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Bitcoin

Bitcoin ETF Countdown: In-Kind vs. In-Cash - Choosing Your Crypto Destiny

A discussion is currently going on between SEC and Bitcoin spot ETF issuers such as BlackRock, GreyScale, etc about the approval of ETFs. It is expected to be approved by January 10. What is the discussion about? it is about whether this spot ETF would be an In-Kind or In-Cash ETF. These two kinds of ETFs differ in the way of their distributions to the shareholders. This post will discuss the pros and cons of owning an In-Kind Bitcoin spot ETF and an In-Cash Bitcoin spot ETF.



In-Kind Spot ETF

As the name indicates, the shareholders of this ETF receive the underlying asset of the ETF which is Bitcoin. What are some of the other popular In-Kind ETFs today? Some common ones available today in the US as well as international markets are equity ETFs, fixed-income ETFs, etc. For example, equity ETFs distribute reinvestment shares representing the underlying companies held in the portfolio. The biggest advantage of this approach is the deferral of capital gains until the shares are sold. This enables the investors and ETFs to hold onto their shares for longer time frames capitalizing on the appreciation


Pros

  • Direct Bitcoin Exposure: Shareholders receive actual Bitcoin, giving them direct exposure to the underlying asset, which aligns with the primary goal of investing in a Bitcoin ETF.

  • Tax Efficiency: Similar to traditional in-kind distributions, reinvesting received Bitcoin immediately may allow for deferral of capital gains taxes until selling.

  • Potential Higher Returns: Direct holding of Bitcoin allows for potential benefits of compound interest and price appreciation of the cryptocurrency.

Cons

  • Storage and Security: Shareholders need to secure their own Bitcoin, which involves choosing and managing a suitable wallet with robust security measures.

  • Transaction Costs: Selling or transferring directly held Bitcoin might incur additional transaction fees depending on the chosen platform.

  • Fractional Shares Challenges: Distributing fractional shares of Bitcoin directly is impractical, meaning rounded-down or up distribution might occur, potentially causing slight deviations from desired portfolio allocation.


In-cash spot ETF

As the name indicates, the shareholders of this ETF receive the cash equivalent of the underlying asset. One of the most popular In-cash spot ETFs is GLD ETF. The SPDR Gold Shares ETF (GLD) distributes its net investment income, primarily consisting of interest earned from holding physical gold bullion, in cash. So, when GLD makes a distribution, shareholders receive a cash payment per share rather than additional shares of the ETF. So, why does GLD use cash distributions?

  • Underlying Asset: GLD primarily holds physical gold bullion, which doesn’t generate periodic income like dividends or interest. Therefore, there’s no underlying asset to distribute in-kind.

  • Transparency and Simplicity: Cash distributions offer greater transparency and simplicity for shareholders. They can easily understand the amount of income received and manage it as needed.

  • Tax Implications: Cash distributions are taxed as capital gains or ordinary income depending on the shareholder’s holding period. This aligns with the standard taxation of interest income.

So, the SEC wants to consider Bitcoin as digital gold and not as an equity or asset. Just like GLD, they want the ETFs to pay interest for investing in Bitcoin with cash and do not want the investor to have a personal wallet ( hot or cold wallet ) to manage the Bitcoin. Now, let's get down to the pros and cons of owing an In-cash spot Bitcoin ETF. 


Pros

  • Convenience and Simplicity: Shareholders receive cash based on the value of their Bitcoin holdings, eliminating the need for managing personal Bitcoin wallets.

  • Flexibility: Cash allows for reinvestment in any asset class or use for other purposes, offering greater flexibility than holding direct Bitcoin.

  • No Security Concerns: Investors avoid the complexities of securing and managing personal Bitcoin holdings.

Cons

  • Potentially Lower Returns: Holding cash instead of the underlying asset exposes investors to potential inflation erosion and misses out on any direct Bitcoin price appreciation.

  • Tax Implications: Cash distributions are immediately taxed as capital gains, potentially impacting returns compared to delayed tax on in-kind Bitcoin distributions.

  • Indirect Bitcoin Exposure: Investors lose direct exposure to the potential benefits of owning the underlying asset and its native ecosystem.


Final Points

I truly believe that spot ETF would be approved and it could be In-cash distribution. I may be wrong. Irrespective of the type of ETF approved, a few things are inevitable when the ETF is approved. These ETFs are supposed to have a hefty expense ratio of around 1%

  1. Despite the hefty expensive ratio, there will be a huge influx of capital ( in billions) for Bitcoin from traditional investors. Combined with Bitcoin halving, this huge influx of capital could drive Bitcoin to new heights (100k is possible). FYI, when the first Gold ETF opened in around 2004, a flood of inbound capital poured in. It was such a large volume that it took nearly seven years of steadily rising gold prices for it to run its course.

  2. Crypto exchanges may lose some of their income from trading Bitcoin ( some exchanges charge around 0.5%) as more people would be invested in ETFs.

  3. if In-cash spot ETF is approved, companies like GrayScale BTC have been accumulating Bitcoin for a long time. Being a spot ETF, They might have to pay the cash equivalent to the appreciation of Bitcoin as interest to the investors and this could be a big tax bill. 


So, how am I positioning? I am holding Bitcoin as well as a position in GBTC and am waiting for the events (ETF approval on Jan 10, Bitcoin halving on April 17) to unfold in 2024.


Thanks for reading this far!!!


Looking forward to hearing your opinion!!!

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