U.S. regulators and asset managers are working to bring crypto exchange traded funds closer to the in-kind settlement model used by mature commodity and securities funds. The change would allow authorized participants to exchange ETF shares directly for Bitcoin or other digital assets, rather than forcing funds to sell coins for cash when investors exit. That could reduce trading costs, limit market impact and improve tax efficiency, while creating new demands on custodians, broker dealers and market makers.
The debate over crypto ETFs is entering a less visible but potentially more consequential phase. After years of attention focused on approvals, fees and daily inflows, the industry is now concentrating on the plumbing that determines how money moves into and out of these products.
At the center of that discussion is in-kind settlement. Under the model, an authorized participant, usually a large bank or market making firm, could deliver cryptocurrency to an ETF in exchange for newly created shares. When investors redeem shares, the authorized participant could receive the underlying cryptocurrency rather than cash. The fund would not necessarily need to sell Bitcoin on an exchange to meet the redemption.
That distinction matters because every creation or redemption affects liquidity. A cash based structure places more responsibility on the fund or its trading counterparties to buy or sell the asset. An in-kind structure moves much of that activity to the authorized participant, which may already have access to inventory, exchange relationships and hedging tools.
The result could be a more efficient connection between traditional capital markets and digital asset markets. It could also expose weaknesses that are less visible when a fund handles redemptions in cash, including custody coordination, settlement timing and the fragmented nature of crypto liquidity.
From cash creation to direct asset exchange
An ETF creation begins when an authorized participant assembles a block of assets and exchanges them with the fund sponsor for ETF shares. Those shares can then be sold to investors on an exchange. A redemption works in the opposite direction.
In a traditional equity or commodity ETF, the authorized participant can often deliver the securities that make up the portfolio or receive them when shares are redeemed. This process helps keep the ETF share price close to the value of its holdings. If the ETF trades at a premium, an authorized participant can create shares and sell them. If it trades at a discount, the participant can buy shares, redeem them and receive the underlying assets.
For a Bitcoin ETF operating only through cash, the process is less direct. The fund receives money when shares are created and uses that money to purchase Bitcoin. When shares are redeemed, the fund or its trading agent sells Bitcoin and sends cash to the authorized participant.
Those transactions can be manageable in normal conditions, particularly when Bitcoin markets are deep and trading is continuous. But they also introduce costs. A large sale may move the market, especially if it occurs during a period of thin liquidity. The fund may incur brokerage fees, bid and offer spreads and the cost of hedging price exposure between the redemption request and the final trade.
In-kind settlement can reduce those frictions by allowing the ETF and the authorized participant to exchange equivalent economic value without requiring the fund to liquidate the asset. The participant takes on more responsibility for sourcing or disposing of Bitcoin, while the fund remains focused on tracking its benchmark and maintaining custody of the holdings.
The U.S. Securities and Exchange Commission has historically scrutinized the operational risks of crypto products, including valuation, custody, surveillance and settlement. Filings from asset managers such as BlackRock have described the limitations and procedures associated with cash creations and redemptions, while the broader ETF industry has continued to seek a structure closer to established exchange traded products.
The question is not simply whether an in-kind mechanism is permitted. It is whether the process can operate reliably under the conditions of the digital asset market.
Why the change matters for capital flows
The immediate benefit would be lower transaction friction. An ETF that must sell Bitcoin to fund redemptions can become a source of forced supply. The sale may be economically neutral for the fund over time, but its timing can still influence prices and spreads. An in-kind redemption transfers the coins directly and reduces the number of market transactions required.
That matters most when flows are large relative to available liquidity. Institutional products can move billions of dollars through primary market activity even when secondary market trading appears orderly. If the fund must repeatedly buy or sell the underlying asset, the cost is absorbed through spreads, execution slippage and the difference between the fund's net asset value and its trading price.
Reducing those costs can improve the economics of the ETF for both large institutions and smaller investors. Lower friction gives authorized participants more room to arbitrage price differences between the ETF and Bitcoin. More effective arbitrage generally supports tighter spreads and closer tracking of net asset value.
