Are there takeaways from the SEC’s rejection of yet one more BTC ETF?

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Updated: 21 October 2019

The dust has finally settled on the SEC’s rejection of yet one more attempt to bring the benefits of a retail Bitcoin Exchange-Traded Fund (ETF) to the masses at large. To its credit, the regulator issued a 112-page stipulation order with no less than 500 footnotes. Bitwise management looked favorably on such a massive response, but others in the industry are not sure how to take the latest news. Will we ever see a retail BTC ETF in our lifetimes, or must only “accredited investors” be allowed to partake in the fun?

One of the linchpins that supports the theory that Bitcoin values could shoot the moon is that public awareness at some point will accelerate across the globe and, with it, easy access to publicly traded ETFs, where retail customers will be able to securely buy shares in a commingled fund without the daunting issues of custody, private keys, fraud, and price manipulation. From the SEC’s response, it seems that the latter issue will be the hurdle that no one can jump over for some time to come.

The reporters at Coindesk noted: “The decision clarified the SEC’s concerns, which mainly revolve around market manipulation. Legal experts say a bitcoin ETF could be years away – because, in the eyes of regulators, the bitcoin market is too small and immature to support a fund right now. The SEC suggested that a surveillance-sharing agreement between a regulated exchange and a bitcoin market of “significant” size might help allay its unease.”

Other prior issues regarding secure custody and fraud seem to have faded away. Philip Liu, chief legal officer and co-founder of investment firm Arca, one of the partners in the Bitwise proposal, stated that the SEC did not mention any concerns at this stage related to custody arrangements: “I assume that the custody issues are pretty much moot at this point.” He also felt that the SEC, in its latest rendering, “pretty much put the kibosh” on any ETF applications for the near-term future.

There also was an absence about the previous lack of monitoring software, which the Nasdaq has been so willingly sharing with crypto exchanges in the United States. There have also been many reports of how Bitwise had presented reports to the SEC, which demonstrated that 95% of Bitcoin volume was fake. It was the firm’s objective to inform the SEC that it was quite knowledgeable as to the nuances of volume demographics that exist in the BTC exchange network, but as outsiders and as the SEC observed, Bitwise could not dispute that the 95% of fake volume did not somehow impact price quotes.

Lindsay Danas-Cohen, general counsel and chief operating officer at crypto exchange and brokerage Velocity Markets, told Coindesk that Bitwise tried to persuade the SEC with its market knowledge: “Bitwise tried to get out in front of these arguments by asserting they’re very aware that only 5 percent of the bitcoin spot markets are ‘real’ and I commend that effort.”

The issue, however, was not the 5%. The 95% figure was where the concerns lay. Zachary Fallon, a principal at Blakemore Fallon and former SEC senior counsel, pinpointed the real issue: “Bitwise did not address the concern that the price quoted on legitimate digital asset trading platforms is itself influenced by the weight of the other 95 percent and the prices quoted there. So it’s like the tail wagging the dog, or the dog wagging the tail, and the SEC said, ‘You need to address that risk.’”

The SEC would like to see surveillance-sharing arrangements between exchanges, as a stopgap measure. Jake Chervinsky, general counsel at Compound Finance and who has often opined on technical and legal aspects of cryptos, is not optimistic for the time being: “Until an ETF sponsor can satisfy the SEC’s demand for surveillance-sharing agreements – or until the SEC changes its view on the Exchange Act (which almost certainly means waiting for a new Chairman) – there will be no bitcoin ETF.”

Will we see a BTC ETF anytime soon? Matt Hougan, Bitwise’s global head of research, remains positive, due to the length of the SEC response: “A bad outcome would have been a cursory [filing]. After digesting it a little bit, we’re pleased with the detail the staff provided and the clarity of what we have to do.”

Three of the experts quoted above are not so sure. Per Coindesk’s reporting:

  • Jake Chervinsky: “It’s reasonable to assume that Jay Clayton’s SEC will never approve a bitcoin ETF.”
  • Lindsay Danas-Cohen: “Under the current regime, I think it’s going to be difficult for an applicant to get all its ducks in a row in a manner that would give the SEC comfort. I think it would take a bit longer for the SEC to wrap their arms around the space.”
  • Philip Liu: “The takeaway is, I just don’t see how it can be approved at this stage – for anybody that comes in.”

Wilshire Phoenix still has a BTC ETF application in the SEC’s pipeline, with Arca as a partner, who happens to be Mr. Liu’s employer. The odds do not look promising for now.