SEC's New Crypto ETF Framework: Opening the Door to Massive Capital Inflows

On July 29th, the U.S. Securities and Exchange Commission (SEC) approved a mechanism for the creation and redemption of physical Bitcoin and Ethereum spot exchange-traded products (ETPs), marking a significant shift in the structural framework underpinning cryptocurrency investment vehicles. The decision replaces the cash-only model employed by the first cryptocurrency ETPs and aligns the regulatory framework for digital asset funds with existing commodity ETPs, such as gold ETPs. SEC Chairman Paul S. Atkins, who took office in April, described the move as part of a broader effort to establish a "fit-for-purpose" framework for cryptocurrencies. The SEC's order also advances a series of related approvals, including applications for exchange-traded products (ETPs) that mix Bitcoin (BTC) and Ether (ETH), options on certain spot Bitcoin ETPs, and raising position limits for these derivatives to the common cap of 250,000 contracts common in traditional commodities markets. These changes are intended to align the cryptocurrency derivatives ecosystem with the long-established ecosystem of real-asset ETPs. This follows a series of applications filed by several exchanges in July, signaling regulators' readiness to adopt a workflow for real-asset ETPs. Unlike a cash structure, in which an Authorized Participant (AP) submits fiat currency and relies on a fund agent to execute cryptocurrency purchases on the open market, a physical mechanism allows the AP to directly deliver or receive the underlying asset, Bitcoin or Ether. This eliminates the need for fund-driven market trading, enabling participants to leverage existing procurement channels such as over-the-counter (OTC) desks, internal inventory, or lending arrangements. The result is typically lower transaction costs, narrower bid-ask spreads, and more accurate net asset value (NAV) tracking, as has been well-documented with commodity exchange-traded funds (ETFs) like the SPDR Gold Shares. How Physical Subscriptions and Redemptions Change the Model This operational shift will reallocate primary market flows for arbitrage-focused APs. Under the physical model, they can short the ETF and directly acquire cryptocurrency for subscriptions when a premium is seen; when a discount is seen, they can redeem ETF shares for cryptocurrency. This eliminates the execution delays and basis risk associated with cash settlement, creating clearer hedging opportunities using CME futures. Given that open interest in CME Bitcoin derivatives neared record highs in mid-2025, liquidity appears sufficient to support these changes. The revised mechanism also changes how ETF flows interact with the spot cryptocurrency market. Under the previous model, fund purchases or redemptions generated buy/sell pressure directly on the exchange, often influencing short-term price movements. APs can now fulfill their asset obligations through over-the-counter (OTC) channels, reducing their market footprint and potentially lowering volatility on high-volume days. This is similar to how the gold market utilizes OTC networks to settle gold ETP trade flows, reducing pressure on public order books. Opening the Door to Large Inflows As the infrastructure matures, several indicators will reflect the market impact of this SEC decision. These indicators include ETF premiums and discounts relative to net asset value, the spread between CME futures and spot prices, and floor depth indicators on major US dollar trading venues. Analysts will be watching to see whether OTC market activity increases on days with high subscriptions and whether liquidity on public exchanges becomes more resilient. Mechanically, this shift may slightly reduce the direct impact of ETF flows on trading, dampening the short-term price effects of primary market activity. However, the broader impact is that this shift will increase scale. Lower costs, clearer arbitrage paths, and more sophisticated hedging tools have all increased the appeal of ETFs for institutional allocators. If these advantages translate into sustained net inflows, the upward pressure on spot demand for Bitcoin and Ethereum could be significant. ETF flow data from early 2025 already demonstrates a strong correlation between net inflows and Bitcoin price increases. By streamlining fund operations, the physical delivery model lowers the barrier to large-scale allocations and makes price movements more predictable. The addition of options and higher derivatives limits further supports institutional investment, mirroring past innovations in accessibility that have helped expand commodity exposure. This regulatory reform effectively modernizes the infrastructure surrounding cryptocurrency ETPs. By allowing physical subscriptions and redemptions, the SEC has created a pathway for demand to flow more efficiently into digital assets, reducing friction without changing the fundamentals: capital flows influence the market, while structure determines how much capital can access the blockchain. Ultimately, a physical subscription and redemption mechanism is essential for Bitcoin ETFs to compete with the world's largest funds in terms of asset size. The opportunities presented by this operating model are enormous, and the efficiency gains it brings are crucial for attracting additional capital. The largest ETF by assets under management is Vanguard Group's S&P 500 ETF (VOO), with $714 billion in assets. In comparison, the largest spot cryptocurrency ETF is BlackRock's IBIT, which currently manages $86 billion. Can physical subscriptions and redemptions allow Bitcoin ETFs to reach the same scale as the $700 billion VOO? This would require Bitcoin ETFs to grow tenfold from their current size, but if the price of Bitcoin against the US dollar continues to rise, who can say what the future holds?

When the Bitcoin price reaches $200,000, even without new capital inflows, IBIT will have already ranked among the top ten ETFs in terms of asset size. If capital inflows continue in the next few years and Bitcoin prices continue to rise, supply shortages are almost inevitable.