The Blockchain Association has called on the Securities and Exchange Commission (SEC) to issue more formal guidance on cryptocurrencies. As such, it has outlined a proposed regulatory framework based on previous SEC comments.
Through a post on Medium, The Blockchain Association attempts to codify language issued by the SEC’s Corporation Finance Direction William Hinman. Titled The Hinman Token Standard, Blockchain Association suggests the following guidance:
“A project should meet the standards for decentralization if it more decentralized than the Bitcoin or Ethereum networks on June 14th, 2018.”
The logic behind this statement stems from Hinman’s clarification in June 2018 that bitcoin and ethereum were not considered securities. It follows that if bitcoin and ethereum were sufficiently decentralized on that date, then other projects should aim to meet that standard.
“This uncertainty has a stifling effect on investment”
Further, the SEC chairman Jay Clayton publicly said: “I believe every ICO I’ve seen is a security.”
If cryptocurrencies are considered securities, they will be subject to much more stringent investor regulations. As the Blockchain Association explains, “we must know when tokens qualify as securities and when they do not so innovators know which regulatory regime applies.”
The contradicting statements and lack of clarity is stifling creativity and forcing promising startups out of the US.
“More decentralized than the Bitcoin or Ethereum networks on June 14, 2018”
The Blockchain Association’s proposed guidelines suggest the SEC stick to its conclusion that Bitcoin and Ethereum are sufficiently decentralized. Future policymaking should use this starting point as a foundation, they urge.
The association argues that this is a reasonable starting point with room for a somewhat centralized leadership when required.
Other proposals suggest implementing The Howey Testto cryptocurrency projects. The Howey Test outlines the definition of a security or investment contract and circles around the expectation of profit from a particular promotor or third-party.
“The Commission finds it appropriate to designate a longer period within which to issue an order approving or disapproving the proposed rule change so that it has sufficient time to consider this proposed rule change.”
The simple answer is that it can. The SEC may take up to 180 days to deliver an approval or disapproval. If required, they can also extend that period an additional 60 days.
With the VanEck and SolidX proposal submitted in July, the SEC is simply taking as much time as possible to consider all angles.
The SEC has also invited comments on the ETF, suggesting it is taking the review seriously.
The Delay Could be a Good Thing
The SEC is well within its rights to reject the bitcoin ETF proposal. You may remember the Commission rejected nine proposals back in August.
The fact that the SEC is taking the full time period to consider the VanEck proposal is a good sign.
There are pro-bitcoin commissioners involved in the decision, including Hester Peirce who said, “You all know that I am working on trying to convince my colleagues to have a bit more of an open mind when it comes to [crypto].”
SEC Concerns Remain
Having said that, the SEC still has major concerns over bitcoin ETFs. As the chairman of the SEC recently revealed, there are issues related to theft, market manipulation, custody, and money laundering that need to be addressed before we see an approval.
There is also concern over how ETFs track the price of bitcoin.
The three options include basing the price on crypto exchanges, bitcoin futures, and the bitcoin OTC market.
The SEC is nervous that exchanges are subject to manipulation. They think bitcoin futures are not yet mature enough, and OTC markets are difficult to track.
So there are big hurdles to overcome before the SEC approves any Bitcoin ETF proposal.
It Could Take Years
Speaking after the decision, Hester Peirce warned the crypto community not to place too much weight on the ETF approval.
“Don’t hold your breath. I do caution people to not live or die on when a crypto or bitcoin ETF gets approved.”
It’s the question on everyone’s lips right now: when are we getting a bitcoin ETF?
If, and when, a bitcoin ETF (exchange-traded fund) is approved, it would provide an easy way for institutional investors to get exposure to the crypto market, without having to buy or store bitcoin itself.
Many see the approval of a crypto ETF as a game-changer and the catalyst for a market recovery.
But if discussions at this week’s Consensus event are anything to go by, that bitcoin ETF approval date might keep moving further back.
One of Clayton’s biggest concerns is the threat of theft in the cryptocurrency market. Almost $1 billion worth of crypto has been stolen from exchanges this year alone and that number is weighing on the SEC’s decision.
“We’ve seen some thefts around digital assets that make you scratch your head,” Clayton explained.
Before we see the approval of a bitcoin ETF, we need an infrastructure of safe, reliable crypto storage.
2. Better Custody of Bitcoin
As Clayton went on to explain, “we care that the assets underlying [the] ETF have good custody, and that they’re not going to disappear.”
Custody and storage solutions are on the horizon. BitGo is one of the pioneers in digital asset custody services and many others are cropping up.
However, even with all the progress, Clayton maintained that these services “need to be improved and hardened.”
3. Market Manipulation
There’s still a dark cloud hanging over the crypto market in terms of price manipulation. It’s one of the key reasons cited by the SEC when rejecting previous ETF proposals.
In Clayton’s words, “what investors expect is that trading in the commodity that underlies that ETF makes sense and is free from the risk of manipulation. It’s an issue that needs to be addressed before I would be comfortable.”
