, the bill cites the famous Howey Test. As such, a token needs to fulfill the following conditions to be classified as a security:
Investment of money In a common enterprise With the expectation of profit To be derived from the efforts of others
Bear in mind that the SEC has already ruled that Bitcoin is not a security as it never sought public funds to develop its technology. Coming back, the Lummis-Gillibrand crypto bill offers additional clarity on how to apply this Howey test for securities. Essentially, a digital asset can be classified as security if it provides:
A financial interest – debt or equity – in a business entity Liquidation rights Interest or dividend payments (that is, a share in the profit) “solely from the entrepreneurial or managerial efforts of others” in that business
The bill treats all cryptocurrencies, including Bitcoin, as “ancillary assets” unless they behave like a security. On a similar note, the bill defines a digital asset as a natively electronic asset that offers economic or proprietary access rights. Similarly, a virtual currency is defined as a digital asset that is used primarily as a medium of exchange, unit of account, or a store of value, and is not backed by any underlying financial asset. Crucially, digital assets that are not fully decentralized and which benefit from the “entrepreneurial or managerial” efforts of others in order to create value, but do not entitle the holders to a debt or equity interest in the entity, will not be classified as securities as long as biannual disclosures are filed with the SEC. With the state of New York poised to ban the mining of Bitcoin using energy from fossil fuels, the bill seeks to authorize a study by the Federal Energy Regulatory Commission, in collaboration with the SEC and the CFTC, to balance climate change goals with the need to encourage financial innovation. In order to encourage the use of Bitcoin and other cryptocurrencies as a form of payment, the bill seeks to exempt transactions of up to $200 from taxes. Critically, cryptocurrency miners are not to be considered brokers, and their income in the form of digital assets will not be taxed until converted into fiat currencies. However, the bill does require Decentralized Autonomous Organizations (DAOs), crypto exchanges, and stablecoin providers to become registered entities in the US in order to enjoy their tax exemption status. Finally, the bill will not ban non-custodial or self-hosted crypto wallets, and mandates 100 percent backing for stablecoins. You can read a brief overview of the bill here. For the full text, head to this link.
How Will the Lummis-Gillibrand Crypto Bill Pave the Way for a Spot Bitcoin ETF?
This brings us to the crux of the matter. The SEC has so far only approved futures-based Bitcoin ETFs. BTC futures usually move at a premium of between 5 and 15 percent relative to the spot price. This is known as contango and is spurred by the implied financing rate, the time left to contract maturity, perceived volatility, etc. This leads to a forward curve that is upward sloping. ETFs that invest in futures have to roll over the front-month contract as it approaches expiration by buying one at the tail end. For example, consider a scenario where an ETF retains exposure to six consecutive monthly contracts. Also, assume that the January contract is nearing expiration. Consequently, the ETF would buy the July contract, with the February one becoming the front-month contract. However, due to contango, the ETF would be buying the July contract at a price that is at a substantial premium to the spot price. Over time, should contango persist, this practice leads to higher costs and ETF underperformance relative to the spot price. Due to this phenomenon, the futures-based Bitcoin investment avenues are not conducive to large-scale institutional adoption. It is for this reason that crypto enthusiasts in the US have been calling for a spot Bitcoin ETF. However, the SEC has been reluctant to approve such an investment vehicle, citing the probability of fraud and manipulation. The SEC has gone on record to state that it won’t approve such an ETF until crypto exchanges are better regulated. Well, the Lummis-Gillibrand bill aims to register a vast number of crypto exchanges worldwide within the financial jurisdiction of the US. Moreover, with the CFTC now appointed as the lead regulator for Bitcoin and other ancillary digital assets, most of the arguments of the SEC against a Bitcoin ETF have been neutralized. It is for this reason that we believe a spot Bitcoin ETF is only a matter of time at this stage. Of course, investors can already access spot Bitcoin ETFs in international jurisdictions. Canada recently approved the Purpose Bitcoin ETF, which has now commenced trading and currently holds over 36,000 Bitcoins. Additionally, Australia has also allowed the trading of two spot-based ETFs: the 21 Shares Bitcoin ETF and the Cosmos Purpose Bitcoin Access ETF, which allows Australian investors access to Canada’s spot-based Bitcoin ETF from Purpose Investments. However, a “home-grown” spot ETF will add a sizable impetus to the growing financialization of Bitcoin. On the flip side, as we’ve continued to note in a number of posts, a spot Bitcoin ETF and the ensuing boost to Bitcoin’s financialization will enhance the cryptocurrency’s correlation with other risk assets, thereby diminishing Bitcoin’s proclaimed role of an inflation hedge.
