By David LaValle, Grayscale’s global head of ETFs
We recently celebrated the 30th anniversary of the birth of the ETF in the US market. These days, the idea of buying one security to get market cap-weighted exposure to the S&P 500 is considered simple when it comes to investing, but back in 1993, this type of exposure was quite sophisticated and not something that retail investors could access with ease, efficiency, or cost effectiveness. The market couldn’t see it at the time, but ETFs were one of the greatest financial innovations of the 20th century.
Black Monday and the crash of 1987 provided the impetus for the ETF’s creation. As the dust settled, the SEC looked at the effect of index trading on market volatility during the crash and recommended “creating an opportunity to trade portfolios on the New York Stock Exchange.” That sparked nearly six years of work, innovation, and collaboration across the investment management industry to create a financial instrument that could track the performance of the broader markets, and thus provide the opportunity to mitigate a similar market dislocation.
Index mutual funds had been around since the 70’s, but they only had to contend with valuation and allowing shares to be purchased and/or sold once per day. In comparison, tracking a weighted basket of S&P 500 names was far more complex. Remember, the internet was barely off the ground, and there were no automated data feeds or trading systems. There were no free trades for retail investors, either! It was still common for traders on the stock exchange floors to use hand signals to communicate (I still remember them!). Stocks were traded in 1/8ths – and it wasn’t until 1997 that tick sizes were reduced to 1/16ths, and until after 2000 when stocks began trading in pennies! Much like crypto, ETFs were a financial innovation built on top of technological innovation.
Even if the tech was ready, there were meaningful legal and regulatory hurdles to overcome. A forerunner of ETFs called the Index Participation Shares (IPS), launched in 1989, but lawsuits from the CME and CFTC it to liquidate soon after. Canadian regulators were more welcoming, and the first ETF on the Toronto Stock Exchange in 1991. (Isn’t it funny how history repeats itself?)
It took a joint effort between Standard & Poors as the indexer, State Street as the trustee, thoughtful securities attorneys including the late, great Kathleen Moriarty, product developers and trading firms at the American Stock Exchange (AMEX), and regulators at the SEC to create an acceptable and practical product for all. The result was revolutionary: Standard & Poor’s Depositary Receipts, today known as the SPDR S&P 500 ETF Trust (SPY).
SPY made its debut on January 29, 1993. Despite being built as a product for institutions to utilize as a broad market exposure tool and hedge, the product received fast adoption by investors of all shapes and sizes.
While the creators were initially surprised by its success, they figured out that this was a format that could be extended to other types of investments. A process soon developed: a new asset or exposure would be identified, the new ETF would be designed, and regulators would examine the vehicle and its underlying asset before approving it to be listed and traded on an exchange. The first ETFs in the US were all listed on the AMEX, making it an early innovation hub for the industry. In this way, they covered a variety of direct exposures like sectors and market cap slices. By the end of 2001 90 ETFs were trading in the U.S. As of March 12, 2023, that number ballooned to 3,123.
At Grayscale, we’re hard at work writing what we expect to be the next chapter of this story. In doing so, we’re working through the same time-tested process of collaborating with securities counsel, index partners, administrators, custodians, and regulators. The debate about Bitcoin ETFs has been ongoing since 2014, when the first Bitcoin ETF filing hit the Federal Register, but the facts and process remain eerily similar to the conversations had in the late 80s/early 90s when SPY was conceived.
That is, with one stark difference!
In 1993, the ETF wrapper was unknown, untested, and uncertain. But over the last 30 years, the ETF structure has been debated, refined, battle-tested, and importantly, widely adopted. Through market disruptions as serious as the dot com bubble, 9/11, the 2008 financial crisis, and the recent COVID-19 pandemic, ETFs have continued to perform as designed, delivering the promise they were built on – allowing investors of all shapes and sizes, from the smallest self-directed retail investor, to the largest institutions in the world – to access the financial markets with confidence. New products were developed, new exposures were introduced, assets ballooned, and market share grew. The ETF is now a staple of the global economy.
I can’t think of a better example of the trust placed in ETFs than the Federal Reserve at the beginning of the COVID-19 pandemic. For the first time in history, their approach to stabilizing uncertain markets during a crisis involved buying bond ETFs individual bonds. In 1993, the participation of Standard & Poors lent credibility to the first ETF. Now the ETF wrapper itself is a significant point of credibility. So, while we currently debate the characteristics of Bitcoin – as a market and as an exposure – we are no longer debating the merits of the ETF wrapper, and that’s meaningful progress. After a 20+ year career working across nearly every vertical of the ETF industry, I came to Grayscale because I want to marry the next technology innovation, digital assets, with the most recent financial innovation, ETFs, and fuel the next 30 years of innovation!
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