The US Securities and Exchange Commission has – after more than five years of spirited resistance – approved applications for spot bitcoin exchange-traded products.
The SEC’s statement on the matter is not exactly gracious. Gary Gensler, chair of the SEC, highlighted that the substance of the approved applications is similar to those the SEC has disapproved in the past. However, the US court of appeals said in August 2023 that the SEC had failed to adequately explain its reasoning in disapproving Grayscale’s application. As a result, Gensler admitted somewhat sulkily, that ‘the most sustainable path forward is to approve the listing and trading of these spot bitcoin ETP shares’.
The SEC’s resistance to allowing exchange-traded funds to be listed is based on their belief that the bitcoin market is subject to fraud and manipulation. The court of appeals’ contention is not that the market is free from manipulation, but that, having approved bitcoin futures ETFs, its decision to disapprove bitcoin spot ETFs was unjustified.
This is hard to argue against. While bitcoin futures are securities traded on regulated exchanges (and therefore legitimate candidates to be represented as ETFs), their price is inextricably linked to the bitcoin spot price. Given that link, it is difficult to disallow one and not the other on the basis of price manipulation.
Is it good for US investors?
The introduction of bitcoin spot ETPs should broaden the universe of investors that is able to get exposure to the performance of bitcoin. Is that a good thing?
On one hand, the returns are enviable. 10 years ago, bitcoin was worth $18.95. Five years ago, it was worth $11,174. At time of writing, it’s $45,980. On the other hand, no one would attempt to claim that the bitcoin market is not, as the SEC contends, subject to manipulation.
In poetic timing, the day before the ETP approval was announced, the SEC’s X (formerly Twitter) account was hacked and a false post claiming that the approval had taken place was published.
It is not clear that this post was an attempt at deliberate market manipulation. A far more obvious strategy would have been to short bitcoin, post that the SEC would never approve a bitcoin ETF, then buy bitcoin when the price dropped in anticipation of the upcoming announcement.
Whether or not the hack was an attempt at market manipulation, it is indisputable that crypto markets suffer from malicious behaviour to a scale that would not be tolerated in regulated markets. Research referenced by SEC Commissioner Caroline Crenshaw in her dissension from the approval found that wash trading on 29 centralised crypto exchanges averaged 70% of the total volume, while a Forbes study of 157 crypto exchanges suggested that 51% of the reported bitcoin trading volume was likely to be ‘fake or non-economic’.
Approximately 0.01% of bitcoin holders control almost 60% of bitcoin’s supply, according to research by Glassnode. That, combined with up to 10% of bitcoin that is irretrievably lost, means that bitcoin is a heavily concentrated asset. Accordingly, the ability for ‘whales’ to impact the price of bitcoin with malicious trading activity should not be overlooked.
ETF flows typically have a small impact on the price of the underlying asset, so the impact is likely to come in one direction. There is a risk that ETF buyers, many of whom will be retail investors or managing funds on their behalf, find themselves the victims of price manipulation by sophisticated investors in the underlying asset.
Is it good for bitcoin?
Many institutional investors, particularly in the wealth management community, are not permitted by their mandate to hold bitcoin directly but make heavy use of ETFs.
Just how much this will mean for the bitcoin price is not yet clear. BlackRock and the handful of other successful applicants will, for the most part, be building up their ETFs from nothing in response to client demand. This buying pressure should be positive for bitcoin. However, with this decision being widely expected since the court of appeals’ judgment in late August 2023, it is possible that much of this demand has been priced in by investors seeking to front-run the ETF demand.
It is also worth noting that there has already been an avenue – via bitcoin futures ETFs or via the shares of listed companies that strongly correlate with the price of bitcoin – to get listed exposure to the asset’s performance. Spot bitcoin ETFs should be preferable though, since maintaining a rolling portfolio of futures is more complex and expensive than simply holding bitcoin and listed companies are exposed to other types of risk (such as key person risk) that does not affect bitcoin.
The vigour with which BlackRock and others have pursued approval for this product suggests that their market research indicates that there will be strong demand. It might also open up more flexible ways for regulated institutions to interact with bitcoin, via securities lending and options.
Is it good for crypto?
Despite the SEC’s insistence that it remains ‘merit neutral’ on bitcoin, the approval of a bitcoin ETF will almost certainly lead to a more widespread exposure to the performance of the asset. It is less likely to improve the prospects of the rest of the cryptoasset market.
Gensler took the opportunity to reaffirm his belief that the ‘vast majority of cryptoassets are investment contracts and thus subject to the federal securities laws’. As such, registering any further cryptoasset ETFs will likely take a long time and a further legal battle. Incoming federal legislation might smooth this path if it determines that the Commodities and Futures Trading Commission has responsibility, rather than the SEC.
This may potentially clear the path for a much more interesting product. A fund could purchase a basket of the top 10 cryptoassets, then sell shares in the basket, offering investors exposure to the aggregated performance of the crypto market.
In the finance industry, many are starting to use blockchain technology to improve investors’ access to traditional products using tokenisation. Efforts like these, if they deliver tangible use cases for the technology, will do more to advance the cause of cryptoasset promotion than offering non-DLT-based exposure to cryptoasset performance. In the long run, increased opportunities for exposure to bitcoin might improve appetite for other cryptoassets, but it’s far from certain.
Lewis McLellan is Editor of the Digital Monetary Institute at OMFIF.