SEC allegedly concerned about money laundering via in-kind creates in a spot BTC ETF

Amid ongoing spot Bitcoin exchange-traded funds (ETFs) race, the US Securities and Exchange Commission (SEC) has been engaging with the institutional players in the race for approvals. By and large, the plain message has reportedly been that the ETFs do cash creates or wait, according to ETF specialist with Bloomberg Intelligence, Eric Balchunas in a recent post.

Also Read: SEC demands ‘cash creates or you will wait’ 

SEC possibly pushing for cash creates over money laundering concerns

The US “SEC [is] worried about ETFs being used as a vehicle for money laundering,” according to Charles Gasparino, senior correspondent with Fox Business News. His comments come amid a pronounced push from the financial regulator, that filers’ ETF products only doe cash redemptions and not crypto redemptions.

Evidence of this is the recent series of amendments where multiple firms, including Invesco, BlackRock, Ark Invest 21Shares, Valkyrie, and Fidelity have indicated having embraced cash creates.

Cash creates, which is a “much more closed system,” according to Balchunas, would require that the customer gives the issuer cash for new ETF shares, and then the issuer buys Bitcoin. Conversely, for in-kind creates, the customer gives the issuer BTC in exchange for the ETF shares.

Increasing demand for a BTC ETF would therefore prompt an intermediary ("the AP") to create new ETF shares. Ultimately, this would mean that either way new ETF shares translate to new Bitcoin purchase.

In a recent post, Balchunas indicated that the SEC is pushing for cash redemptions because it would mean only the ETF issuer handles Bitcoin and not the intermediaries, who could be registered and/or unregistered broker dealers.

Further, he detailed that cash creates are worse for taxes because in this offering, cash would be changing hands as opposed to in-kind, which is basically a trade for crypto for ETF shares, with no cash exchanging hands. Citing another ETF specialist, also with Bloomberg, James Seyffart on this matter:

A superpower of the ETF structure is the tax efficiency derived from in-kind creations and redemptions, where underlying assets are exchanged directly for shares of the ETF [in] a non-taxable event.

Seyffart also indicated that cash creates are detrimental to one of the key participants in the ETF race, Grayscale, which has deep pockets full of BTC tokens bought at lower prices and would be looking to sell. In the case of cash creates where Grayscale is concerned, the fund must purchase and sell Bitcoin, which is a taxable event.

This could complicate the conversion of Grayscale’s GBTC into an ETF as the former holds many BTC tokens at a low-cost basis (bought at low prices) that would incur capital gains if sold under a cash-only model.