Dentons US LLP

02/19/2021 | News release | Distributed by Public on 02/19/2021 16:09

Canadian Capital Markets Embrace Bitcoin ETFs

February 19, 2021


On February 16, 2021, the price of one Bitcoin traded above US$50,000 for the first time, in response to increasing institutional adoption of Bitcoin as well as significant interest from retail investors.Reflecting the growing acceptance of Bitcoin, Canadian securities regulators recently cleared the prospectuses of the world's first two exchanged traded funds ('ETFs') dedicated exclusively to acquiring and holding Bitcoin.

On February 11, 2021, the Ontario Securities Commission ('OSC') issued a receipt for a final long-form prospectus of Purpose Bitcoin ETF (the 'Purpose Fund'), providing regulatory clearance for the first ETF dedicated to buying and holding Bitcoin for long-term appreciation. On February 16, 2021, the OSC issued a receipt for a final long-form prospectus of The Bitcoin ETF (the 'Evolve Fund'), providing regulatory clearance for the second ETF dedicated to investing in Bitcoin. Both prospectuses were filed in all provinces and territories of Canada.

This article highlights the growing popularity of Bitcoin and the recent launch of the world's first Bitcoin ETFs in Canada. Information contained in this article is based on public disclosure.

Similarities Between the Purpose Fund and the Evolve Fund

The two ETFs cleared for launch by Canadian securities regulators share a number of features, beginning with their objectives. The Purpose Fund was created to buy and hold substantially all of its assets in long-term holdings of Bitcoin to provide holders of its units with the opportunity for long-term capital appreciation. To achieve its investment objective, the Purpose Fund invests in and holds substantially all of its assets in long-term holdings of Bitcoin. Similarly, the Evolve Fund's investment objective is to provide holders of its units with exposure to the daily price movements of the U.S. dollar price of Bitcoin while utilizing the benefits of the creation and redemption processes offered by the ETF structure. The intention in both cases is to provide unitholders with a secure and convenient alternative to a direct investment in Bitcoin and potentially facilitate the holding of Bitcoin by investors that otherwise would not be able to acquire the cryptocurrency.

Both funds constitute an 'alternative mutual fund' within the meaning of NI 81-102 - Investment Funds ('NI 81-102'). This means the funds have adopted fundamental investment objectives that permit them to invest in physical commodities or specified derivatives, to borrow cash or to engage in short selling in a manner not permitted for other mutual funds under applicable securities laws.

In each case, the funds have retained a manager to act as trustee, manager, and portfolio manager and, in accordance with NI 81-102, a custodian and sub-custodian to hold its assets. Purpose Investments Inc. is the manager of the Purpose Fund and Evolve Funds Group Inc. is the manager of the Evolve Fund. Cidel Trust Company acts as custodian of the assets of each fund and Gemini Trust Company, LLC acts as sub-custodian of the assets of each fund. Each fund's Bitcoin will be held in the sub-custodian's cold storage system, protected in accordance with specified protocols. Cold storage of Bitcoin theoretically reduces the risk of theft in the event of a security breach. The sub-custodian will use segregated cold storage Bitcoin addresses for each fund which are separate from the Bitcoin addresses that the sub-custodian uses for its other customers and which are directly verifiable via the Bitcoin blockchain.

The sub-custodian is also responsible for providing each fund, on an annual basis, a SOC 2 type 2 Report in respect of its internal controls during the course of the applicable calendar year, which report will be made available by the applicable manager for review by the fund's auditors in connection with the audit of the fund's annual financial statements. A SOC 2 type 2 report is an internal controls report intended to demonstrate how well a company safeguards customer data and how well those controls are operating. Each fund also undertook to the OSC to, so long as it is a reporting issuer, obtain from its custodian or sub-custodian: (1) an annual service auditor's report (SOC 2 type 2 report) and (2) written confirmation from the custodian or sub-custodian to permit the fund's auditor to test its internal controls in connection with its audit of the fund's annual financial statements in any year when a SOC 2 type 2 report is not obtained.

