Wall Street is desperate to get in on the Bitcoin game, but the Securities and Exchange Commission remains wary, and industry insiders don’t expect that to change anytime soon.
As much as Bitcoin trading has matured over the past year—price spreads between different exchanges are tighter, for instance—there’s still too much evidence that digital currencies can be manipulated, and the exchanges where most trading occurs are vulnerable to hacking and shady operators. Regulators don’t yet have the legal authority to conduct steady surveillance of those markets.
This week the SEC rejected proposals from three companies—ProShares, Direxion and GraniteShares—that had collectively proposed a total of nine Bitcoin ETFs. The products would all be backed by Bitcoin futures, not Bitcoin itself, which the providers thought would make them more likely to win approval.
But the SEC said that the underlying Bitcoin market remains too opaque, endangering investors whose investments could be manipulated by the unregulated trading on spot Bitcoin exchanges. And the futures market isn’t big enough yet to ensure that it is resistant to manipulation, the agency said. The SEC’s commissioners are reviewing the decision, which was made by agency staff.
There’s now one remaining ETF proposal still being considered by the SEC. VanEck Associates and SolidX Partners have proposed a Bitcoin ETF that would be backed by Bitcoin itself and cost $200,000 per share, meaning it would be targeted to institutional buyers and not retail investors. VanEck thinks its proposed product meets the SEC’s tests, said Gabor Gurbacs, the director of digital strategy at VanEck and MVIS, a company that develops benchmarks for digital assets, in a statement sent to Barron’s.
VanEck said it’s “cautiously realistic about the approval timeline,” but that its efforts to ensure liquidity and appropriate valuation, together with the focus on institutional investors, have yielded a product regulators could use to bring Bitcoin under government oversight. “The proposed product may be better suited to protect investors than the current alternatives, which is something regulators are actively seeking,” it said.
But others are skeptical that the product will win approval.
The VanEck product “seems to have the most life left” of the proposed ETFs, but still has only a slim chance of success, wrote Eric Ervin, the chief executive of Reality Shares, in an email to Barron’s. Reality Shares has launched two ETFs tracking blockchain technology. “The SolidX VanEck proposal incorporates two key benefits that other proposals did not, insurance, and a $200,000 share price. Even with that, however, this seems like a difficult obstacle to overcome.”
Ervin thinks that regulators are sending a mixed message. The Commodity Futures Trading Commission has allowed Bitcoin futures to start trading, and yet the SEC says that the market is vulnerable to manipulation. That “implies that the CFTC is mistaken by believing that the futures contracts are based on a fair and orderly market instrument,” Ervin argues. The SEC declined to comment on the criticism, and the CFTC did not respond to a request for comment.
The SEC has addressed this seeming contradiction, in its prior rejection of an ETF proposed by the Winklevoss twins. The agency said that the CFTC’s decision to allow Bitcoin futures trading did not imply that the underlying markets are manipulation-resistant, and the CFTC in general has a narrower mandate when it comes to allowing futures products to start trading.
In its most recent rejections, the SEC the agency said that a Bitcoin ETF would need to have a surveillance-sharing agreement with a market of “significant size,” a hurdle that the latest proposals could not clear.
Benjamin Kauter, a lawyer at Kobre & Kim who advises clients on digital currency disputes, says he thinks that the SEC and CFTC are trying to indirectly get leverage over Bitcoin trading that they haven’t been able to obtain by other means. Bitcoin exchanges, which allow people to turn dollars or other currencies into cryptocurrencies, are largely unregulated. “Both agencies are using their powers of approval over financial products to essentially coerce financial innovators into surveilling the markets for them,” he wrote in an email to Barron’s.
“Earlier this year, in response to futures contracts self-certified by CBOE and CME, the CFTC issued guidance directing futures exchanges to collect and share trading information and trading data with the government.
The SEC is now using the ETF approval process to achieve the same purpose by refusing to approve an ETF unless the sponsor establishes broad surveillance-sharing agreements with underlying digital currency exchanges.
Until Congress provides these agencies with regulatory authority over the underlying exchanges, the SEC and the CFTC will likely continue putting the squeeze on financial innovators as a means to obtain Bitcoin trading…