The Rise of Bitcoin Spot ETFs: A South African Perspective

Source: TaxDAO

Over the past decade, blockchain-based digital assets such as Bitcoin have grown into a multi-billion dollar asset class, providing a variety of services to individuals and businesses. Originally designed as a peer-to-peer payment method, Bitcoin has undergone a major transformation into an investable asset.

This evolution has prompted the integration of these blockchain-based assets into the traditional financial services industry, driving the need for a regulatory framework.

As the asset class matures, so do custody methods, with early adopters applying self-custody to their digital asset holdings because custody services are not readily available.

However, as the industry has evolved, new business models have emerged, including professional custodians and hybrid custodians. The latter is also known as a cryptocurrency or digital asset exchange. These digital asset exchanges provide an alternative to self-custody and also serve as blockchain-based digital asset trading markets, such as the Johannesburg Stock Exchange (JSE).

It is important to understand that these platforms act as custodians and trading venues, unlike traditional stock exchanges, which only provide a trading environment where custody services are provided by independent parties.

Digital asset exchanges are more similar to commercial banks where individuals can hold and exchange currency. However, unlike these exchanges, commercial banks are subject to strict regulations in terms of customer asset segregation, liquidity, capital requirements, and deposit guarantees to protect customers and depositors.

Regulation

Regulation of the digital asset industry has begun to evolve as investor demand for exposure to digital assets through regulated investment options increases. The change reflects a trend toward more regulated global financial conditions.

South Africa has also followed this shift, moving from an unregulated zone to a more regulated zone. Amid this evolution, there is a growing need to invest in digital assets through exchange-traded funds (ETFs), a highly regulated investment vehicle. While dedicated or hybrid custodians have not yet made a wholesale shift to regulated ETFs, demand for such products has risen significantly, driven largely by commercial investors in South Africa and other countries.

Earlier this year, the U.S. Securities and Exchange Commission made a historic decision by approving several Bitcoin spot ETFs. The approval is not the first in the world, with countries such as Canada, Germany, Brazil and Australia already launching similar ETFs linked to the spot price of the world’s largest cryptocurrency by market capitalization – but it is certainly a watershed moment for the asset class.

Fees

When considering these Bitcoin spot ETFs, you must consider the associated fees, which are typically 0.25 per year based on assets under management (AUM) % to 1.5%.

While these fees are consistent with similar non-Bitcoin ETFs, they are relatively high compared to digital asset exchanges that act as custodians. These hybrid custodians typically charge an initial transaction fee or spread of 0.3% to 1.5% and no annual custodian fees.

However, investors making this comparison must realize that AUM plays a vital role, covering the operational costs required to ensure the fund operates in a regulated environment and Helps in producing audited financial statements. These financial statements are made public to current and potential investors, which sets the ETF apart from other custodians whose financial affairs remain private due to their corporate structure.

Custody

One also needs to consider how the ETF handles custody of the underlying assets. They often rely on existing dedicated and hybrid custodians such as Coinbase, which currently hosts 80% of approved Bitcoin spot ETFs in the United States.

Whether investing in an ETF or holding assets directly through Coinbase, trading risks remain relatively consistent, underscoring the importance of due diligence.

We may also see examples of South African and global commercial banks introducing hybrid custody solutions into their existing business models to disrupt the business models of digital asset exchanges, such as what has been done by UK fintech Revolut method.

Tax Classification

The South African Revenue Service (Sars) has not yet provided comprehensive, authoritative guidance on classifying digital asset disposals as capital or income. However, Sars said the burden is on the taxpayer to prove that the asset is in fact of a capital nature. Notably, blockchain-based digital assets such as Bitcoin lack the traditional “fruit and tree” principle, which typically distinguishes between capital gains and income gains. As a result, they may fall into higher tax rates on their taxable income.

Tax Advantages

From a South African perspective, there may be tax advantages to holding digital assets through listed ETFs. However, there may be significant advantages to seeking exposure through a regulated vehicle such as a Bitcoin spot ETF.

Section 9C of the South African Income Tax Act will apply to listed securities such as Bitcoin spot ETFs, but will not apply where individuals hold Bitcoin on-chain or through hybrid custodians such as digital asset exchanges.

Therefore, under section 9C, if you hold shares (including interests in a collective portfolio of securities such as ETFs) for more than three years, they may be deemed to be capital in nature, as opposed to being deemed income. This may result in a lower tax rate compared to.

The question remains when South African stock exchanges such as the JSE and Cape Town Stock Exchange will launch a Bitcoin spot ETF.

Over the past decade, many fund managers have attempted to list these innovative investment vehicles, but both South African platforms have been cautious and refused approval.

However, recent global market developments, including the emergence of Bitcoin spot ETFs in various jurisdictions such as the United States, signal a shift in the landscape. These developments demonstrate the growing acceptance and demand for such investment options. This global trend may force the South African Stock Exchange to seriously consider approving South Africa’s first Bitcoin spot ETFs in 2024.