On August 26, 2018, the SEC announced that it was delaying its decision on a new Bitcoin exchange-traded fund (ETF) proposal from VanEck and SolidX. The price of Bitcoin fell from $7,022 USD to $6,366 USD 10 days later.
ETFs allow investors to gain exposure to assets without the inconvenience of actually owning those assets. In this context, a Bitcoin ETF may seem counterintuitive. BTC is a digital currency maintained by a decentralized network of nodes. The whole point of Bitcoin is to allow people to serve as their own banks, without the intervention of centralized parties like banks or governments — which prompts this question: Why would investors want to own a Bitcoin ETF in the first place?
There’s been a lot of noise in the cryptocurrency community around Bitcoin ETFs. Announcements of new ETF proposals and SEC decisions on specific ETFs have even moved the price of BTC. Proponents of Bitcoin ETFs believe that they will open the floodgates and give institutional investors greater access to Bitcoin. Critics argue that Bitcoin ETFs can’t protect retail investors against potential manipulation or fraud in the market.
In this article, we’ll explain how ETFs work, why a Bitcoin ETF matters, and what the current proposals for Bitcoin ETFs are.
What’s a Bitcoin ETF?
Before we dive into Bitcoin ETFs, let’s take a step back and explain what an ETF actually is.
An ETF is a marketable security that tracks either a basket of securities and assets or commodities, bonds, or foreign currency. An ETF divides ownership of its assets into shares, which investors can purchase on the stock market.
If one were an investor who wanted to gain exposure to the S&P 500 — not individual stocks in the index, but rather the index as a whole — it could actually be quite expensive and impractical to do so on one’s own. One would have to buy shares of each of the 500 companies in the index in proportion to their market capitalizations and then adjust one’s holdings as the value of those shares fluctuated over time. An ETF like the SPDR S&P 500 manages that complexity for investors by directly owning shares in each company in the index and adjusting those holdings over time.
ETFs can also be used to track the value of commodities like gold or oil. If an investor wanted to invest in gold but didn’t want to go through the trouble of buying that gold, transporting it, and securing it, she could purchase shares in a gold ETF that tracks the value of gold by buying and selling it according to the market price. The same goes for oil. If an investor wants to invest in oil but doesn’t want to keep barrels of it her your backyard, purchasing shares of an oil ETF is a much more convenient option.
At first glance, a Bitcoin ETF seems different from both index-based and commodity ETFs. Bitcoin ETFs propose to track the value of BTC, rather than a basket of other assets.
Bitcoin ETF proponents make the case that for retail or institutional investors unfamiliar with crypto, managing and storing one’s own BTC with a private key can be confusing and prone to security risks. They argue that a Bitcoin ETF would give these investors exposure to BTC in an easy and convenient way.
Unlike gold or oil, BTC is a digital asset that can be purchased easily on a number of exchanges and transferred to a digital wallet. While a Bitcoin ETF might usher in wider investment from institutional investors, it’s unlikely that a Bitcoin ETF will intrinsically have a large impact on the market.
Beyond the utility of an ETF itself, however, there is one important reason to look forward to the approval of a Bitcoin ETF. A Bitcoin ETF that meets with the approval of a regulatory body like the SEC conveys a broader legitimacy for Bitcoin within the market.
The status of Bitcoin ETFs
So far, it’s been an uphill battle to get any type of Bitcoin ETF approved. Last year, the SEC rejected nine different proposals for ETFs from ProShares, Direxion, and GraniteShares.
Bitcoin ETF proposals thus far have relied on one of two strategies to track the price of BTC:
- Physically backed Bitcoin ETFs that purchase and sell bitcoins and take care of storing them securely.
- Futures-backed Bitcoin ETFs that track the price of BTC by buying and selling bitcoin futures contracts. Futures-backed Bitcoin ETFs wouldn’t have to manage storing the digital asset, but they would have a higher trading cost.
Neither physically-backed nor futures-backed proposals for a Bitcoin ETF have passed muster with the SEC so far.
The main reason cited by the SEC was that the Commission didn’t believe these proposals did enough to mitigate the risk of fraud and manipulation for the underlying asset:
The Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular, the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices. [Emphasis added.]
This concern has been repeated by the SEC’s decisions on Bitcoin ETF proposals over the years. The statement on “fraud and manipulation” from the SEC touches on a number of broader issues around the size of the market and accurately pricing assets.
For physically-backed ETFs that source pricing data from an exchange — like the first Winklevoss proposal — the SEC’s argument is that the exchange’s market is too small to accurately represent global trading of BTC. According to the SEC, relying on a single exchange to determine Bitcoin’s price incurs a significant risk of market manipulation.
The SEC’s position is similar for futures-backed ETFs. While the Chicago Mercantile Exchange (CME) is a regulated institution that offers Bitcoin futures, the SEC found that the existing futures market isn’t large enough to prevent manipulation or provide accurate pricing data for Bitcoin.
Not all within the SEC, however, agree with its rulings on Bitcoin ETFs. In her dissenting opinion on one of the rulings, SEC Commissioner Hester Peirce wrote:
The Commission’s mission historically has been, and should continue to be, to ensure that investors have the information they need to make intelligent investment decisions and that the rules of the exchange are designed to provide transparency and prevent manipulation as market participants interact with each other. The Commission steps beyond this limited role when it focuses instead on the quality and characteristics of the markets underlying a product that an exchange seeks to list.
While concerns around manipulation and fraud have prevented a Bitcoin ETF from being approved so far, there are still two promising proposals for Bitcoin ETFs that are awaiting a verdict from the SEC.
VanEck SolidX Bitcoin ETF
The VanEck SolidX Bitcoin ETF proposal was submitted to the SEC in February 2019, after a previous proposal was rejected in 2018. The ETF is a partnership between VanEck, an investment and ETF manager, and SolidX, a blockchain technology company. The ETF would be physically backed by the purchase of bitcoins and listed on the CBOE BZX exchange.
The SEC has delayed making a decision on the VanEck SolidX Bitcoin ETF until May 21, 2019.
The Bitwise ETF proposal was submitted to the SEC on January 10th, 2019. Bitwise had previously created the first cryptocurrency-based index fund. The Bitwise proposal would be physically backed by the purchase of bitcoins, with bitcoins being stored and secured by third-party custodians. If approved, the ETF would be listed on the NYSE Arca, an exchange that focuses on stocks and options.
The SEC has delayed making a decision on the Bitwise ETF until May 16th, 2019.
The future of Bitcoin ETFs
Although efforts to launch a Bitcoin ETF have been stymied so far, there’s still hope. Robert Jackson, a commissioner at the SEC, said in an interview, “Eventually, do I think someone will satisfy the standards that we’ve laid out there? I hope so, yes, and I think so.”
Whether a Bitcoin ETF is approved in the next year, or the year after that, the discussion around Bitcoin ETFs have sparked increasing conversation and dialogue between regulators and private companies. More dialogue provides greater regulatory guidance around Bitcoin, helping to pull the digital currency into the mainstream — and that can only be a good thing.
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