The manager of each Fund conducts due diligence on each proposed trading platform or over-the-counter counterparty from which Bitcoin will be purchased, which includes confirming that the relevant source maintains appropriate know-your-client policies and procedures. The manager is also prohibited from transacting with any person or entity that is on a list of designated persons or entities established and maintained under applicable anti-money laundering rules. In addition, the manager has discretion to determine where to place an order for Bitcoin based on price and liquidity. Upon approval of a Bitcoin transaction, the custodian will be notified and payment for the trade is settled. Once the sub-custodian receives the Bitcoin on behalf of the applicable fund, the manager places the fund's Bitcoin in cold storage, ensuring that such Bitcoin is allocated to the fund's account on a segregated basis with the sub-custodian.

Differences Between the Purpose Fund and the Evolve Fund

Two notable differences between the two funds relate to their capital structure and initial method of calculating net asset value.

Pursuant to the Purpose Fund's declaration of trust, the Purpose Fund has three authorized classes of exchanged-traded units, as follows: (i) ETF units denominated in Canadian dollars; (ii) ETF non-currency hedged units denominated in Canadian dollars; and (iii) ETF non-currency hedged units denominated in U.S. dollars (collectively, the 'Purpose Units') The Purpose Units are issued and distributed on a continuous basis and there is no maximum number of Purpose Units that may be issued. By contrast, the Evolve Fund does not have currency-hedged units. Instead, the Evolve Fund has one class of U.S. dollar-denominated unhedged units and one class of Canadian dollar-denominated unhedged units. As of the date of this article, the Purpose Units have commenced trading, and the Evolve Units are expected to trade, on the Toronto Stock Exchange.

Another notable difference between the funds is the method of calculating each fund's respective net asset value ('NAV'). Although the same valuation agent is engaged by each fund, it uses different Bitcoin price benchmarks to calculate the applicable NAV. Initially, the Purpose Fund's manager will use the TradeBlock XBX Index as the primary source upon which the Purpose Fund's Bitcoin will be valued. By contrast, the fund administrator of the Evolve Fund will use a once-a-day benchmark index price for Bitcoin denominated in U.S. dollars to calculate the fund's NAV.

Next Steps in Crypto: Increased Commercial Adoption and U.S. Regulatory Response

Regulatory clearance for the world's first Bitcoin ETFs by Canadian securities regulators does not come in a vacuum. Indeed, regulators around the globe are grappling with the same issues raised by blockchain technology, digital currencies and decentralized finance. Generally, Canadian and U.S. securities regulators have viewed Bitcoin as a type of commodity while other jurisdictions have taken action to treat the cryptocurrency as a currency for taxation purposes. As Canadian regulators have now cleared the launch of Bitcoin-focused ETFs and such funds are becoming more prevalent in the Canadian capital markets, attention will shift to the U.S. Securities and Exchange Commission and whether it will similarly clear such ETFs in the U.S. market.

Against this evolving regulatory landscape, businesses, including some of largest and well-known global companies, continue to embrace Bitcoin and other cryptocurrencies. In its latest annual report, Tesla, Inc. disclosed that it had acquired US$1.5 billion in Bitcoin and expects to begin accepting Bitcoin as a form of payment for its products in the near future, subject to applicable laws. On February 11, 2021, The Bank of New York Mellon, the oldest bank in the U.S., announced that it will hold, transfer, and issue Bitcoin and other cryptocurrencies on behalf of its asset-management clients. Similarly, Mastercard recently announced that, beginning in 2021, it will support select cryptocurrencies directly on its network to allow customers, merchants, and businesses to move digital value in any manner.

Stay tuned as efforts at commercial adoption and the regulation of Bitcoin continues to evolve around the globe. For more information about the corporate and securities law issues related to Bitcoin, investments in Bitcoin or other cryptocurrencies, blockchain technology and/or investment funds, contact Michael C. DeCosimoor Suraj Rammohan.