SEC Embraces In-Kind Creations and Redemptions: 3 Areas of Financial Impact for Crypto ETPs

In a pivotal shift, the SEC has approved in-kind creations and redemptions for digital asset exchange-traded products (ETPs). This decision marks a significant upgrade to the previously approved spot Bitcoin and Ethereum ETPs, which limited such transactions to in-cash only. By aligning crypto ETPs with the operational norms of other commodity-based ETPs, the SEC is paving the way for greater efficiency, reduced costs and enhanced market flexibility. The approval is expected to streamline operations, improve arbitrage mechanisms and reflect a broader regulatory trend toward normalizing digital assets within traditional financial structures.

For ETP sponsors and institutional investors, this development introduces new financial reporting and disclosure considerations, among others. It’s important for sponsors and investors to not only capitalize on developments like this, but also to understand their impact while maintaining robust processes and controls. Below highlights key operational, market, financial reporting and sponsor considerations.

1. Operational and Market Impacts

The approval of in-kind creations and redemptions reduces friction and costs for authorized participants (APs) and sponsors. Prior to approval for in-kind creations, ETPs would receive cash from APs and then immediately convert the cash to the digital asset held to maintain grantor trust status for tax purposes. Similarly for redemptions, a sale would be required to raise cash to send to APs.

The flexibility contained within this new process reduces those trading costs as well as the slippage associated with those trades, allows for seamless capital activity, and promotes a digital asset denominated ecosystem to operate efficiently outside of the ETPs while staying on-chain.

In-kind creations and redemptions also help APs engage in ensuring alignment between the ETP’s market price and its net asset value (NAV). Without price slippage and inefficiencies due to the differential in time from when the cash is received and converted by the AP compared to the time of NAV strike, arbitrage is increasingly more effective and allows for more efficient markets for digital asset ETPs.

2. Financial Reporting Impacts

This increased flexibility will also encourage more emphasis on investor transparency, thanks to disclosures for financial reporting in accordance with ASC 946. Below are some examples of required disclosures specific to in-kind creations and redemptions:

• Separate disclosure is required for realized gain/loss associated with in-kind redemptions. Redemptions in-kind are assumed to have a realized gain/loss impact at the time of redemption, similar to those redemptions being made in-cash.
• Accounting policies should be stated to reflect the accounting treatment for in-kind creations and redemptions. This should include the valuation policy for in-kind transactions.
• A disclosure should be included in the footnotes presenting the amount of proceeds from in-kind creations and redemptions.
• If fees apply to in-kind creation or redemption orders, those fees should be disclosed in the footnotes, including the details of the fee arrangements and amounts paid during the period.
• If portfolio turnover is presented in the financial highlights, proceeds from in-kind creations and redemptions should be excluded from the calculation and a footnote should be added to disclose this fact.

3. Sponsor Considerations for Audits

As in-kind transactions become more common for digital asset ETPs, it is important for sponsors to understand the audit implications and areas where auditors will devote attention. This will help ensure you properly account for these transactions in accordance with U.S. GAAP.

Items sponsors should expect auditors to examine more closely consist of the following:

• Verifying the accuracy of the date and amount of digital assets transferred by the transfer agent for in-kind transactions by comparing the amounts to what’s recorded in the accounting records.
• Identifying the digital asset wallet being used for the in-kind creation or redemption reported by the transfer agent, and verifying the completeness of such transactions for that digital asset wallet with custodian, when compared to the accounting records.
• Testing the reasonableness of the amount recorded as cost of digital assets in the case of an in-kind creation, as well as similar testing of the amount of proceeds recorded as part of the realized gain/loss calculation for an in-kind redemption, and the associated cost relief.

This change signals a significant shift in regulatory posture at the SEC related to digital assets. Through this approval as well as commentary from the SEC, the increased appetite to produce regulatory clarity for digital assets will improve efficiency of capital markets.

Furthermore, this regulatory evolution is likely to unlock broader institutional participation. With the approval of in-kind creations and redemptions, institutional investors now have a more familiar and operationally efficient framework with which to engage crypto markets.

Contact Mike Dellavalle or a member of your service team to discuss this topic further.

In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.