The tax implications are also important. Securities ETFs have long used in-kind redemptions to limit the need to sell appreciated holdings inside the fund. A fund that distributes securities rather than selling them can reduce the realization of capital gains for remaining shareholders. Crypto taxation is more complex, and the treatment of particular transfers depends on the structure, jurisdiction and applicable guidance. Still, avoiding unnecessary asset sales could reduce the number of taxable dispositions generated by portfolio activity.
For institutions, operational efficiency may matter more than headline fees. A pension fund, family office or registered investment adviser assessing a Bitcoin ETF is not only comparing expense ratios. It is evaluating tracking quality, liquidity, custody arrangements, reporting and the risk that a large order will create market impact. In-kind settlement could improve several of those measures at once.
That does not guarantee new inflows. Capital allocation still depends on investor demand, regulation, macroeconomic conditions and the relative appeal of direct ownership. But if the structure becomes more efficient, fewer institutions may view ETF ownership as an expensive substitute for holding the asset through a different vehicle.
Market makers would gain a larger role
The shift would also change the responsibilities of market makers. Under a cash model, the fund and its trading counterparties are central to acquiring or selling the underlying cryptocurrency. Under an in-kind model, authorized participants need to manage the digital asset inventory required to create or redeem shares.
That could favor firms with established crypto trading operations, custody relationships and access to multiple venues. A market maker may source Bitcoin through an exchange, an over the counter desk or another institutional counterparty, then deliver it to the ETF custodian. On a redemption, the firm may receive Bitcoin and sell it where liquidity is strongest, use it to hedge derivatives or retain it as inventory.
The competitive advantage would not be limited to balance sheet size. Timing and settlement technology would become critical. Bitcoin trades continuously, while the ETF is listed on a regulated exchange with defined market hours. An authorized participant must manage price exposure between the moment an order is agreed and the moment the underlying asset is delivered.
This is familiar in other markets, but crypto adds complications. Bitcoin transfers require blockchain confirmations and may pass through custody systems that have their own approval, withdrawal and screening procedures. A firm can be economically hedged but still unable to move the exact coins needed for settlement at the required time.
The ability to transfer assets quickly could become a source of differentiation. Market makers with strong relationships across custodians and exchanges may quote more aggressively than firms that depend on a narrower network. That competition could improve ETF liquidity, but it could also concentrate primary market activity among a small number of institutions.
Concentration is a concern because authorized participants are the link between ETF shares and the underlying asset. If only a limited group can handle in-kind transactions at scale, operational problems at one firm could affect the market more broadly. Regulators and sponsors will need to assess whether there are enough participants to support orderly creations and redemptions in stressed conditions.
Custody is the central operational test
The most important question is where the cryptocurrency resides during the exchange. A traditional ETF can transfer securities through established clearing systems, with standardized records and well understood legal claims. Digital assets rely on private keys, wallet controls and blockchain settlement.
An in-kind process would require clear instructions about when ownership changes. Is the transaction complete when the authorized participant initiates a transfer? When the custodian sees the transaction on the network? When the transaction receives a specified number of confirmations? Or only after the fund's custodian determines that the asset is final and available?
Each answer creates a different risk profile. If the ETF issues shares before receiving final Bitcoin, the fund could face counterparty exposure. If it waits for extensive confirmation, the authorized participant carries price risk for longer. If a network becomes congested, the delay could widen the difference between the ETF price and the value of its holdings.
Custody controls must also address the movement of assets between wallets. Sponsors need to identify which wallets can receive or deliver Bitcoin, who can authorize transfers and how transactions are reconciled. Any error in a wallet address is difficult to reverse. A mistaken bank transfer can sometimes be recalled. A blockchain transfer generally cannot.
Security procedures are equally important. Institutional custodians may use multi party approval, segregated wallets and limits on withdrawals. Those safeguards reduce theft risk but can add time to the settlement cycle. The challenge is to maintain strong controls without making the process too slow to support active arbitrage.
BlackRock's iShares Bitcoin Trust illustrates the level of operational detail required in a large crypto ETF. Its public fund materials describe custody, valuation, creation and redemption procedures, as well as the risks associated with holding Bitcoin. An expansion toward in-kind settlement would require those arrangements to accommodate a more direct flow of assets between the fund and its authorized participants.
Settlement rules and broker dealer capital
Broker dealer regulation adds another layer. A firm handling in-kind creations or redemptions may need to carry digital assets temporarily, even if it does not intend to take a long term position. That inventory can affect capital requirements, balance sheet usage and internal risk limits.
