What's behind BlackRock's timing for a spot bitcoin ETF?

BlackRock Inc.'s surprise application to offer a spot bitcoin exchange-traded fund — filed with federal regulators earlier this month with little fanfare — has kicked off a mad scramble among institutional players to file their own applications for similar products before the U.S. Securities and Exchange Commission picks a winner.

In the weeks since BlackRock's application was filed with the SEC, several other financial services firms, including Fidelity Investments, WisdomTree, Valkyrie and Invesco, have resubmitted filings with regulators. At least one other firm — Cathie Wood's ARK Investment Management — already has a pending application for a spot bitcoin ETF.

All are jockeying to get the first spot bitcoin ETF approved by the SEC after a long line of rejections over the past two years — a prize that would come with serious first-mover advantage, giving crypto-curious institutional investors the first real opportunity to gain direct exposure to bitcoin.

Matt Hougan, chief investment officer of Bitwise — which refiled its spot bitcoin ETF application a day after BlackRock — said first mover advantage is a "big thing in all ETFs" but suggested that bitcoin investors may have a preference for specialist providers with "real-world crypto experience," something that has also been seen in other niche markets like real estate and commodities.

"I suspect first-move advantage will still play a huge factor in this market," Mr. Hougan added. "Our hope is that the SEC creates an even playing field for providers to compete."

The timing of BlackRock's application — which comes amid an ongoing crypto winter and after the SEC filed suit against Coinbase, BlackRock's custodial partner for the ETF – and its slew of imitators has prompted speculation that BlackRock "knows something" the public doesn't that would make it more likely for the SEC to approve its application.

BlackRock's Gargi Chaudhuri, head of iShares Investment Strategy, Americas, declined to comment on the application during a midyear outlook news conference on Wednesday.

But industry insiders like Kristin Smith, chief executive officer of Blockchain Association, an industry trade group, said BlackRock's application is not necessarily indicative of any arcane knowledge about the inner workings of the SEC. It likely has more to do with external factors, including the pending outcome of a lawsuit filed against the SEC by crypto investment manager Grayscale, a wholly owned subsidiary of Connecticut-based crypto venture capital firm Digital Currency Group, she said.

The Grayscale Bitcoin Trust is currently the only way institutional investors can get exposure to bitcoin, and its limitations include high annual fees (Grayscale charges holders 2% annually, a much higher fee than comparable commodity products) and the inability to redeem shares.

Grayscale has long maintained that its plan is to convert GBTC to a spot ETF — a plan that was foiled last year when the SEC rejected its application. Grayscale appealed, filing suit against the regulator in October and calling the rejection "arbitrary, capricious, and discriminatory."

Though a decision has not yet been reached by the District of Columbia Court of Appeals in Washington, Grayscale CEO Michael Sonnenshein has said he expects a decision this fall.

If and when Grayscale wins the case, Grayscale's victory would potentially open the floodgates for other spot bitcoin ETFs.

Meanwhile, major ETF players like BlackRock have filed their own applications, hoping to beat Grayscale at its own game while it's tied up in federal court.

BlackRock, the world's largest asset manager, had assets under management totaling $9.09 trillion as of March 31. That includes ETF assets totaling $3.07 trillion.

ETF analysts such as Bloomberg's Eric Balchunas have put BlackRock's odds of getting its application approved at 50% — higher than average odds for ETF approvals — buoyed by the asset manager's historical success rate.

BlackRock has had 575 applications approved by the SEC, and only one rejection for a non-transparent ETF in 2014, said Mr. Balchunas, based in Princeton, N.J.

BlackRock has seemingly learned from its rejected application: the asset manager's only failed application was for a non-transparent ETF with Precidian in 2014. And the SEC's historical reasoning for denying all other spot bitcoin ETF applications has been the potential for fraud and manipulation.

BlackRock's application, with Coinbase as crypto custodian, contains a first-of-its-kind surveillance sharing agreement with NASDAQ. Coinbase is also the primary crypto custodian for the U.S. government, which owns nearly $6 billion worth of bitcoins, and has been listed as custodian for many of the other institutional players now filing.

The surveillance agreements would give regulators access to information about market trading activity, clearing activity, and customer identities, reducing the possibility of market manipulation. However, according to a report from the Wall Street Journal on Friday, citing people familiar with the matter, the details about the surveillance-sharing agreements found in applications from BlackRock and others are "insufficient" and need to be updated and refiled with more information.

In addition to providing more snooping access for regulators, BlackRock's ETF might come with another perk for the SEC — the ability to save face by approving another, more regulator-friendly spot bitcoin ETF and thus beating Grayscale to the punch. As Bloomberg litigation analyst Elliot Z. Stein put it: "The SEC and Chair Gary Gensler may be bracing for a loss and looking to pre-emptively soften it or make it meaningless by approving a spot bitcoin ETF application before or around the same time as a court decision."

Ms. Smith said she's also heard this line of thinking on Capitol Hill.

"The SEC might want to approve (BlackRock's) ETF application and then go back to the court and basically prevent the court from having to make a decision at all," Ms. Smith explained. "The SEC realizes they're probably going to lose, they don't want to lose, so if they do this that would sort of moot the other case and the judge wouldn't have to make a decision."

While many in the market think that the flood of spot bitcoin ETF applications is connected to the Grayscale suit and other external circumstances, others have dismissed this as speculation.

Speaking on the Bankless podcast on June 22, Austin Campbell, a New York-based professor of business at Columbia University and managing partner of Zero Knowledge Consulting, said: "Anytime something like this happens at a traditional finance firm, and you see things come together over a two-week period, that's probably a culmination of six to 18 months of work behind the scenes. Everything moves slowly at these places."

"The time scales you operate on are just glacial compared to what you're going to see in the regular world. If BlackRock filed an ETF application, they've been thinking about it for a while," he said.

As for why they picked the current moment to file, Mr. Campbell put it down to two things: "One, it's telling the SEC and the U.S. government, if we can't get our act together here, there's a lot of things that are already happening offshore … if you block us here, we're probably just going to take our business offshore."

Another thing, he said, is that BlackRock CEO Larry Fink "is pretty influential in the Democratic Party. I think this may be a little bit of a signal from the TradFi world, that we'd like you to find a constructive solution to this problem and not just keep blocking it."

Mr. Campbell explained that U.S. financial regulators have been slow to provide regulatory guidelines for crypto — a fact that has chagrined many industry participants, who decry the SEC's so-called regulation by enforcement — while regulators in places like Japan and the European Union have created laws and guidance.

Mr. Hougan of competitor Bitwise added that "spot bitcoin ETFs have been operating well globally for multiple years."

"I think U.S. traditional financial firms are genuinely at the point of being very worried about being left behind, and that's part of the reason you're seeing these things come forward," Mr. Campbell said.

Kathie O'Donnell contributed to this story.