Ark raises concern over Coinbase concentration in Bitcoin ETF filings days before potential approval

Gunnar Larson g at
Sun Dec 31 06:23:16 PST 2023

As the anticipation of the approval of a spot Bitcoin ETF finally comes to
a head, the Ark 21Shares Bitcoin Trust has made 16 significant
clarifications and additions to its S1 filing across several areas, ranging
from operational processes to financial responsibilities and regulatory
aspects, providing a more explicit, more detailed framework for the ETF’s

Change Description
Index Price Update Updated the Index price for the Bitcoin – U.S. Dollar
trading pair to a specific value as of December 22, 2023.
Bitcoin Counterparty Definition Clarified that the third party involved in
Share transactions is not an Authorized Participant but may be an affiliate.
Share Redemption Process Modified the redemption process for Shares,
specifying cash-only transactions and detailing responsibilities for
Bitcoin Counterparties.
Marketing Support Arrangements Added provisions for potential marketing
support arrangements with fees payable by the Sponsor and/or Sub-Adviser.
Creation and Redemption Risks Outlined risks associated with creation and
redemption processes, particularly during unanticipated difficulties.
Trading Balance Limitation Set a limit on the amount of bitcoin in the
Trading Balance, tied to specific transactional or expense needs.
Service Provider Concentration Risk Highlighted the risks associated with
the Bitcoin Custodian and Prime Broker serving multiple competing products.
Post-Trade Financing Agreement Update Amended details related to borrowing
bitcoin or cash from the Lender to facilitate timely transactions.
Interest Rate on Trade Credits Established the determination of interest
rates on Trade Credits based on various factors.
Authorized Participant Transaction Model Specified that Authorized
Participants will only deal with cash for creating and redeeming Shares.
Creation and Redemption Procedure Update Updated procedures for the
creation and redemption of Baskets, including expense responsibilities.
Reduced In-Kind Transaction wording Reduced the wording of the possibility
of in-kind transactions for creating and redeeming Shares, pending
regulatory approval.
Use of Bitcoin for Expenses Indicated that the Trust might use Bitcoin to
pay certain expenses, with implications under IRS guidance.
Taxation Changes on Share Sales Updated tax implications for shareholders
on the sale of Shares and the redemption process.
Additional Expenses Disclosure Provided details on the estimated expenses
related to the issuance and distribution of Shares.
The revised filing specifies the CME CF Bitcoin Reference Rate – New York
Variant for the Bitcoin – U.S. Dollar trading pair, setting a clear
historical reference point with a rate of $43,731.74 as of December 22,
2023. This provides a precise valuation marker for the Bitcoin market at
that time.

Further, the role of third parties, named “Bitcoin Counterparties,” is
distinctly clarified. They are identified as affiliates but not Authorized
Participants, delineating their role in the purchase process of Bitcoin for
the Trust. This distinction underscores the separation of responsibilities
in the ETF’s operational structure.

In a critical amendment regarding the roles of Authorized Participants,
it’s emphasized that their involvement will be strictly in cash
transactions for creating and redeeming shares. The Trust retains the sole
responsibility for selecting Bitcoin Counterparties for Bitcoin
transactions, underscoring an independent operational procedure.

The filing also introduces new information about potential marketing
support arrangements, specifying that such arrangements will not involve
the Trust directly and the Sponsor will bear any associated costs and/or
the Sub-Adviser. This arrangement aims to protect the Trust’s assets from
being used for marketing activities.

Notably, the filing addresses potential challenges in the creation and
redemption process of the ETF’s Baskets. It outlines scenarios where market
disruptions could impact the ETF’s ability to maintain its share price
close to Bitcoin’s actual value. Provisions for suspending the creation and
redemption of Baskets during significant disruptions are included,
indicating a cautious approach to market volatility and operational risks.

