What role do authorized participants (APs) play in cryptocurrency ETFs?

Key Points

• Authorized participants play a pivotal role in facilitating authorized creations and redemptions of cryptocurrency ETFs.
• APs are typically large financial institutions, such as market makers and brokerage firms, that provide liquidity to cryptocurrency markets and act as intermediaries between the ETF and the underlying cryptocurrency.
• The specific role of APs in authorized creation and redemption process involve submitting creation or redemption baskets to the authorized issuance and servicing agent.
• Authorized creation involves APs acquiring the underlying cryptocurrency from the market and transferring it to a custodian, which then releases ETF shares to the AP.
• Authorized redemption involves APs redeeming their ETF shares with the issuance and servicing agent and receiving the underlying cryptocurrency in exchange.
• APs assume a significant amount of risk by holding the underlying cryptocurrency, ensuring that the ETF has enough liquidity, and facilitating the trading of ETF shares.
• Regulators have established strict requirements for APs to ensure the integrity and efficiency of authorized creations and redemptions.

Authorized Participants (APs) Role in Cryptocurrency ETFs1. Submission of Creation or Redemption Baskets

Authorized participants play a crucial role in both authorized creation and redemption of cryptocurrency ETFs. When an AP decides to create or redeem ETF shares, it submits a creation or redemption basket to the authorized issuance and servicing agent. The basket must meet size and quality criteria established by the ETF's prospectus.

2. Authorized Creation Process

In authorized creation, the AP acquires the underlying cryptocurrency from the market and transfers it to a custodian approved by the ETF sponsor. The custodian is responsible for holding the cryptocurrency and releasing ETF shares to the AP in exchange for the deposited cryptocurrency. Once the ETF shares have been created, they are made available for trading on the stock exchange.

3. Authorized Redemption Process

In authorized redemption, the AP presents its ETF shares to the authorized issuance and servicing agent, which redeems these shares and transfers the underlying cryptocurrency to the AP. The AP can then sell the cryptocurrency in the market or hold it in their portfolio.

4. Risk Management and Liquidity Provision

Authorized participants assume a substantial amount of risk by holding the underlying cryptocurrency. They are responsible for ensuring that the ETF has sufficient liquidity by participating in the trading of ETF shares on the stock exchange. This ensures that investors can buy and sell ETF shares at fair market prices.

5. Regulatory Oversight

Regulators have established stringent requirements for authorized participants. These requirements are aimed at ensuring the integrity and efficiency of authorized creations and redemptions. APs must meet capital, cybersecurity, and operational standards to qualify for this role.

FAQsWho is eligible to become an authorized participant?

Authorized participants are typically large financial institutions, such as market makers or brokerage firms. They possess sufficient capital and resources to meet the regulatory requirements and are experienced in trading both cryptocurrency and traditional financial instruments.

How are authorized participants regulated?

Authorized participants are subject to regulatory oversight by the Securities and Exchange Commission (SEC). The SEC requires APs to register with the Financial Industry Regulatory Authority (FINRA) and adhere to specific rules and regulations. These regulations cover areas such as capital adequacy, cybersecurity, and operational risk management.

What are the benefits of becoming an authorized participant?

Authorized participants benefit from participating in the growing cryptocurrency ETF market. They can generate commissions and fees from facilitating authorized creations and redemptions. Additionally, APs can benefit from arbitrage opportunities and market making activities involving cryptocurrency ETFs and the underlying cryptocurrency.