He did at least offer a hint into what mechanisms the SEC is looking for to counter manipulation:
4. Market Surveillance
Traditional stock exchanges are monitored by smart surveillance systems which spot signs of manipulation and wash trading.
“Those kinds of safeguards do not exist currently in all of the exchange venues where digital currencies trade.”
Again, there are improvements on the horizon. Nasdaq’s new bitcoin futures market, for example, will integrate some of those surveillance features into the crypto trading arena. Similarly, the Gemini exchange (owned by the Winklevoss Twins) struck a deal with Nasdaq to integrate its surveillance technology.
Better regulated exchanges are likely to be a key requirement before a bitcoin ETF is approved by the SEC.
5. Anti Money Laundering Protections
The final point of contention comes down to anti-money laundering. In order to counter money laundering in the crypto space, exchanges would need to implement the following:
Despite the excitement around the pending approval of a bitcoin ETF, we’re still a long way from satisfying some of the key concerns. Progress is being made, but it may be some time before that approval date comes.
In a strange twist, SEC Commissioner Hester Pierce tweeted shortly after the initial rejection. She implied the decision was made by SEC staffers, and the Commission would now review the applications on a higher level.
“Accordingly, IT IS ORDERED, pursuant to Commission Rule of Practice 431, that by November 5, 2018, any party or other person may file a statement in support of, or in opposition to, the action made pursuant to delegated authority.”
The deadline for these public comments is November 5th.
The SEC may, therefore, reveal its decision at any point in the coming days, weeks, or months.
4. “Godfather of ETFs” Says Approval is Coming “No Time Soon”
Reggie Brown, the so-called “Godfather of ETFs” and senior managing director of Cantor Fitzgerald (a prominent ETF firm) is bearish on the prospects of an ETF approval.
While speaking at a Georgetown University conference last week, he said, “it’s very difficult for the Commission to wrap their heads around a positive approval because there’s no data yet…the markets just aren’t here.”
5. Approval in 2019?
It’s widely considered that forthcoming ETF proposals from VanEck and Solid X have a better likelihood of approval. Not only are they based on physical bitcoin (rather than bitcoin futures contracts), the two companies have significant experience with launching and running ETFs.
While their initial proposal was rejected earlier this year, the group will submit a follow up in 2019.
We expect to hear a decision from the SEC in the coming days or weeks, but don’t hold your breath. The bitcoin and cryptocurrency market has not sufficiently evolved since the previous rejections, so we’re unlikely to see a change of heart just yet.
While an approved ETF could be the catalyst that kicks off a new bitcoin bull run, there is still misunderstanding and misinformation among crypto enthusiasts.
It’s time to answer some burning questions: what is a bitcoin ETF? What consequences will it have for the future bitcoin price? And, of course, how likely it that a bitcoin ETF is approved in the coming months?
What is an ETF? (A Simple Explanation)
To start with, let’s define an ETF itself.
ETF stands for Exchange-Traded Fund. It’s a fund that tracks and mirrors the price of an underlying asset (like gold, for example). An ETF might also track a basket of assets (like tech stocks).
Shares of an ETF are traded on real stock exchanges and generally do not differ from traditional stocks in terms of trading.
Some of the most popular ETFs include those for gold (GLD) and crude oil (USO).
The main advantage of an ETF is simplicity and convenience. It is much easier to trade an ETF than it is to purchase gold or bitcoin or oil itself.
Who Makes and Approves ETFs?
ETFs are created by asset management firms. The firm buys the underlying assets (i.e. bitcoin) and keeps them under custody before creating an ETF.
An ETF share represents a certain percentage of the fund, but it does not represent ownership of the underlying asset. If you buy a bitcoin ETF, you are not buying bitcoin itself.
ETFs are popular investments for diversifying portfolios with minor monetary and timely expenditures.
What is a Bitcoin ETF?
A bitcoin ETF is an investment tool that would track the price of bitcoin. If approved, it would introduce an easy way for investors to get exposure to bitcoin without having to buy or store it directly. Traders would be able to buy and sell shares of the bitcoin ETF on a regulated stock exchange.
Although Bitcoin is already one of the most liquid assets on earth, it still can’t be traded on a regular stock exchange.
As well as the added convenience, investors could buy the bitcoin ETF through their existing, familiar investment account.
Why a Bitcoin ETF Could Lead to “Big Money” Institutional Investors
The most significant benefit of buying ETF shares instead of real bitcoins, apart from its availability on stock markets, is the fact that institutional investors don’t have to store it themselves.
Therefore, there is no risk of the bitcoins getting stolen.
Big institutions are currently prohibited from buying bitcoins directly, but an ETF would make their participation in the market a reality.
Regarding that, there are currently two different types of bitcoin ETFs proposed by multiple asset management firms: physical-backed ETFs and futures-backed ETFs.
What is a Physical-Backed Bitcoin ETF?
As you might have already suspected, a physical-backed bitcoin ETF gains its value through actual bitcoins.