The filing also delves into the overlap in roles of the Bitcoin Custodian
and Prime Broker, addressing industry concentration risks. The limitation
on the amount of Bitcoin held in the Trust’s Trading Balance for
transactional and expense management purposes is highlighted, reflecting a
strategic approach to risk management.

Further, a more defined process for borrowing bitcoin or cash from Coinbase
Credit, Inc. is laid out, emphasizing efficient cash management for trade
and expenses. The amendment also discusses the dynamic determination of the
“Authorized Amount” of Trade Credits, adding an element of flexibility and
responsiveness to market conditions.

The amendment introduces a new aspect concerning the interest rates on
Trade Credits, emphasizing a dynamic approach to setting these rates based
on various market and credit factors.

Moreover, the Trust’s decision to cover on-chain transaction fees for
Bitcoin transactions is a significant operational change, simplifying the
cost structure for Authorized Participants. The potential for in-kind
creation and redemption of shares was shortened as it remains subject to
regulatory approval and is currently uncertain.

Regarding taxation, the Trust’s use of bitcoin for expenses is now
interpreted as a sale, impacting tax implications. The amendment provides a
more detailed view of the tax treatment for various shareholder
transactions, reflecting a nuanced understanding of cryptocurrency taxation.

Lastly, the “Item 13. Other Expenses of Issuance and Distribution” section
in the filing offers a comprehensive overview of the estimated costs
associated with issuing and distributing Shares, providing transparency on
financial obligations related to the ETF offering.

These amendments enhance the clarity and detail of the Ark 21Shares Bitcoin
Trust’s operational, financial, and regulatory framework, addressing
various complexities and risks inherent in managing a Bitcoin ETF amid an
intricate and competitive scene among several other major institutional

Breakdown of all 16 amendments.
Below is a detailed run-through of all the major amendments and their
potential implications for the Bitcoin ETF filing from Ark.

Index Price Update
The filing was amended to specify the CME CF Bitcoin Reference Rate – New
York Variant for the Bitcoin – U.S. Dollar trading pair. Initially, the
document left the date and the reference rate value as placeholders. These
placeholders have been updated with the amendment to reflect a specific
date and value. As of December 22, 2023, the rate, which CF Benchmarks Ltd.
calculates, was set at $43,731.74. This change adds a precise historical
reference point to the filing, giving a clearer picture of the Bitcoin
market value at that particular time.

Bitcoin Counterparty Definition
The filing was also amended to clarify the role and identity of the third
parties involved in the process of purchasing shares for the Ark 21Shares
Bitcoin ETF. Initially, the document described these third parties as
potentially being affiliates of Authorized Participants, but with no clear
distinction regarding their direct involvement as Authorized Participants.
The amendment specifies that these third parties, referred to as “Bitcoin
Counterparties,” are not Authorized Participants themselves but maybe
Authorized Participants’ affiliates.

This distinction is important as it clarifies the separation between the
entities authorized to purchase and redeem shares directly from the Trust
(Authorized Participants) and those designated to handle the actual
purchase of Bitcoin equivalent to the cash deposited by the Authorized
Participants (Bitcoin Counterparties). The rest of the process, as outlined
in the document, remains unchanged: the Sponsor, on behalf of the Trust,
instructs these Bitcoin Counterparties to purchase Bitcoin with the
deposited cash and then deposit this Bitcoin into the Trust’s account with
the Bitcoin Custodian, resulting in the issuance of the corresponding
amount of Shares to the Authorized Participant.

Share Redemption Process
The roles and responsibilities of the Authorized Participants in creating
and redeeming shares in the Ark 21Shares Bitcoin Trust was also clarified.
The revised text emphasizes that Authorized Participants will exclusively
deal in cash transactions when creating shares (investing in the Trust) and
redeeming them (withdrawing from the Trust). This change highlights that
Authorized Participants will neither handle Bitcoin directly nor instruct
the Trust or a Bitcoin Counterparty on managing Bitcoin transactions during
the share creation or redemption processes.

