Another day, another application for a spot Bitcoin exchange-traded fund (ETF) rejected. Yesterday, the SEC rejected an application from Fidelity's Wise Origin Bitcoin Trust, the fifth such rejection in three months. Back in November, the SEC rejected an application from Van Eck Bitcoin Trust, and in December it rejected applications from Kryptoin Bitcoin ETF Trust and Valkyrie Bitcoin Fund.And on 20th January, it rejected First Trust Skybridge Bitcoin ETF Trust's application. Valkyrie had already had an application for a Bitcoin futures ETF approved by default. So the rejection of its spot ETF came as something of a surprise. Indeed, some analysts seem to have expected the SEC's default approval of Bitcoin futures ETFs for Valkyrie and ProShares in October to open the floodgates for
Frances Coppola considers the following as important: Bitcoin, ETF, markets, regulation, SEC
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Another day, another application for a spot Bitcoin exchange-traded fund (ETF) rejected. Yesterday, the SEC rejected an application from Fidelity's Wise Origin Bitcoin Trust, the fifth such rejection in three months. Back in November, the SEC rejected an application from Van Eck Bitcoin Trust, and in December it rejected applications from Kryptoin Bitcoin ETF Trust and Valkyrie Bitcoin Fund.And on 20th January, it rejected First Trust Skybridge Bitcoin ETF Trust's application.
Valkyrie had already had an application for a Bitcoin futures ETF approved by default. So the rejection of its spot ETF came as something of a surprise. Indeed, some analysts seem to have expected the SEC's default approval of Bitcoin futures ETFs for Valkyrie and ProShares in October to open the floodgates for approval of spot Bitcoin ETFs.
But these are not the first spot Bitcoin ETFs the SEC has disapproved. The SEC has previously rejected applications from Winklevoss Bitcoin Trust, SolidX Bitcoin Trust, ProShares Bitcoin Trust and Granite Bitcoin Trust. In fact it has rejected every single application for a spot Bitcoin ETF. The only Bitcoin ETF applications the SEC has approved have been for futures ETFs, where the underlying futures are traded on regulated exchanges such as CME.
Clearly, it's not the quality of the proposed ETFs themselves that is the problem. It's the nature of the Bitcoin spot market. The Bitcoin spot market is widely regarded as the Wild West of crypto trading. Unlike the regulated exchanges on which Bitcoin futures are traded, it is unregulated, opaque, volatile and fragmented. The bar for spot Bitcoin ETF approval is thus much higher than it is for futures ETFs. Not one of these applications has reached that bar.
In its response to Winklevoss Bitcoin Trust's application (pdf), the SEC set the conditions that a spot Bitcoin ETF would have to meet for approval to be granted. Either the applicant must prove that both the Bitcoin spot market and Bitcoin itself are "inherently and uniquely" resistent to fraud and manipulation; or the ETF's methodology must include measures capable of identifying and counteracting fraud and manipulation in the Bitcoin spot market and Bitcoin itself; or there must be a surveillance-sharing agreement with a regulated market of significant size related to Bitcoin. The SEC examined the submissions in all of the recent applications for compliance with these conditions, and found them wanting.
Firstly, the Bitcoin spot market. In its submission for Van Eck Bitcoin Trust, BZX Exchange argued that the Bitcoin spot market is extremely difficult to manipulate and that any fraudulent actors would be visible and hence easily avoided. It said that arbitrage would quickly eliminate any price disparities between trading platforms, and that the high cost of market manipulation would make it unsustainable. But it didn't provide any evidence in support of its argument.
The SEC was distinctly unimpressed. It said that efficient arbitrage was insufficient to prove that a market was "inherently and uniquely" resistant to manipulation, and pointed out that other markets with efficient arbitrage, such as equity options on exchange-traded securities, still had to have surveillance-sharing agreements. Furthermore, in the absence of evidence there was no reason to believe that fraudulent or manipulated trading would not affect prices, nor that market manipulation would be too costly for participants with deep pockets.
The SEC concluded that BZX had failed to prove that the Bitcoin spot market was "inherently and uniquely resistant to manipulation". And it then went on to point out that there is significant evidence that the Bitcoin spot market is riddled with market abuse, security breaches and outright fraud. It listed seven significant risks in the spot Bitcoin market that it said it had identified previously but BZX's proposal had failed to address:
- wash trading
- persons with a dominant position in bitcoin manipulating bitcoin pricing
- hacking of the bitcoin network and trading platforms
- malicious control of the bitcoin network (51% attack)
- trading based on material, non-public information, including dissemination of false and misleading information
- manipulative activity involving the purported "stablecoin" Tether (USDT)
- fraud and manipulation at bitcoin trading platforms.
if these spot markets “do not operate smoothly or face technical, security or regulatory issues, that could impact the ability of Authorized Participants to make markets in the Shares” which could lead to “trading in the Shares [to] occur at a material premium or discount against the NAV”
The SEC sardonically pointed out that this hardly supported BZX's argument that the SEC should treat the Bitcoin spot market more favourably than regulated markets.
...the Exchange’s assertions that the Benchmark’s methodology helps make the Benchmark resistant to manipulation are contradicted by the Amended Registration Statement’s own statements. In the Amended Registration Statement, the Sponsor states that the Benchmark is “based on various inputs which may include price data from various third-party exchanges and markets” and that these inputs may be subject to “technological error, manipulative activity, or fraudulent reporting from their initial source.
However, the level of regulation on the Benchmark’s constituent platforms is not equivalent to the obligations, authority, and oversight of national securities exchanges or futures exchanges and therefore is not an appropriate substitute....
The paper finds that the CME bitcoin futures market dominates the spot markets in terms of Granger causality, but that the causal relationship is bi-directional, and a Granger causality episode from March 2019 to June/July 2019 runs from bitcoin spot prices to CME bitcoin futures prices. The paper concludes: “[T]he Granger causality episodes are not constant throughout the whole sample period. Via our causality detection methods, market participants can identify when markets are being led by futures prices and when they might not be.”
At present, the available evidence supports the SEC's position. The seven risks in the Bitcoin spot market that the SEC identifies are well documented and create a serious hazard for investors and the general public. And the cavalier attitude to risk and disdain for regulation displayed by all the applicants does not inspire confidence in their products. Nor, frankly, does the carelessness so evident in the preparation of their submissions to the SEC. They will have to do a lot better if they are ever to reach the high bar that the SEC has set for approval of a spot Bitcoin ETF.
But I am not convinced they will reach it anyway without root and branch reform of the Bitcoin spot market. While market abuse and fraud remains rampant, the SEC is not going to approve any spot Bitcoin ETF, however responsible the applicant. The way forward for wannabe exchange-traded Bitcoin funds is not repeated applications to the SEC that they know will fail, it is campaigning for much better regulation and oversight of Bitcoin trading platforms and exchanges.