During this past week the Securities & Exchange Commission (SEC) of the United States rejected nine separate Bitcoin ETF submissions from three applicants. GraniteShares, Direxion, and ProShares’ hopes for a Bitcoin ETF this year are down but not out, as the SEC followed their denial of said ETFs with a statement that they will review the rejections. The primary reason for rejection was that these ETFs did not comply with the Exchange Act Section 6(b)(5), which concerns the prevention of fraudulent activities. Let’s examine the major reason why these ETFs did not pass the test from the SEC.
LACK OF FRAUD PREVENTION
Section 6(b)(5) of the Exchange Act is important because it helps to protect consumers and investors from fraudulent trades such as insider trading and excessive price manipulation. The ETF inquiries by all three applicants did not meet the standards of fraud protection as exemplified by the SEC in this excerpt: “Among other things, the Exchange has offered no record evidence to demonstrate that Bitcoin futures markets are ‘markets of significant size.’ That failure is critical because the Exchange has failed to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, and therefore surveillance-sharing with a regulated market of significant size related to Bitcoin is necessary.”
In a market where volatility and extreme price fluctuations are commonplace, adding an ETF without proper surveillance could end up hurting the cryptocurrency market. Price manipulation of said ETFs could cause a ripple effect on the entire cryptocurrency market – without any actually owned bitcoin being traded.
DERIVATIVE BACKED ASSETS IN CRYPTOCURRENCY
As alluded to in the last section, these ETFs are derivative-backed securities. For those unfamiliar with such terminology, the ETF assets would be trading based on real-time prices derived from the price of Bitcoin. The nature of these derivative-based ETFs could create an environment unfavourable to those actually trading Bitcoin (and other cryptocurrencies) due to price manipulation on a separate exchange.
Contrary to the major support from institutions in the cryptocurrency industry, many investors and leaders are opposed to the ETF proposals because they seem to undermine the actual development of Bitcoin as a payment method and store of value. The same parties share concerns that the Bitcoin ETFs could create a similar situation to that when the CBOE futures went live. The ability to short Bitcoin, as well as short at leveraged rates, created downward pressure on the price of Bitcoin.
The SEC does not have a horse in the race when it comes to the price of Bitcoin and assessing the ETF proposals. The SEC made it clear in the following statement: “[The agency] emphasizes that its disapproval does not rest on an evaluation of whether Bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment.”
While the rejection of the Bitcoin ETF may sound like bad news for the market, many experts believe it to be the opposite. One reason for this is that the SEC did not undermine cryptocurrency as an asset class; instead the United States-based commission treated it fairly and congruently with all other securities. Chairman of the Board of the SEC, Jay Clayton, has been a proponent of this since he made statements in early June supporting the traditional definition of a security.
Secondly, the SEC highlighted one positive point to the Exchange Traded Funds when it conceded the fact that these securities and investment mediums would create an additional layer of protection to consumers: “The Commission acknowledges that, compared to trading in unregulated Bitcoin spot markets, trading a Bitcoin-based ETP [exchange traded product] on a national securities exchange may provide some additional protection to investors…”
Most experts feel comfortable with the stance taken by the SEC in both of these matters. When the proper infrastructure as well as price controls are developed to support the necessary management and surveillance of the ETFs, we believe the SEC will grant approval.
BLESSING IN DISGUISE
With Bitcoin prices and the overall cryptocurrency market cap near 12-month lows, the SEC’s recent decision may be one that prevents the market from greater erosion. The proposed ETFs would certainly have created more access to trading Bitcoin, but at the same time created more ways to short the price of Bitcoin. This double-edged sword is one that perhaps cryptocurrency investors are not ready to wield. Regardless of price action, proper infrastructure and security are critical when introducing a powerful financial product such as an ETF. The SEC got this one right and provided us all with a blessing in disguise.