Bitcoin Exchange-traded fund (ETF) l
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The US Securities and Exchange Commission (SEC) has repeatedly rejected every application for a spot BitcoinBTC Exchange Traded Fund (ETF) with direct exposure to Bitcoin as the underlying asset. The SEC has consistently cited the safeguarding of investors against potential crypto market manipulations and concerns about Bitcoin market liquidity as the primary reasons for rejections. According to previous denial rulings on spot ETF applications by the SEC, a Bitcoin trust sponsor must form a “surveillance-sharing agreement” with a sizable and regulated market of considerable scale. This SEC position relegates the ETF applicant to either execute such an agreement with a spot Bitcoin exchange or provide in-depth details about the surveillance arrangement.
The SEC, on the other hand, has continued to approve both long and short exposure Bitcoin futures ETFs. These products are tied to the price of the Chicago Mercantile Exchange (CME) Bitcoin futures product and its associated index. All commodity futures contracts, including Bitcoin futures contracts, fall under the regulatory purview of the Commodity Futures Trading Commission (CFTC) and must trade on CFTC-regulated exchanges. The Bitcoin futures ETFs rely on the market surveillance arrangement with the CME, the primary platform for Bitcoin futures trading. CME is a CFTC-registered and regulated Designated Contract Market (DCM) with robust regulatory oversight to prevent market manipulation.
Approval is Likely Coming, But may not be a game-changer for Crypto: Earlier in 2023, prominent asset managers, such as BlackRockBLK, Fidelity Investments, Ark Investment Management, InvescoIVZ, WisdomTree, Franklin Templeton, Bitwise Asset Management, and Valkyrie Invesco Digital Assets, submitted spot Bitcoin ETF applications, taking into account concerns of the SEC. In August 2023, Nasdaq and CBOE Global Markets refiled applications with the SEC to list spot Bitcoin ETFs on behalf of asset managers, detailing Coinbase Global, Inc. (CoinbaseCOIN) as the market surveillance partner. With the traditional finance heavyweight houses stepping in, pressure is mounting on the SEC. Expectations are running high for the approval of the latest spot Bitcoin ETFs.
The CFTC oversight of CME, a regulated Bitcoin futures exchange, facilitated the approval of Bitcoin futures ETFs by the SEC. However, the lack of regulatory oversight for US spot Crypto exchanges such as Coinbase might continue to impede US spot Bitcoin ETF approvals. The SEC contends that Coinbase lacks the regulatory framework of exchanges and can’t be trusted to self-police against fraud and manipulation. The SEC has recently sued Coinbase, charging it with operating its crypto asset trading platform as an unregistered national securities exchange, broker, and clearing agency, bypassing the safety and investor protection guidelines of the SEC.
Recently, Coinbase secured a futures commission merchant (FCM) registration with CFTC, akin to an SEC-registered broker-dealer. Onnig H. Dombalagian, Professor at Tulane University School of Law and author of Chasing the Tape: Information Law and Policy in Capital Market, states, “However, FCM registration doesn’t equate to being a regulated trading market. While FCMs have the authorization to hold customer assets and serve as brokers in futures markets, they do not serve as trading markets in the conventional sense; they do not match buying and selling orders or quote and publish prices.” Nevertheless, Coinbase is the first crypto-native company to secure FCM registration, pioneering a path for US regulatory oversight. As a publicly traded company on Nasdaq, Coinbase offers financial transparency, quarterly financial report releases, and annual third-party audits as mandated by law. Furthermore, Coinbase internally maintains robust security and compliance measures.
The recent developments point to a marked investor appetite for risk exposure to crypto assets. Traditional entities like pension funds, hedge funds, and banks are progressively adopting crypto and blockchain technologies, suggesting that cryptocurrency as an alternative asset class is here to stay. In light of the market demand and the imperative for investor protection, reaching an agreement between crypto exchanges and the SEC has become a pivotal step for the introduction of spot Bitcoin ETF products. While many predict that a spot Bitcoin ETF could be a game-changer, its actual effects may be subdued. The current resolve of the Federal Reserve to hold higher interest rates for longer could continue to dampen risk appetite, thereby curbing speculative zeal in the Crypto markets. Rather than sparking a speculative surge in crypto assets, the approval and introduction of spot Bitcoin ETFs can solidify crypto as a unique asset class with numerous exciting use cases and innovations for the mainstream economy.
