How financial advisors can navigate crypto and bitcoin spot ETFs

While there have certainly been early adopters and proponents of cryptocurrency among financial advisors, many have been at least a little wary about the scandal and volatility that have dogged digital currencies in recent years.

But this week, the Securities and Exchange Commission reportedly dropped the fight against Grayscale Investments‘ quest for a spot-bitcoin ETF, a sign that approval of the product may be imminent. That may give those still watching from the sidelines or only dipping their toes in the crypto pool the legitimacy they need to more fully test the waters.

“There has been a fiduciary risk. If I put my client into bitcoin and ethereum and there is fraud, that’s a problem,” said Adam Blumberg, a certified financial planner and co-founder of both PlannerDAO and Interaxis, which focus on blockchain and crypto education and collaboration. “For financial advisors, I can now allocate a little to my clients without as much fiduciary risk because I’m doing so in a regulated product.”

Among the other benefits expected if or when a spot ETF hits the market are lower fees, less risk than confronted by futures-based ETFs and an influx of investment.

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“Bitcoin futures compared to bitcoin is the same as comparing stock futures to investing in stocks,” said Ric Edelman, founder of the Digital Assets Council of Financial Professionals, a research and educational organization that offers financial advisors an online certificate in blockchain and digital assets. “Most advisors don’t recommend futures trading for their clients in the stock market and aren’t motivated to do so in the crypto environment.”

The crypto ETF background
The SEC gave its blessing to futures-based crypto ETFs in 2021. Those funds trade in futures contracts like commodities but don’t hold the underlying crypto assets. 

The SEC has rejected applications to create spot-crypto ETFs. That led Grayscale to file a federal lawsuit against the regulator. A federal appeals court earlier this year ruled in Grayscale’s favor, saying that there was no reason a spot ETF should be rejected when the regulator had approved futures ETFs.

While the SEC has the option to continue fighting the lawsuit in an expanded appellate court or the U.S. Supreme Court, it’s been reported that the regulator won’t do so. That makes the creation of a spot ETF seem imminent.

And that may open the floodgates. Besides Grayscale, several other companies have applied for approval of spot-crypto ETFs, including BlackRock, ARK Invest and Fidelity.

“If they have a good reason to deny, they’ll have to deny everyone and they’ll be set up for more lawsuits,” Blumberg said. “More likely, they’ll approve one. And if they approve one, they’ll approve them all.”

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Dave LaValle, global head of ETFs at Grayscale, said the firm is expecting the SEC to approve all the spot ETFs simultaneously as it did when ethereum futures ETFs came to market.

“We believe that’s an appropriate way to ensure that there’s an appropriate level of competition and that everyone has a fair start,” LaValle said in an interview.

Creating legitimacy
It’s no secret that crypto has had its share of bad news in recent years. 

There is the massive fraud that took down crypto exchange FTX and has its founder Sam Bankman-Fried facing a raft of fraud charges; the bankruptcies of crypto lenders and exchanges Celsius Network, Voyager Digital, BlockFi and Genesis Global; and the collapse of stablecoins like Terra and Luna. 

That’s not to mention the overall volatility of bitcoin and others. In the last year alone, bitcoin has traded as low as nearly $16,000 and as high as nearly $32,000.

SEC Chair Gary Gensler has noted the fraud that has pervaded some corners of the crypto universe as reason to oppose a spot-crypto ETF. But the regulator’s approval of those vehicles would add legitimacy to the asset class that some advisors have longed for.

“Many institutional investors have been reluctant to invest in bitcoin directly because of the lack of regulatory clarity. An ETF eliminates those concerns,” Edelman said. “The stumbling block that many investors faced would disappear.”

He points to a 2022 Nasdaq survey in which 72% of advisors said they would be more likely to invest client assets in crypto if a spot ETF was approved.

“The holy grail of crypto for advisors is a spot-bitcoin ETF. We’ve been waiting for this for many, many years,” Edelman said.

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LaValle said he sees similarities with the SPY ETF, State Street Global Advisors’ product that tracks the S&P 500, which launched in 1993.

“We think of SPY as this plain vanilla S&P 500 exposure … but in 1993, it was a pretty exotic institutional class of exposure that was then made available to the entirety of the marketplace.

“Well, now the ETF wrapper has been battle-tested for 30 years, so it is a point of credibility for advisors and the advice market to say, ‘OK, now this is a wrapper. This is a framework. I understand this,'” LaValle said. “It’s really just a question about whether the underlying asset is a fit for their client’s portfolio from a suitability perspective.”

SEC approval of a spot ETF would also open the crypto door for more institutional investors, such as endowments and family offices.

“They have to go with a regulated, proven exchange,” said Jackson Wood, portfolio manager at Freedom Day Solutions in Houston. “This allows them to get in.”

Advisors then stand to gain in terms of assets under management, LaValle contends. He said he’s heard from advisors whose clients have moved some assets out of firms that are not equipped to purchase crypto for their clients.

“I’ll use the word frustration. They lost a lot of assets in the last bull run when their clients weren’t able to access digital assets more broadly,” LaValle said. “There’s two problems for the advisor. No. 1, their asset base decreases, so their revenue is adversely impacted. And No. 2, probably more importantly, they don’t have a holistic view on what their client’s investment exposure is.”

Investment considerations
An eventual SEC adoption of spot-crypto ETFs also stands to boost prices of the assets and reduce costs for investors.

A crypto trade publication, Cointelegraph, erroneously sent a message on X (formerly Twitter), announcing that the SEC had approved the spot ETF on Monday. Bitcoin’s price jumped to around $30,000. When it became clear that the news was false, the price dropped back to about $28,000, still around 3.5% higher than it had been the day before.

Investors would also save on crypto trading fees in an ETF.

Futures contracts are expensive. The Grayscale Bitcoin Trust, for example, has a 2% management fee. And the company’s ethereum product has a 2.5% fee. Those are much higher than the costs for trading for actual crypto at places like Onramp and Flourish, where fees range from 25 basis points per trade to around 1% as a sales fee.

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Those higher fees come due to the active management required of futures contracts.

“Futures contracts expire and have to be rolled forward into the next month’s contract. It’s expensive, and there are tracking errors,” Wood said. “Because they’re commodities, they’re not tied to bitcoin held in a wallet, and it doesn’t track the underlying asset perfectly.”

Next steps
The SEC has given some spot ETF applicants feedback on their applications, a sign that the regulator is planning approvals, Blumberg said. But he hasn’t ruled out the possibility that the SEC has “figured out a really good way to deny the ETFs.”

More likely, however, an approval announcement could come within days or weeks that one or more ETFs has the SEC’s blessing.

“I think it shows a thawing of this regulatory overreach, or at least the regulatory posture of this administration, this government,” Blumberg said. “Many of the other regulators, the OCC [Office of the Comptroller of the Currency] and the Fed are looking at the SEC. Once the SEC starts to thaw, it gives more legitimacy across the board.”