Traditional securities regulations were not designed around assets that trade on a global network outside standard exchange hours. A broker dealer may be required to demonstrate that it can value the asset, control the wallet and meet obligations even during a weekend price gap or a sharp overnight move in related derivatives.
Capital rules could determine whether in-kind settlement becomes widely used or remains available only to a few specialized firms. If the cost of holding or transferring Bitcoin is high, authorized participants may continue to prefer cash, even when in-kind transactions are legally allowed. The structure would then exist on paper without becoming the dominant route for ETF activity.
Regulators must also consider whether the underlying transfer creates a sale, a financing transaction or another form of exposure under existing rules. The legal classification affects reporting, custody requirements and the responsibilities of the firms involved.
The SEC's role is especially significant because ETF approval does not remove the need to supervise the trading and custody ecosystem around the product. The agency has focused on market surveillance and investor protection in crypto products, while other regulators oversee broker dealers, banks, commodities markets and financial crime controls. A practical in-kind model will require these regimes to work together.
Weekend markets create a structural mismatch
Crypto's continuous trading cycle is one of the biggest differences between digital assets and traditional ETF markets. Bitcoin trades on weekends and during U.S. holidays, while the ETF may not. During those periods, the value of the underlying asset can move substantially without a corresponding change in the ETF's exchange price.
That gap affects both primary and secondary markets. An ETF may open on Monday at a premium or discount because Bitcoin moved while the fund market was closed. Authorized participants can help close the gap, but their ability to settle assets depends on custodian availability, banking access and internal operating schedules.
In-kind settlement does not eliminate this mismatch. It may make the response more efficient, but it can also increase the need for firms to hold inventory through periods when traditional market infrastructure is inactive. A market maker that receives Bitcoin late on a Friday may face several days of price exposure before it can complete related ETF activity.
The same issue applies during network disruptions. A blockchain can continue producing blocks while a custodian pauses withdrawals for security reasons or a trading venue experiences an outage. The asset is technically transferable, but the institutional settlement chain is not fully available.
These risks are manageable if they are disclosed, priced and supported by adequate liquidity. They become more dangerous when market participants assume that digital asset settlement is always immediate simply because the network operates continuously.
A structural improvement, not a guaranteed inflow engine
The push toward in-kind settlement reflects the maturation of crypto ETFs. Early products had to satisfy a cautious regulatory framework and demonstrate that cash based operations could function within existing market infrastructure. As assets grow, the focus is shifting toward efficiency, scale and the ability to handle institutional flows without unnecessary trading.
The change could strengthen the connection between ETF demand and spot market liquidity. When capital enters through creations, authorized participants would deliver Bitcoin directly to the fund. When capital leaves, the fund would deliver Bitcoin back. That creates a clearer two way channel between regulated investment products and the underlying asset.
It may also make flow data more informative. Net ETF creations and redemptions already provide a visible measure of investor demand. If in-kind settlement becomes standard, those flows could more directly reflect the transfer of Bitcoin inventory between long term holders, market makers and fund custodians. Analysts would still need to distinguish genuine new demand from arbitrage and hedging activity, but the mechanics would be easier to interpret.
The limits are just as important. In-kind settlement cannot solve weak liquidity, uncertain regulation or a lack of institutional custody capacity. It cannot prevent investors from selling during a risk off period. It does not remove the volatility of Bitcoin or guarantee that ETF shares will trade at net asset value in stressed markets.
What it can do is reduce the amount of unnecessary market activity required to move capital through the ETF structure. That is a meaningful improvement in a market where execution costs, custody delays and fragmented liquidity remain central barriers to scale.
For Wall Street, the significance lies in the details. The next stage of crypto adoption may not be defined by another product launch or a new record for assets under management. It may be defined by whether the industry can make a digital asset fund settle with the same reliability investors expect from an established commodity ETF.
If regulators, custodians and broker dealers can resolve the operational questions, in-kind settlement could move crypto funds closer to the architecture of mainstream markets. The flow of capital would become less dependent on forced buying and selling, market makers could compete more effectively, and institutional investors would gain a more efficient route to digital asset exposure. The technology would remain unconventional, but the financial plumbing would look increasingly familiar.