Bitcoin ETF faces a major change! SEC approves physical creation and redemption, how will 710 billion dollars in funds flow in?

The U.S. Securities and Exchange Commission (SEC) approved an order on July 29 allowing the creation and redemption of Bitcoin and Crypto Assets exchange-traded products (ETPs) in physical form, thereby reversing the restrictions that only allowed cash payments during the Bitcoin Spot issuance in January and the Ether fund issuance in the spring of this year. The SEC stated in an official announcement that Bitcoin and Ether ETPs "will be allowed to create and redeem shares in physical form," aligning them with the mechanisms long used for commodity ETPs. SEC Chairman Paul Atkins stated, "This is a new day for the SEC," adding that this change should make these products "cheaper and more efficient."

Bloomberg Industry Research senior ETF analyst Eric Balchunas further elaborated on this news on X, stating the chairman's comments: "This is a new day for the SEC... [physical] creation and redemption of large amounts of Crypto Assets ETPs." His post highlighted the policy shift: allowing authorized participants (AP) to directly deliver or receive Bitcoin or Ether tokens instead of transferring cash in the market through public assets.

1. Why Physical Redemption is Significant for the Bitcoin ETF Market

Bitwise CEO Teddy Fusaro made a technical explanation on July 30, stating that this transition will eliminate the recurring friction in the cash creation model. Under the cash creation model, ETFs facing inflows must "purchase Bitcoin from the market," usually paying a spread that is at least comparable to the benchmark price.

To illustrate this point, Fusaro assumes that, in a $100 million purchase, the CME CF Bitcoin reference rate (New York variant) would be at a premium of two basis points: "If the ETF pays a price that is 0.02% higher than the benchmark price (BRRNY) in a $100 million purchase, that would be $20,000." He wrote that these costs would not be passed on to the stock price; whereas in physical trading, the AP would deliver the required Bitcoin, "without the 0.02% slippage," thereby excluding this cost "from consideration."

The operational mechanism behind the Fusaro case is not unfamiliar to ETF practitioners, but it is often opaque to the ultimate investors. In the primary market, APs will form creation units and exchange ETF shares with the trust institution; under a pure cash trading mechanism, this forces the issuer or its agents to acquire Bitcoin at an observable benchmark price plus execution costs. The BRRNY index (calculated from trades conducted on audited component exchanges between 3 PM and 4 PM New York time) anchors the pricing window for the U.S. trading day, but actual transactions will still generate price discrepancies and affect the market.

Physical trading in the exchange replaces cash with Bitcoin, allowing holders to directly invest in or receive assets, and net earn from their inventory without forcing fund trades. Over time, this often narrows the secondary market spread, reduces tracking noise at closing, and compresses the "implicit" costs borne by investors during periods of significant subscriptions or redemptions.

2. The SEC's orders go far beyond just one operational adjustment

In addition to physical exemptions, the SEC also stated that it has approved other measures to "advance a preferential neutral assessment of crypto asset ETPs," including the listing and trading of ETPs that simultaneously hold Bitcoin spot and Ether spot on exchanges, options for certain Bitcoin spot ETPs, FLEX options for specific Bitcoin ETP shares, and the SEC also released a schedule regarding the authorization for the listing of two large crypto asset ETPs.

Commissioner Mark T. Uyeda sees this move as a correction to an anomalous policy: "Before July 29, cryptocurrency ETPs could not be created and redeemed with physical assets—this sharply contrasts with other forms of commodity ETPs—this restriction has caused unnecessary costs and burdens." His statement aligns with the cost pipeline emphasized by Fusaro, which also helps explain why since the launch of spot cryptocurrency products, ETF market makers and APs have been lobbying for cryptocurrencies to maintain parity with gold and other commodity funds.

From the perspective of market structure, its impact is concrete rather than theoretical. The physical mechanism allows authorized participants (AP) to manage Bitcoin inventory among prime brokers, over-the-counter trading platforms, and custodians, without forcing funds to enter the spot market at closing. This, in turn, can enhance arbitrage, making ETF prices closer to net asset value, especially during periods of high market volatility, as cashing out may force investors to buy hastily, pushing prices above benchmark levels.

The implementation speed varies by issuer; the AP agreement, operations, and custodial mechanisms must be updated to support real liquidity. However, the policy baseline has already changed.

Conclusion:

The SEC's approval of the physical creation and redemption mechanism for Crypto Assets ETPs is a milestone in the cryptocurrency market. This transformation will not only enhance the efficiency of Bitcoin and Ether ETFs and reduce costs, but it will also open the door to attract large-scale institutional funding inflows, potentially triggering a massive supply crunch of up to $710 billion, thereby reshaping the landscape of the cryptocurrency market.