Two recent proposals for bitcoin exchange-traded funds ("ETFs") are vying to become the first to receive approval from the U.S. Securities and Exchange Commission ("SEC") – one filed by CBOE BZX Exchange, Inc. ("CBOE") and the other by NYSE Arca, Inc. ("NYSE Arca"). The SEC has yet to approve a cryptocurrency ETF, although several applications were filed throughout 2018.
A bitcoin ETF would allow investors to easily invest in bitcoin without needing to directly buy and manage the cryptocurrency themselves, potentially ushering in additional capital and enabling a wider range of institutional investors to tap into the market.
Once the proposals are published in the Federal Register, the SEC has an initial 45 days from the date of publication to issue a decision or request an extension, with total time not to exceed 240 days.
SEC Skepticism Regarding Bitcoin ETFs
The CBOE and NYSE Arca proposals face a challenging environment at the SEC. The SEC has not looked favorably on bitcoin ETFs thus far. In a previous post, we examined the SEC and CFTC's hesitancy to endorse cryptocurrency markets, including through the approval of cryptocurrency ETFs.
In January 2018, the SEC published a staff letter that identified several questions it had for bitcoin ETF applicants. The Commission has also raised some of these concerns in denying previous ETF proposals. Specifically, the letter focused on issues surrounding:
- Valuation – whether funds would be able to adequately value cryptocurrencies or cryptocurrency-related products;
- Liquidity – how funds investing in cryptocurrencies or cryptocurrency-related products would assure that they have sufficiently liquid assets to meet daily redemptions;
- Custody – how funds would comply with the custody requirements of the 1940 Act and other relevant rules;
- Arbitrage – how a bitcoin ETF would maintain a market price in exchange trading that would not deviate materially from the ETF's Net Asset Value (NAV); and
- Possible manipulation and other risks – how funds would address concerns raised by the SEC that cryptocurrency markets, as then operating, offered substantially less investor protection than more established markets and carried a potential risk of fraud and manipulation.
CBOE and SolidX
On January 30, 2019, CBOE refiled its proposal to list and trade shares of SolidX Bitcoin Shares, issued by VanEck SolidX Bitcoin Trust. CBOE had initially sought SEC approval in June of 2018 but withdrew its application on January 23, 2019 amidst the U.S. government shutdown. CBOE's refiled proposal appeared in the Federal Register on February 20, 2019.
The proposal from CBOE attempts to address issues that the SEC has raised. The proposal states that, with an estimated initial per-share price of 25 bitcoin, the SolidX ETF will be cost-prohibitive for smaller retail investors, which would limit the ETF's market size and potentially control any possible bull impact on the market. The ETF purportedly would also initially carry $25 million in primary insurance and $100 million in excess coverage, with the ability to increase coverage. Additionally, the ETF's NAV would be calculated using an index that relies on prices from several OTC market participants, rather than a single exchange.
NYSE Arca and Bitwise
On January 10, 2019, the Bitwise Bitcoin ETF Trust ("Bitwise"), a cryptocurrency index fund provider, filed a registration form with the SEC for its own bitcoin ETF. NYSE Arca has filed its proposal to list shares of the Bitwise ETF on its exchange, which was published in the Federal Register on February 15, 2019. NYSE Arca is an exchange headquartered in Chicago that trades both stocks and options (whereas the New York Stock Exchange trades in large-cap stocks).
The Bitwise ETF contains three notable distinctions from past proposals. First, the Bitwise ETF will track the Bitwise Bitcoin Total Return Index, the value of which is calculated based on the price of bitcoin according to approximately ten of the most reliable exchanges (which the application dubbed "Verified Exchanges"). Second, the ETF would have provisions for handling events in the cryptocurrency markets, such as hard forks. A hard fork occurs if, for example, an alternative version of the Bitcoin protocol is developed and the holders of Bitcoin on the original version also end up holding a pro-rata share of the cryptocurrency on the new version. Third, Bitwise will store the bitcoin for its ETF with an institutional third-party custodian.
Possible Emergence of an SEC Split on Bitcoin ETFs
While the SEC has not approved a bitcoin ETF proposal to date, statements from the commissioners indicate that an approval may be on the horizon.
Hester Peirce, one of four SEC commissioners, dissented when the SEC rejected the Winklevoss ETF proposal back in July 2018. Her first basis is that the Commission erroneously looked at the manipulability of the underlying bitcoin spot market, rather than focusing on the shares in question. While the relevant statute, Section 6(b)(5) of the Exchange Act, does not relate to an ETF's underlying market, the SEC has historically taken the underlying market into account in evaluating ETF proposals. Commissioner Peirce also dissented on the basis that more participation from institutional investors would improve protections and deter market manipulators, and that inhibiting bitcoin as the basis of an Exchange Traded Product stifles innovation in the securities market.
Following the denial of the Winkevosses' ETF proposal, the brothers attempted to address some of the regulatory concerns around cryptocurrency by establishing a Self-Regulatory Organization (SRO), the Virtual Commodity Association (VCA), which we covered in this post.
In an interview leaked on Twitter, Commissioner Robert J. Jackson Jr. expressed confidence that an applicant for a bitcoin ETF will eventually meet the agency's requirements for a cryptocurrency-based fund that could be traded by ordinary investors:
"Eventually, do I think someone will satisfy the standards that we've laid out there? I hope so, yes, and I think so."
Whether the CBOE or Bitwise proposal meets this standard remains to be seen.
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