“The Commission has no basis for the position that investing in the derivatives market for an asset is acceptable for investors while investing in the asset itself is not.” This statement to the Securities and Exchange Commission (SEC) by lawyers representing Grayscale Investments should be obvious.
Grayscale seeks approval for a Bitcoin exchange-traded fund (ETF) that reconciles to Bitcoin’s global price. Thus far, the Commission has only approved a few ETFs for Bitcoin futures, but not those tied to the “spot” market that carry the actual Bitcoin asset. The Commission argues futures are subject to additional investor protections through the Investment Company Act of 1940 and the Commodity Futures Trading Commission.
The SEC distinguishes Bitcoin from other assets because it is globally traded and outside of a federal regulatory framework. Its irrational fear of the global Bitcoin marketplace puts applicants in an impossible position where denial of most Bitcoin ETFs is preordained. Thus, it makes accessing Bitcoin more difficult and riskier for the average investor.
The Commission claims spot ETF applicants have failed the anti-fraud and market manipulation provisions of Section 6(b)(5) of the Exchange Act. It sets out two ways they could theoretically meet this burden: (1) entering into “a comprehensive surveillance-sharing agreement with a regulated market of significant size related to the underlying or reference bitcoin assets” or (2) “establish[ing] that the underlying market inherently possesses a unique resistance to manipulation beyond the protections that are utilized by traditional commodity or securities markets,” although “Such resistance . . . must be novel and beyond those protections that exist in traditional commodity markets or equity markets[.]”
As Grayscale argues, after four years and multiple denials, the SEC still has not established metrics for markets of “significant size” or what “novel” investors protections would pass muster.
Applicants have tried various approaches. For market size, they have suggested tying prices to the Chicago Mercantile Exchange (CME) market, where futures trade, to no avail.
For the “novel” and “beyond traditional markets” standard, Grayscale states applicants have proposed various solutions, all lacking sufficient “novelty”:
[Exchanges have argued] among other things that index pricing would be based on the CME’s manipulation-resistant CF Bitcoin Reference Rate, that “the geographically diverse and continuous nature of bitcoin trading render it difficult and prohibitively costly to manipulate the price of bitcoin,” and that “[f]ragmentation across bitcoin platforms, the relatively slow speed of transactions, and the capital necessary to maintain a significant presence on each trading platform” make it especially resistant to manipulation. But the Commission has found in every instance that the justifications are insufficient to satisfy Section (6)(b)(5): the Commission’s “unique,” “inherent” and “novel” protections standard evidently cannot be satisfied.
SEC Commissioner Hester Pierce in a now-famous dissent from the 2018 Winklevoss Bitcoin Trust on Bats BZX Exchange, Inc. (BZX) spot ETF denial argued the Commission’s focus on the global Bitcoin market misread its mandate.
The Commission erroneously reads the requirements of Section 6(b)(5). The disapproval order focuses on the characteristics of the spot market for bitcoin, rather than on the ability of BZX—pursuant to its own rules—to surveil trading of and to deter manipulation in the [ETF] shares listed and traded on BZX. … Section 6(b)(5), however, instructs the Commission to determine whether “[t]he rules of the exchange” are, among other things, “designed to prevent fraudulent and manipulative acts and practices [and] to promote just and equitable principles of trade,” and “are not designed to permit unfair discrimination between customers, issuers, brokers, or dealers.” It says nothing about looking at underlying markets, as the Commission often has done in its orders.
The SEC showed its cards in that denial by complaining that “a substantial majority of Bitcoin trading occurs outside the United States, and even within the United States, there is no comprehensive federal oversight of Bitcoin spot markets.”
Bitcoin’s global reach and non-security status prevents the kind of draconian federal oversight the Commission insists on as a matter of course. Game over.
The SEC’s de facto position has several negative effects for investors and the agency itself.
- It is discriminatory. Grayscale claims blanket denials of spot ETFs, combined with acceptance of futures ETFs, lack legal basis and expose the Commission to challenges under the Administrative Procedures Act.
- It embroils the Commission in merit review. As Grayscale asserts: “The Exchange Act does not authorize the Commission to regulate the suitability of an asset class, such as Bitcoin, or particular securities, such as BTC shares, relative to competing assets and securities.” The Commission’s role, as provided in the Exchange Act, is to provide disclosure of information for investors, not to ban investments from the market due to a perceived lack of quality.
- It suppresses institutional participation. As Commissioner Peirce notes, spot ETF denials “discourage new institutional participants from entering this market” and delays market maturation because “potential institutional investors may reasonably conclude that the Commission will continue to repress market forces for the foreseeable future.”
- It denies Bitcoin exposure less tech savvy investors. Some people do not have the time, desire, wherewithal, or risk tolerance to purchase Bitcoin from an online exchange.
- It denies investor choice. As Peirce put it, Commission denials “preclude investors from accessing Bitcoin through an exchange-listed avenue that offers predictability, transparency, and ease of entry and exit.” The futures market provides a less attractive product as CoinDesk’s Michal Casey explains: “On an annualized basis, if investors held shares in a Bitcoin futures fund that had rolled over every month for the past year, they’d have ended up with a cumulative cost of 28% relative to the spot market.”
As long as the SEC continues to view the nearly 13-year-old Bitcoin with undue suspicion, it will likely keep denying many Bitcoin ETF applications. Despite contrary declarations, these denials only serve Commission interests by providing cover for unforeseen and unpredictable market events. They do not serve the interest of investors.