This means an asset management firm needs to buy bitcoins from the market and then store them in their own wallets or custody service.
Price swings in the ETF should, therefore, be reflected by the price of an actual bitcoin. If bitcoin’s price increases by one percent, the price of a physical-backed ETF should rise by one percent as well.
What is a Futures-Backed ETF?
When trying to set up a futures-backed ETF, the issuing company does not have to buy actual bitcoins, but bitcoin “futures contracts”. Futures are financial instruments that are used to bet on the future price of that asset.
All futures contracts expire on a certain date, although there are different timeframes, e.g. weekly or quarterly.
Futures traders are confronted with higher risks, but also higher rewards. Regarding the ETF, the issuing company has to update their future contracts every time the contracts expire.
Historic Bitcoin ETF Proposals and Rejections
Although Bitcoin ETFs received a lot of media attention in 2018, there have been dozens of attempts to push one through before.
Two of the most popular applicants might be the Winklevoss twins, who have supported bitcoin for several years. As CoinDesk investigated in 2017, the brothers submitted their first ETF proposal in mid-2013, with numerous additional proposals in the following years. Unfortunately, the SEC was not satisfied with their offerings so far.
Often referred to as the most promising ETF is a proposal given by a collaboration of the investment firm VanEck, the blockchain company SolidX and the CBOE.
In this case, the ensemble is proposing a physical-backed ETF. Experts think this particular group has a higher chance of approval, due to their past experience issuing ETFs.
The date for a decision has already been postponed by the SEC for the second time. While the next date would be on December 29, it is very likely that it will be changed another time.
What Does the SEC Need to See Before It Approves a Bitcoin ETF?
According to most experts, it probably seems more logical to introduce a physical-backed ETF than a futures-backed one.
However, from the angle of an asset management firm, it’s actually quite the opposite. Roughly 85% of all Bitcoin ETF applications are futures-backed ETFs.
A major reason for this trend is, without a doubt, the frequently discussed custody question. Securely storing large amounts of cryptocurrencies has been a great stumbling block for many big players, like exchanges, in the past and present.
Additionally, bitcoin futures are already a financial instrument open to institutions and have been approved by the SEC before. Consequently, it appears like a smaller step to introduce a futures-backed ETF.
However, a very critical development the SEC wants to see, before approving an ETF, is a steep reduction of market manipulation and fraud attempts.
When rejecting nine ETF proposals in August, the SEC stated that
“…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.”
“Volume from institutional investors would facilitate a significant regulated market that would reduce the scale of price manipulation thereby easing the SEC’s concerns. An ETF would also open up the market to more retail investors.”
After being asked for a date, Ivanovs said, “2020 is my prediction.”
Income Locker CEO Csaba Csabai thinks that there might be other hurdles that need to be cleared. “There is still technological development needed to make Bitcoin exchange-tradable because when buying an ETF, someone has to actually purchase bitcoins,” he said in a conversation with Finance Magnates. Nevertheless, Csabai also sees a silver lining, as he went on with “if the rate of adoption continues to grow at the current pace, we will soon see an ETF, because it’s the only way institutions can access this asset class, so solving it as soon as possible is in their best interest.”
“We have pegged the odds at less than 25 percent. That is because the very first thing the SEC lists in its own mission statement is protecting the investing public. When you think about the game theory aspect of this, if I work at the SEC and I approve this ETF. and it goes well, nobody is probably going to come around and pat me on the back and give me a promotion. But if I approve it and a lot of money flows into it, and something goes wrong, I am likely to lose my job.”
However, there are also parties that don’t believe in a Bitcoin ETF at all. Nouriel “Dr. Doom” Roubini believes that the crypto space has several issues, like fraud and manipulation, that will make an ETF not feasible in the near future. In a debate at CoinTelegraph’s BlockShow, Nouriel recently stated that “The academic evidence is, that this market is totally manipulated.” He later continued, “How do you expect anybody, who is an institutional investor, who has to be compliant with the rules and regulation, KYC/AML, to enter the space.”
Could an ETF Influence Bitcoin’s Price?
To answer this question, one clearly needs to distinguish between a futures-backed and a physical-backed ETF. As already elaborated in the beginning, to create a physical-backed ETF the issuing firm needs to buy bitcoin from the market.
Although those deals wouldn’t be made on a regular crypto exchange, it would inevitably have an effect on bitcoin’s price, due to the immense amounts of bitcoin that would be needed for an ETF.
In addition, an approved ETF would attract countless speculators, who would probably buy bitcoin right away.So yes, a physical-backed ETF would, with almost full certainty, have a great impact on the price of bitcoin.
In regard to a futures-backed ETF, the impact might not be as big as with the physical one. The issuer would only need to buy futures contracts, hence the price wouldn’t be directly affected.
Futures would most probably help to spread adoption in institutional circles, but this would only be valid in the long term. In the worst case, it could even have a negative impact on bitcoin, as the past has already shown when bitcoin futures were introduced for the first time.
Still, we can’t be sure about the impact before an ETF has even been officially approved.