On March 10, 2017, the SEC released a long-awaited ruling on its first Bitcoin Exchange Traded Fund (ETF) proposal, electing to disapprove the proposal.
A Bitcoin ETF would have been a major step forward for the new currency. Since Bitcoin’s launch in 2008, businesses and startups offering Bitcoin services have been pushing for further acceptance in the greater global economy. The listing of Bitcoin as an ETF on a major U.S. exchange would have put Bitcoin on track to one day rival other global commodities such as gold, silver and oil. Many market participants anticipate a Bitcoin ETF would have a positive impact on the current price of Bitcoin, as it would allow for institutional investors, funds and individuals to add Bitcoin to their portfolios.
But it didn’t happen. Per the SEC (emphasis mine):
[The] Commission is disapproving this proposed rule change because […] First, the exchange must have surveillance-sharing agreements with significant markets for trading the underlying commodity or derivatives on that commodity. And second, those markets must be regulated.
The ruling is quite clear in stating its two main reasons for disapproval. Let’s take a deeper look at the two reasons.
Problem 1: Exchange Surveillance-Sharing Agreements
A surveillance sharing agreement is an agreement between a self-regulatory organization (SRO), in this case, the Winklevoss Bitcoin Trust’s “Self-Regulatory Organization: Bats BZX Exchange,” and a commodity exchange operator.
With respect to the Bitcoin exchange market, there is serious concern about potential market manipulation.
As you can see from this chart, which outlines the reported global Bitcoin trading volume across all public bitcoin exchanges over the past two years. the clear dip in January 2017 is the result of Chinese bitcoin exchanges removing no-fee trading.
The first point of suspicion is the incredible drop in trading volume in entering 2017. We see the trading volume from Huobi, BtcChina, and OKCoin virtually vanish. These three China-based exchanges were under Chinese government scrutiny near the end of 2016. Markets with proper oversight simply do not experience such sudden and precipitous drops in trading volume.
The proposed “Winklevoss Bitcoin Trust” ETF only had a surveillance sharing agreement on Bitcoin exchange named “Gemini Exchange,” but Gemini Exchange is a digital currency exchange also owned by Digital Asset Services LLC (the same group petitioning the SEC to list the ETF). As the SEC ruling notes (emphasis mine):
The Gemini Exchange conducts only a small fraction of the worldwide trading in bitcoin …
… Gemini Exchange accounted for just 0.07% of all worldwide bitcoin trading, and 5.16% of the much-smaller bitcoin-USD market worldwide …
In fact, the SEC is correct in assessing that Gemini exchange is by no means a “significant market” for bitcoin trading. In this chart, we can see quite clearly that over the past six months, Gemini has contributed very little to the overall BTC/USD market. Not only does Gemini not have a significant market share, the majority of BTC/USD trading actually occurs on offshore exchanges. As a matter of fact, Bitfinex, the world’s largest market for BTC/USD trading, lost over $70 million of customer funds in 2016, yet remains the world’s largest exchange.
Problem 2: Exchange Regulation
In the SEC’s analysis, it deals a secondary blow to the Winklevoss Bitcoin Trust’s proposal.
… the Gemini Exchange is not a “regulated market” comparable to a national securities exchange…
Having a look at Gemini’s website, we see that Gemini exchange does not define itself as a “regulated market,” but rather as a trust under the oversight of the New York Department of Financial Services. As a matter of fact, of the three currently operating exchanges in the United States (Gemini, itBit and coinbase), none are currently classified as a “regulated market.”
For A Bitcoin ETF To Succeed, Key Changes Are Needed
Given all these hurdles, significant changes in the market are required before a bitcoin ETF proposal could see the light of day. In my opinion, there are two key changes needed in the market before this can happen:
- Majority of Bitcoin trading must occur on U.S.-based exchanges
- U.S.-based Bitcoin exchanges petition for access to “regulated markets”
The first requirement is going to be very difficult but is likely the only way significant trading activity could ever fall under regulated, surveillance-exchange agreements. The majority of Bitcoin trading currently occurs on overseas exchanges. Other commodity ETFs track products traded on the Chicago Mercantile Exchange.
With respect to regulations, it is unlikely that current Bitcoin exchanges will petition for increased regulation in the near future due to the significantly increased related costs. A more prudent approach would be to gain closer relationships with regulated commodities exchanges.
Fundamentally, the prospects of a Bitcoin ETF are low; it will not likely happen in the near future. Institutional investors looking to gain exposure to the digital currency markets will likely have to work with regulated brokers, or, offshore ETFs, such as the one currently listed in Sweden.
Nevertheless, current Bitcoin investors have a lot to gain from a future ETF approval. It would solidify Bitcoin, and digital currencies themselves, as a whole as a new asset class.