By Shaed Hashimkhial
The SEC’s endorsement of U.S. spot Bitcoin ETFs significantly influenced the cryptocurrency markets. Shortly after the announcement, we witnessed a substantial rally in Bitcoin, a notable increase in Ethereum’s value amidst anticipation of its own ETF, and a surge in daily trading volumes for leading ETFs. This development has also re-ignited discussions around the broader institutional embrace of cryptocurrencies.
However, it’s important to highlight a frequently overlooked aspect: the concept of spot Bitcoin ETFs is not entirely new. In 2021, the Ontario Securities Commission approved Purpose’s application, introducing the first spot Bitcoin ETF globally. Now, three years on, these Canadian ETFs are encountering formidable competition from their U.S. counterparts.
The market reaction to SEC approval
Bloomberg and Coingecko data reveal that the aggregate value of Canada’s six spot Bitcoin ETFs rose by 11% between Dec. 18, 2023, and Feb. 15, 2024. During this interval, the value of the underlying cryptocurrency surged by about 24%, indicating a slight capital withdrawal from Canadian crypto funds.
Despite this, the Canadian market has shown notable steadiness, especially when considering the significant impact of the news and the considerable advantages the U.S. market holds in terms of market size, available capital, and brand visibility. This resilience may be partly due to investor prudence and a reluctance to act hastily. Given the recent upswing in the crypto market, long-standing investors in Canadian Bitcoin ETFs might face capital gains taxes upon selling their holdings, necessitating that the benefits of transitioning to the U.S. market substantially outweigh these potential costs. Currently, assessing the full extent of these advantages is challenging. The cost structure of ETFs isn’t just about the stated management fees; it also involves brokerage fees, bid/ask spreads, trailing commissions, tracking errors, and other charges. Since U.S. spot Bitcoin ETFs are a relatively new investment avenue, there’s a lack of historical data to draw reliable conclusions from.
Optimization is inevitable
Canada’s Crypto ETFs might currently benefit from being early entrants, but it’s crucial to acknowledge that detailed fee information will inevitably become public knowledge. During the relatively competition-free period from 2021 to 2024, it’s vital for these ETFs to focus on optimizing their offerings. While other players in the market were introducing competitive management fees ranging from 0.20% to 0.94%, with some even offering fee waivers for the initial six months, Grayscale maintained its 1.5% fee structure. This approach led to significant outflows from the Grayscale Bitcoin Trust, which saw a loss of $1.62 billion in just the first four days following the SEC’s approval of spot Bitcoin ETF applications, despite its near-monopoly status in the U.S. market at the time.
Investors in ETFs primarily seek two attributes: minimal fees and robust trading liquidity. Achieving high liquidity may not be straightforward, but reducing fees is expected to become a norm in the Canadian crypto market. For instance, Fidelity Investments Canada slashed its management fee to 0.39% on Jan. 11, effectively lowering the anticipated management expense ratio from 0.95% to potentially as little as 0.44%.
While Fidelity has the advantage of cutting fees by capitalizing on its strong brand, lower perceived risk, and large transaction volumes, this strategy might be more challenging for other fund managers. Nonetheless, even Blackrock’s ETF filings suggest that although it initially partnered with Coinbase Prime for its transactions, the firm is actively exploring alternative third-party Bitcoin purchasing options. This openness to negotiation could lead to improved terms, and even small reductions in fees could significantly influence a fund’s market standing.
Regulatory arbitrage: unrealized efficiency
Canadian funds have the opportunity to minimize the tracking error between the net asset value (NAV) and the market price of the fund through regulatory arbitrage. In an efficient market, the discrepancy between the NAV and the fund’s trading price should be minimal. In Canada, Authorized Participants (known as Designated Brokers or Dealers) can engage with the fund to either acquire new shares at the NAV or exchange shares for portfolio assets. This mechanism typically provides an arbitrage opportunity that helps align the ETF’s market price with its intrinsic value. For instance, if the market price of a share is below its NAV, Authorized Participants can redeem shares and then sell the assets for a profit. Conversely, if the market price exceeds the NAV, they can purchase shares at the NAV and sell them on the open market, thus narrowing the price gap.
However, the SEC has imposed restrictions on this process for Bitcoin ETFs, permitting the issuance and redemption of shares exclusively in cash. This constraint can lead to transaction delays, potentially causing ETFs to hold excess cash, thereby diminishing market efficiency and enlarging the tracking error. The prospectus for the Purpose Bitcoin ETF, which is not only Canada’s largest crypto ETF but also ranks fourth globally, indicates that Canadian ETFs are not subject to this regulatory limitation. Nonetheless, the process of share creation and redemption, and consequently price discovery, can take two to three business days in Canada, which is significant compared to Blackrock’s one-day settlement period.
The future of Canadian crypto ETFs
Canada continues to play a pivotal role in the market, particularly with its progressive stance on BTC and ETH ETFs. The slight dip in the total assets of these ETFs is not entirely unexpected, yet there’s a risk of continued outflows if Canadian funds don’t adapt to remain competitive. Emphasizing their advantageous fee structures and early market entry could be key strategies to counter the growing pressure from U.S. competitors.
However, the most significant challenge lies in education. There’s a pressing need for financial advisors and wealth managers to deepen their understanding of cryptocurrency offerings. They often serve as the initial contact point for clients considering a shift in their investment portfolios. BTC and ETH represent just the tip of the iceberg in the broader trend towards widespread institutional cryptocurrency adoption.
About the author: Shaed Hashimkhialhas been an active innovation leader within the Canadian fintech ecosystem, known for launching cutting-edge products for some of the country’s leading banks and providing strategic consultancy to financial institutions and startups across North America. His journey in fintech led him to discover Bitcoin in 2016 and ultimately transition into the industry to help propel the adoption of this new asset class. He is currently at Bitget, leading go-to-market strategy and operations for North America. Prior to Bitget, Hashimkhialwas responsible for Global BD & Partnerships at Koinly, a leader in crypto tax software used by more than 1 million investors around the world.
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