The amendment further details that the Trust is solely responsible for
choosing the Bitcoin Counterparty to facilitate Bitcoin transactions,
whether receiving Bitcoin for share creation or delivering it for share
redemption. This distinction is crucial as it underlines that the Bitcoin
Counterparty acts independently and is not an agent of the Authorized
Participant in these transactions.

Additionally, the amendment names the Prime Broker and the Lender as the
Bitcoin Counterparties as of the prospectus date, providing a specific
reference to the entities involved in the transaction process.

Overall, this amendment brings more clarity to the operational structure of
the Trust, explicitly defining the roles of Authorized Participants and the
Trust concerning Bitcoin transactions and identifying key entities involved
in these processes.

Marketing Support Arrangements
Information about potential marketing support arrangements for the Trust
was added. This new section specifies that the Sponsor and/or the
Sub-Adviser of the Ark 21Shares Bitcoin Trust might engage in additional
agreements to support the marketing of the Trust. Significantly, it is
clarified that the Trust itself will not be a party to these marketing
support arrangements.

The amendment also addresses the financial implications of such agreements.
It states that any fees or costs arising from these marketing support
arrangements will be borne by the Sponsor and/or the Sub-Adviser, not the
Trust itself. This clarification ensures that the financial
responsibilities for marketing-related activities are explicitly assigned
to the Sponsor and/or Sub-Adviser, safeguarding the Trust’s assets from
being utilized for these purposes.

Creation / Redemption Risks and Trading Balance Limitations
If the creation and redemption process of the ETF’s Baskets (which are
essentially bundles of shares) encounters unexpected difficulties, and
amendment states that this could significantly impact the ETF’s ability to
maintain its share price close to the actual value of Bitcoin (NAV, or Net
Asset Value). These difficulties could arise from various issues, including
volatility in Bitcoin’s price, problems with the Bitcoin Custodian (such as
insolvency, business failure, security breaches, or operational failures),
disruptions in Bitcoin trading platforms, or issues within the Bitcoin
network itself, such as network outages, congestion, or high transaction
fees demanded by miners.

In response to these potential challenges, the ETF has provisions for
suspending the creation and redemption of Baskets. This suspension could
happen if, for instance, the Bitcoin network faces outages or other
significant problems that disrupt transaction processing. During such
suspensions, the spread in trading – the difference between the buying and
selling price – may widen, leading to the ETF’s shares trading at a premium
or discount compared to the actual price of Bitcoin. Moreover, if the
Bitcoin market becomes less liquid, meaning it’s harder to buy and sell
large amounts of Bitcoin quickly without affecting its price, this could
also cause the ETF’s share price to diverge from the underlying value of

In a related amendment, the filing clarified limits on the amount of
Bitcoin that may be held in the ETF’s Trading Balance. This balance will
only contain enough Bitcoin to manage a specific creation or redemption
transaction or to cover Trust Expenses that the Sponsor Fee does not
already cover. This limitation is likely aimed at reducing the risk
associated with holding large amounts of Bitcoin, which can be volatile and
subject to various external factors that could impact its value.

Service Provider Concentration Risk
A detailed explanation regarding the potential overlap in the roles of the
Bitcoin Custodian and Prime Broker for Ark’s 21Share Bitcoin Trust and
other competing products was added. This amendment highlights the current
market situation where only a limited number of digital asset
intermediaries have the reputation and operational capability to serve as
Bitcoin Custodian and/or Prime Broker. The concern addressed is that these
service providers may also serve similar functions for competing
exchange-traded products (ETPs) that offer exposure to the spot bitcoin
market or other digital assets.

