Introduction
The recent approval by the U.S. Securities and Exchange Commission (SEC) of generic listing standards for cryptocurrency exchange-traded products (ETPs) on September 17, 2023, heralds a transformative phase within the digital asset ecosystem. This regulatory development has significantly truncated the launch timeline for crypto ETPs to a mere 75 days, thus facilitating the proliferation of plain-vanilla products. Industry forecasts, such as those from Bitwise, anticipate the introduction of over 100 crypto-linked exchange-traded funds (ETFs) by the year 2026.
However, as James Seyffart, a senior ETF analyst at Bloomberg, astutely observed, this anticipated growth will be accompanied by an inevitable wave of liquidations. This juxtaposition of rapid expansion alongside simultaneous market culling elucidates the complexities that characterize this evolving landscape.
The Dynamics of Growth and Liquidation
The SEC’s establishment of generic standards addresses a temporal challenge rather than a liquidity crisis. For leading cryptocurrencies—specifically Bitcoin (BTC), Ethereum (ETH), and Solana (SOL)—the influx of new products may reinforce their market dominance. Conversely, this surge could serve as a stress test for lesser-known altcoins.
Key observations include:
– The SEC’s prior actions in 2019 regarding equity and bond ETFs catalyzed an increase in annual launches from 117 to over 370.
– A similar pattern may emerge in the cryptocurrency sector; however, it faces exacerbated initial conditions.
– Custodial concentration remains a significant concern, with Coinbase reportedly managing assets for approximately 85% of global Bitcoin ETF holdings.
As authorized participants (APs) and market makers navigate this new landscape, they will encounter challenges related to asset pricing and borrowing—issues that are particularly pronounced for altcoins absent robust derivatives markets capable of hedging creation/redemption flows without inducing significant market disturbances.
In-Kind Order Implications
The SEC’s July 29 directive permitting in-kind settlements for Bitcoin and Ethereum trusts mandates that APs source, hold, and manage tax implications associated with each product basket. While this operational model is feasible for BTC and ETH due to their established ecosystems, it poses considerable hurdles for altcoins with limited liquidity.
– **Operational Constraints:** In volatile conditions, access to borrowing may diminish entirely for these thinly traded assets, leading to potential halts in creation processes and persistent premiums in ETF trading until sufficient supply is restored.
Infrastructure Resilience Under Strain
Authorized participants and market makers possess the capacity to manage heightened volumes for liquid cryptocurrencies. However, their operational frameworks are constrained by short availability—particularly when new ETFs are introduced based on tokens with limited borrowing capacity. Under such circumstances, APs may either widen spreads or withdraw from participation altogether, resulting in funds relying on cash creations that exhibit elevated tracking errors.
The underlying plumbing mechanisms are susceptible to disruptions if reference prices cease to update—an issue highlighted in Dechert’s October analysis.
Coinbase’s predominant position within the custody arena presents both opportunities and vulnerabilities. As institutional players such as US Bancorp revive interest in Bitcoin custody and other financial institutions explore crypto-ETF custody partnerships, questions arise regarding the risk associated with reliance on a singular counterparty.
Influence of Index Providers
Index providers wield substantial influence in determining eligibility criteria based on surveillance agreements and reference indices that fulfill exchange standards. Dominant firms such as CF Benchmarks, MVIS, and S&P have historically monopolized traditional ETF indexing, establishing barriers for emerging entrants even when superior methodologies are proposed.
Future Launch Landscape: Categorization
The anticipated influx of crypto ETFs can be categorized into distinct buckets based on their underlying assets:
| Launch Category | Likely Underlyings | Custody Notes | Index/Benchmark Notes | AP/Creation-Redemption & Spread Notes | 19b-4 Requirement |
|—————–|——————–|—————|———————–|————————————-|——————-|
| Single-asset majors | BTC/ETH clones | High concentration at Coinbase | Direct exposure; simple NAV calculations | In-kind allowed; competition mainly on fees | No |
| Single-asset altcoins | SOL, XRP, DOGE | Thinner custody options | Fragmented spot markets | Real borrow constraints; wider spreads expected | Often no |
| Long-tail/meme coins | TRUMP, BONK | Small custodians used | Composite indices from centralized exchanges | Cash-only creations likely; chronic wide spreads | Yes |
| Broad large-cap indices | GLDC-style baskets | Consolidated custody risks | Must meet surveillance tests | More complex plumbing on rebalance days | No |
| Thematic index ETPs | L1/L2 smart contracts | Multi-provider custody risks | Must meet generic regime | Fragile due to sourcing requirements | Often yes |
| Options-overlay ETPs | Buy-write strategies | Additional derivatives risks | Active management complicates structure| Liquidity management critical during volatility| Yes |
The Inevitable Culling
Historical data from ETF.com indicates that numerous funds fail to reach critical mass—often closing when assets under management fall below $50 million within two years. Seyffart’s predictions suggest that by late 2026 or early 2027, we may witness significant liquidations within the crypto ETF space. The most susceptible offerings include:
– Duplicate single-asset funds with inflated fee structures.
– Niche index products lacking sufficient market adaptability.
– Thematic ETFs where market dynamics outpace operational agility.
Fee compression will likely exacerbate these closures as newly launched Bitcoin ETFs introduce competitive pricing models that undercut earlier issuers. As competition intensifies amidst a crowded marketplace, long-tail funds may struggle to maintain relevance.
Secondary-market mechanics are particularly prone to disruption in thin markets where an ETF holds small-cap tokens. A sudden spike in demand can lead to inflated premiums until APs acquire adequate inventory for creations.
For major assets like BTC, ETH, and SOL, however, this dynamic may invert as an expanded ETF framework enhances connections between spot and derivative markets—a phenomenon expected to tighten spreads while concurrently reinforcing their status as foundational institutional collateral.
Regulatory Implications and Future Considerations
The newly established generic standards explicitly exclude actively managed funds, leveraged products, and those featuring “novel” attributes from expedited approvals under the SEC’s framework. This delineation raises pertinent questions regarding regulatory oversight:
– **Potential Market Fragilities:** Commissioner Caroline Crenshaw has voiced concerns about potential systemic risks arising from a flood of inadequately vetted products that could correlate during periods of stress.
As the SEC’s guidelines direct capital flow toward the most liquid and institutionalized segments of the crypto landscape, the implications are profound:
– **Consolidation vs. Access:** The core question revolves around whether this influx consolidates institutional infrastructure around a select few dominant currencies or serves to broaden market access while distributing risk more equitably across varied assets.
In conclusion, while the advent of these generic standards streamlines the launch process for crypto ETFs significantly—thereby enhancing legitimacy—this facilitation does not guarantee longevity or operational viability amidst fluctuating market conditions. As issuers speculate which products will endure while subsidizing less viable alternatives, custodians must navigate their own strategic considerations concerning concentration versus diversification in an increasingly competitive environment.
