The SEC has given the green light, and encryption ETFs are entering the commodity era.

The US SEC has approved the creation and redemption of encryption ETF, integrating crypto assets into the deep structure of mainstream finance.

Written by: Golem, Odaily Planet Daily

On July 29, the U.S. SEC officially allowed authorized participants (AP) to create and redeem encryption ETFs in physical form. This means that in the future, Bitcoin and Ethereum ETFs will be consistent with other commodity ETFs (such as oil and gold), allowing for the creation and redemption of ETF shares in physical form, whereas previously, Bitcoin and Ethereum ETFs were limited to cash-based creation and redemption.

Cash Form vs Physical Form

So, what is the difference between creating and redeeming an encryption ETF in cash form and creating and redeeming an encryption ETF in physical form?

Cash form: AP settles in cash with the ETF issuer

The process for creating and redeeming ETF shares for Bitcoin and Ethereum ETFs in cash form is briefly outlined as follows:

ETF Creation Process

The ETF issuer publishes a basket of cash amounts daily, representing the total cash required to create one "creation unit";

Authorized Participants (AP) deliver cash to the ETF issuer;

After the ETF issuer receives cash, they purchase the corresponding amount of encryption assets in the market and include them in the ETF custody pool.

The ETF issuer finally distributes the corresponding number of ETF shares to the AP.

ETF Redemption Process

When the ETF price in the market is lower than the day's net asset value (NAV), the AP will buy the corresponding number of ETF shares in the secondary market;

AP returns these shares to the ETF issuer;

The ETF issuer sells the corresponding amount of Bitcoin / Ethereum based on the redeemed shares and exchanges it for cash in the spot market.

The issuer will then return this portion of cash to AP, completing the redemption.

Physical form: AP settles with ETF issuers in "physical" (i.e., coins)

ETF Creation Process

The ETF issuer specifies a "creation unit," usually consisting of tens of thousands of ETF shares, and the net asset value (NAV) corresponding to that unit is the total amount of encryption assets required to be delivered by the AP;

AP packages the specified basket of encryption assets and transfers it to the designated custody account through a security custody and transfer agreement pre-arranged with the ETF issuer.

After the issuer verifies that the assets received are correct, the corresponding number of ETF shares will be delivered to the AP.

ETF Redemption Process

When the market price of the ETF on the exchange is lower than its NAV, the AP will buy at least one creation unit of ETF shares in the secondary market.

AP returns this batch of ETF shares to the issuer and submits a "physical redemption" application;

After the issuer confirms receipt of the ETF shares, the equivalent encryption assets (based on the latest NAV and position weights) will be transferred back to the AP from the custody account via the original route.

AP reclaims the corresponding encryption assets.

What does it mean?

From the above, it can be seen that allowing the creation and redemption of encryption ETFs in physical form does not mean that ordinary investors can directly exchange their held ETF shares for encryption assets. Instead, it refers to the settlement subject between authorized participants (AP) and ETF issuers changing from cash to "encrypted physical". This not only means that existing encryption ETF assets (such as Bitcoin and Ethereum) have gained the same regulatory status as commodities like gold and oil, but also brings the following benefits:

Reduce AP costs and improve market efficiency

In cash form, ETF issuers need to purchase encryption assets with cash delivered by AP. Due to the rapidly changing nature of the encryption market, this process may increase transaction fees and slippage.

In physical form, when AP directly delivers encryption assets to the ETF issuer, it effectively avoids more transaction fees and slippage, reducing costs. At the same time, by reducing the delays and costs associated with spot trading, it not only streamlines the onboarding process with the ETF issuer but also allows the secondary market price of the ETF to be closer to NAV, enhancing market efficiency.

In addition, cash transactions in cash form may trigger capital gains distributions at the fund level, but physical transfers generally do not constitute capital gains at the fund level, further reducing the tax costs for the AP.

reduce the impact of ETF redemptions on encryption market prices

In cash form, the redemption of an ETF means that the ETF issuer passively has to sell encryption assets in the market to exchange for cash, which may trigger a "liquidity crunch."

However, in physical form, the redemption of the ETF only represents that the ETF issuer has returned the encryption assets to the AP without going through market transactions. Once the AP receives Bitcoin or Ethereum, whether to sell immediately, in what manner to sell, and to whom, entirely depends on its own strategy. Compared to the one-time large-scale liquidation of the ETF fund, the actions of the AP are more decentralized, market-oriented, and flexible.

provides a more efficient mechanism for ETF arbitrageurs.

The basis for ETF market arbitrage lies in the "primary market arbitrage" mechanism, where AP creates/redeems based on the price difference between the ETF and its NAV. In cash form, due to the time difference between spot trading and ETF creation/redemption, market price fluctuations may lead to arbitrage failure or increased costs. In physical form, AP can directly build or close positions with encryption assets, resulting in higher arbitrage efficiency, larger scale, and faster speed.

At the same time, a more efficient arbitrage mechanism can help the encryption ETF price closely track its net asset value, thereby enhancing liquidity.

encryption assets are incorporated into the deep structure of mainstream finance.

International commodity ETFs, such as gold, silver, and crude oil ETFs, are often created and redeemed in physical form. Encryption ETFs today use the same mechanism, which means that encryption assets are being integrated into the deeper structure of mainstream financial products, promoting global institutional allocation of encryption assets.

The introduction of a physical mechanism provides a structural buffer for larger future capital inflows, which is beneficial for institutions, pensions, hedge funds, and other long-term capital entry.