This situation creates a risk for the Trust due to the industry
concentration of these service providers. The amendment explains that
sharing these custodial and brokerage services among various products might
lead to fewer options for intermediaries available to the Trust. This could
pose challenges in finding and appointing replacement service providers if
needed. Furthermore, the amendment addresses the risk of magnified impact
due to this concentration. If the Bitcoin Custodian or Prime Broker faces
operational disruptions or adverse developments, it could affect the Trust
and other products using the same services, leading to a broader loss of
confidence in ETPs related to the spot Bitcoin market or other digital

Additionally, the amendment introduced a clause about the management of the
Trust’s bitcoin holdings. It specifies that the amount of bitcoin held in
the Trading Balance will be limited. This limitation is set to ensure that
the bitcoin held is only what is necessary for processing creation or
redemption transactions or for paying Trust Expenses not covered by the
Sponsor. This addition aims to clarify the operational limits regarding the
Trust’s bitcoin holdings, ensuring they are explicitly managed on
transactional necessity and expense management.

Post-Trade Financing Agreement Update
Ark’s 21Shares Bitcoin Trust, in its agreement with Coinbase Credit, Inc.,
now has a more defined process and purpose for borrowing bitcoin or cash as
trade credit. This revision elaborates on how the Trust can use borrowed
funds to efficiently manage cash creations, redemptions, and payment of
various expenses, including the Sponsor’s Fee. The key change is the
detailed explanation of how this borrowing mechanism allows the Trust to
lock in bitcoin prices at the time of trade or payment rather than waiting
for the transfer of funds or bitcoin between accounts, which could be
subject to delays.

Additionally, the amendment clarifies the process for both purchasing and
selling Bitcoin in connection with creation and redemption orders. It
highlights the Trust’s strategy of borrowing either cash or bitcoin to
expedite these transactions, emphasizing the aim to secure bitcoin prices
swiftly rather than being delayed by fund transfers.

The Trust’s acknowledgment of an unspecified maximum amount of trade credit
that could be established in the future is another significant addition.
This indicates a potential limit on the amount of funds the Trust can
borrow, though it’s not currently defined.

Furthermore, the amendment details determining the “Authorized Amount” of
Trade Credits. It specifies that this amount will be decided daily at the
Lender’s discretion, based on various factors, including the availability
of financing and credit assessment of the Trust. This introduces a dynamic
element to the amount the Trust can borrow, dependent on the Lender’s
conditions and the market environment. The Lender’s discretion in extending
Trade Credits, especially during material market disruptions or shortages
of bitcoin for lending, is also emphasized, highlighting the conditional
nature of this financial arrangement.

Interest Rate on Trade Credits
Ark amended the interest rates on Trade Credits, also known as the
“financing fee.” This fee will now be determined daily at the discretion of
the Lender. Several factors, including the availability of financing,
market prices, and a credit assessment of the Trust, will influence the
Lender’s decision. This change implies a more dynamic and flexible approach
to setting the financing fee, potentially reflecting the volatile nature of
the cryptocurrency market.

Additionally, the amendment specifies the process of creating and redeeming
shares within the Trust. Authorized Participants (APs) will only use cash
for these transactions to create and redeem shares. Notably, APs will not
engage in direct or indirect purchase, holding, delivery, or receipt of
Bitcoin in the creation or redemption process. This responsibility is
solely on the Trust, which will select a Bitcoin Counterparty different
from the Authorized Participant for these transactions.

When creating shares, the Trust will receive Bitcoin from a Bitcoin
Counterparty, which it selects independently and not as an agent or under
the direction of an Authorized Participant. Similarly, the Trust will send
Bitcoin to a chosen Bitcoin Counterparty, again independent of the
Authorized Participant, for redemption. This structure ensures that the
Authorized Participants’ involvement is limited to cash transactions. At
the same time, the Trust manages the Bitcoin transactions with its chosen
counterparties, maintaining a clear separation of roles and
responsibilities in the share creation and redemption process.