Bitcoin Futures ETF vs. spot Bitcoin ETF: Bitcoin futures ETFs do not possess actual Bitcoins; instead, they hold futures contracts. As these contracts approach maturity, they must be settled or rolled over into new ones, introducing rollover risk. Near-expiry futures often trade 0.5-1% lower than the next one, leading the Bitcoin futures ETF to trail spot Bitcoin. This is called “contango bleed” from monthly contract rollovers, which can be exacerbated by Bitcoin price volatility. Furthermore, futures prices can deviate from the underlying asset price. Positively, since the futures ETF doesn’t store the physical commodity, it avoids storage costs and generally offers higher liquidity than spot-based alternatives.
Spot Bitcoin ETFs will directly hold Bitcoins and, as long-term investments, are projected to outperform their futures-based equivalents. The spot Bitcoin ETFs are expected to more efficiently reflect the real-time supply-demand and price discovery mechanisms of the market. Their approval in the US would increase liquidity and strengthen price transparency in spot Bitcoin markets. Investors can hold their positions indefinitely, thereby eliminating rollover costs and mitigating the rollover risks. However, owning the actual Bitcoins incurs storage costs, ongoing maintenance, and the usual management fees.
Professor Onnig H. Dombalagian further states, “A key distinction among the ETFs lies in the pricing mechanism for the underlying asset. The SEC relies on the CFTC’s oversight of the CME marketplace and its self-regulatory market mechanisms (e.g., circuit breakers) to ensure the integrity of intraday and end-of-day settlement prices for Bitcoin futures. As a matter of regulatory comity, the SEC should, of course, recognize a CFTC-designated contract market as a ‘regulated market of sufficient size’ to deter fraud or manipulation, but the SEC cannot currently extend such recognition to decentralized or centralized exchanges that operate unregulated markets.”
Why is a spot Bitcoin ETF a big deal? A tradable spot Bitcoin ETF would be notably significant for both the Crypto and investment markets. Currently, acquiring cryptocurrency is a complex process: navigating crypto exchanges, account verification, funding, order placements, and secure custody and storage – steps outside the usual TradFi platforms, potentially deterring investors. In contrast, ETFs provide a more familiar and frictionless investment vehicle accessible to anyone. A spot Bitcoin ETF would enable investors to trade through a traditional brokerage account, making these transactions as straightforward as trading stocks on a familiar platform. Traditional financial institutions such as Blackrock, Fidelity, Invesco, Franklin Templeton, etc., with trillions under management, could use spot Bitcoin ETFs to offer crypto exposure through their existing investment platforms.
Alexander Arapoglou, Professor at UNC Kenan-Flagler Business School, states,” Investing in cryptocurrencies requires a degree of know-how; however, anyone can buy and participate in ETFs, thereby elevating risk factors in the less liquid Bitcoin market.”
Notably consequences are catching up with Crypto Industry “villains.” Prominent figures, including Sam Bankman-Fried, are in custody and in criminal trial, the former Celsius CEO, Alex Machinsky, has been arrested, and individuals with ties to Arrows Capital are currently facing legal actions and lawsuits. It’s now evident that Bitcoin and cryptocurrencies have endured rigorous scrutiny, and despite government efforts to enhance regulatory oversight, the underlying revolutionary essence of this technology remains resilient. Furthermore, BlackRock’s unexpected venture into crypto ETFs and PayPal’s stablecoin launch are paving the way for a strong foundation in the crypto’s future expansion into fresh applications and markets.
A Bitcoin spot ETF holding Bitcoins would serve as a much desired crypto investment vehicle, allowing investors to engage with crypto within the familiar TradeFi spheres. In contrast, the somewhat unfriendly structure of approved futures-based products discourages investor engagement. Major players in asset management are eagerly awaiting SEC approval for Bitcoin ETFs. However, instead of igniting a speculative frenzy in crypto assets trading, the launch of these products for trading on US-regulated exchanges are expected to establish crypto as a distinct asset class, replete with numerous promising applications and innovations for the wider economy.
