Can the promotion of physical design resolve the operational discrepancies that have continued to prevent Bitcoin ETFs from functioning like traditional funds that are aimed at replicating?
summary
- In late July, five major ETF providers, including Fidelity, Ark21Share and Vanek, filed filings to shift Bitcoin and Ethereum ETFs from cash-only models to physical creation and redemption.
- The SEC began to take a more flexible stance, releasing a detailed framework that sets custody, disclosure and risk expectations, and reviewing approval timelines more quickly.
- The physical structure makes it more closely related to the spot market by direct crypto transfer between the issuer and approved participants, reducing transaction costs, improving tax efficiency, and maintaining ETF prices.
- If changes are made, US registered cryptographic ETFs may begin to act like global counterparts, thanks to better infrastructure for institutional use.
Bitcoin ETF Giants push clean cipher swap models
In late July 2025, fund providers traded on five major exchanges, Ark 21Shares, Fidelity, Invesco Galaxy, Vaneck and WisdomTree, filed adjusted amendments to the SEC and CBOE BZX exchanges.
Filing advocates a rework of how Spot Bitcoin (BTC) and Ethereum (ETH) ETFs are structured. Each company is about to move from a cash-based model to a physical creation and redemption mechanism.
The official rule change notice was published separately on July 22nd to begin the public comment period.
Under the existing cash-only model introduced when Spot Bitcoin ETF was first approved in January 2024, ETF issuers must manage their transactions via Fiat conversions.
The current approach has been criticized by market participants for increasing transaction costs and causing inconsistencies with underlying spot prices.
In contrast, the physical model allows authorized participants to transfer actual crypto assets within and outside the fund in exchange for ETF shares. Similar structures are also used in international markets, such as Hong Kong’s Bitcoin exchange products.
Approval of proposed changes could potentially make US listed Crypto ETFs more in line with established global practices. This shift is expected to improve price efficiency and operational transparency within these products.
The evolving stance of the SEC
The SEC is beginning to show signs that it will adopt a more flexible attitude towards the structure of funds traded on crypto exchanges.
One development took place on July 7th, and the agency released a 12-page supervisory framework that outlines expectations for crypto-related ETFs. This document addressed three key areas: disclosure, custody, and risk management.
ETF issuers were asked to provide more detailed information on how crypto assets are stored and what risks arise along the way. The goal appears to standardize the evaluation criteria for these products.
The same framework also suggested changes to the approval process. Instead of relying on a case-by-case exemption that could take up to 240 days, the SEC proposed using a predefined template that could shorten the timeline to approximately 75 days.
Regulatory progress is progressive. Applications from BlackRock, Bitwise and others are still pending, but the SEC continues to assess custody procedures, market protection and anti-money laundering compliance.
Brian Armour, ETF analyst at Morningstar, observed that the delay reflected the SEC’s attention. In his view, agents hope that strong investor protection is in place before allowing the ETF structure to directly transfer crypto assets.
James Seyfert of Bloomberg described his recent application as part of a broader improvement process between the SEC and the ETF industry. The timing of submission suggests that both parties may be converging on shared technical standards and risk management.
New: More positive signs about Bitcoin and Ethereum ETF
Five different funds for the CBOE have submitted amendments to the SEC. This shows me that there is likely a positive movement and tweak that is happening at SEC pic.twitter.com/xw0z7sbywj
– James Seyfert (@jseyff) July 22, 2025
Several experts are supporting the reading of this event. Bitbo’s post suggested that previous regulatory resistance to the physical model was attributed to concerns about money laundering and unregulated intermediaries.
Deloitte also noted that several ETF applications submitted in 2023 and 2024 originally included current mechanisms, but were changed to cash only under regulatory pressure.
Their reintroduction may now indicate that previous objections have been resolved.
Why is the actual structure important?
The proposed move from cash-only creation to physical creation and redemption changes how spot Bitcoin ETFs interact with the assets they represent.
Today, when new ETF shares are created or redeemed, they are resolved using cash. This means that ETF issuers must step into the market to buy and sell Bitcoin on behalf of participants, introducing transaction costs, delays, and execution risks.
In contrast, the creation of physical institutions allow large financial institutions known as certified participants (APS) to either deliver Bitcoin directly to the ETF issuer when creating stocks or receive Bitcoin directly on redemption.
This mechanism is already widely used in traditional equity and commodity ETFs and is designed to make the process more cost-effective, transparent and operationally smooth.
Applying the structure to a Bitcoin ETF introduces several core benefits that can improve fund performance, investor outcomes, and market efficiency.
Improved implementation and reduced market friction
The current cash-based system creates a two-stage process. Approved participants will deliver cash and ETF issuers will implement market orders to buy and sell Bitcoin.
This creates exposure to market fluctuations between cash receipts and asset purchases, leading to slipping and widespread bid spreads.
Inefficiency is particularly pronounced during volatile trading sessions when liquidity is low or the order form is shallow.
The physical mechanism streamlines the process. APs can trade Bitcoin directly, eliminating the need for ETFs to enter the market, reducing the number of intermediaries, simplifying execution, and lowering the risk of price impact.
Improve tax efficiency in fund management
Traditional ETFs rely on physical transfers to minimize the distribution of capital gains to shareholders. When an investor redeems a stock, the ETF can transfer the underlying assets rather than selling it. This avoids triggering taxable events within the fund.
Bitcoin ETFs using physical redemption work under the same logic. If the AP receives Bitcoin by redeeming shares rather than cash, the transaction does not include sales by the fund. This helps prevent internal capital gains.
Tax liability arises only if the AP later sells Bitcoin, improves investors’ after-tax returns, and helps maintain a stable fund net asset value (NAV) over time. This is especially important for long-term holders and institutions managing large allocations.
Stronger arbitration and price adjustments
One of the roles of APS in the ETF market is to maintain ETF prices in line with the value of the underlying assets. They do that through arbitrage, buy stocks when ETF stocks are undervalued and sell when they are overvalued compared to the actual price of Bitcoin.
Cash-based ETFs introduce delays into the process.
Since redemption involves converting Bitcoin to cash, there is a timing gap between when APS acts and when the fund can reflect the transaction, weakening the arbitrage link and allowing ETF prices to separate from true net asset value.
Removes physical creation and redemption delays. APS can act directly and instantly, trading Bitcoin for stocks or vice versa.
As a result, ETF stock prices are more likely to reflect actual Bitcoin prices throughout the trading day, increase transparency and increase market confidence.
The final bridge to traditional finance
If approved, with the creation and redemption of physical institutions, Bitcoin ETFs could be more operationally aligned with the infrastructure already used by institutional investors in their traditional asset classes.
One expected outcome is improved arbitrage efficiency.
With fewer conversion steps, ETF prices could track Bitcoin spot prices more closely, and could strengthen the link between crypto and broader capital markets, especially as base trading and hedging strategies are easier to implement on both equity and crypto platforms.
The Federal Reserve analysis notes that physical mechanisms contribute to a decline in NAV premiums and closer bid spreads, particularly during periods of market stress.
At the system level, the adoption of physical mechanisms indicates that the custody and compliance infrastructure of cryptographic ETFs has reached a level that is deemed appropriate by regulators.
Retail investors will not redeem Bitcoin stocks directly, but as ETF operations become more consistent with institutional norms, they may benefit from narrower spreads and more reliable price tracking.
In practice, Shift does not introduce new access, but adjusts existing access features. For institutions that manage size, structures often determine ease of use. In that context, it could make Bitcoin ETFs easier to use in physical form.