Authorized Participant Transaction and Creation / Redemption Procedure
The Ark 21Shares Bitcoin Trust will now cover the costs associated with
Bitcoin-related on-chain transaction fees for both creation and redemption
transactions and transactions with the Prime Broker. The Sponsor will
assume these expenses as part of the Sponsor Fee. It clarifies that
Authorized Participants are only responsible for cash liabilities related
to creation and redemption costs, such as trading fees and slippage. This
amendment simplifies the cost structure for Authorized Participants,
clarifying that their financial responsibilities are limited to specific
cash-related costs.

Additionally, the amendment introduces a significant change regarding the
potential for in-kind creation and redemption of shares, with the section
reduced significantly. While the Trust may allow Authorized Participants or
third parties acting on their behalf to engage in in-kind transactions for
creating and redeeming shares in the future, this is subject to regulatory
approval. The amendment highlights that the timing for such regulatory
approval is uncertain, and no guarantee will be granted. This update
implies that while the option for in-kind transactions may be considered,
there is no assurance that it will be available to Authorized Participants
or their third-party counterparts in the future. This change adds a layer
of uncertainty regarding the operational mechanics of the Trust,
particularly in terms of how shares might be created or redeemed in the

Use of Bitcoin for Expenses and Taxation Changes on Share Sales
The Trust will now explicitly use Bitcoin to cover certain expenses, a move
interpreted under current IRS guidance as constituting a sale of Bitcoin.
This new aspect implies that when the Trust utilizes Bitcoin for expenses,
it is effectively selling that portion of it, potentially impacting its tax

Regarding the taxation of shareholders, the amendment clarifies and expands
on the tax treatment of various transactions involving the Trust’s shares.
Previously, it was outlined that when shareholders sell their shares, they
are treated as selling their proportional share of the bitcoin in the
Trust. The gain or loss on this sale is calculated based on the difference
between the sale price of the shares and the shareholders’ tax basis in

The recent amendment refines this by stating that the above treatment
applies specifically to sales other than redemptions. Additionally, it
introduces the concept of cash redemptions. In such cases, when the Trust
sells bitcoin to fund a shareholder’s redemption, the gains or losses from
this sale are expected to be treated as if they were incurred directly by
the shareholder being redeemed. This could mean that the tax implications
for the shareholder in a cash redemption scenario are directly linked to
the gains or losses realized by the Trust from the sale of bitcoin used to
fund that redemption.

Furthermore, the amendment maintains the previous stance that a redemption
of shares in exchange for the underlying bitcoin is generally not a taxable
event. The shareholder’s tax basis and holding period for the bitcoin
received in such redemption are aligned with their basis and holding period
in the Trust’s bitcoin immediately before the redemption.

Overall, these changes emphasize a more detailed and nuanced approach to
the taxation of different types of transactions shareholders might engage
in with the Trust, reflecting a response to the evolving understanding of
cryptocurrency taxation.

Additional Expenses Disclosure
A new section detailing the estimated costs associated with issuing and
distributing the Shares, as outlined in the Prospectus, was filled in. This
section, titled “Item 13. Other Expenses of Issuance and Distribution,”
provides an overview of various fees and expenses, excluding underwriting
commissions and discounts, that the registrant (Ark 21Shares Bitcoin Trust)
expects to incur.

Significantly, the SEC registration fee is marked as “N/A,” with a note
explaining that the exact amount is indeterminate at this stage. This is
because the securities being registered have an unspecified quantity, and
the fee will be determined under specific SEC rules.

The listing fee for the Shares is specified as an actual amount of $12,000.
The estimated costs include $87,000 for auditor’s fees and expenses and a
substantial $670,000 for legal fees and expenses. Printing expenses are
estimated at around $168,000, and miscellaneous expenses amount to $13,000.

In total, the estimated expenses for issuing and distributing the Shares
are projected to be $950,000. This inclusion gives potential investors and
stakeholders a clearer picture of the financial obligations and costs that
Ark 21Shares Bitcoin Trust anticipates concerning their ETF offering.
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