Could a bitcoin ETF happen in the near future?

Now that the market excitement over the possibility of a bitcoin ETF seems to have been put to bed with the SEC rejecting both the Winklevoss and the SolidX proposals, it’s worth thinking about what needs to change for an official bitcoin investment vehicle to happen.

Forbes published today an interesting article by Moe Adham that unpacks the SEC decision. He pins the causes on two things:

    1) The lack of “surveillance-sharing agreements with significant markets”, in this case between the listing exchange (BATS) and a commodity exchange operator (Gemini, which does not have a significant market position). The concern is that the market insignificance of the exchange on which the underlying asset will be traded could leave it vulnerable to manipulation.
    2) The Gemini Exchange is not regulated enough (it is, though, one of only two regulated bitcoin exchanges in New York – but apparently that’s not enough).

Moe then goes on to hypothesize on what would need to happen before a US-listed bitcoin ETF is approved:

    1) The majority of bitcoin trading needs to happen on US-based exchanges.
    2) US-based bitcoin exchanges need to be regulated.

I agree with Moe that both of the above are unlikely to happen in the near future, but I don’t believe that those are the necessary conditions.

In its ruling, the SEC specified that the main reason for the rejection was:

“because the Commission believes that the significant markets for bitcoin are unregulated.”

While this may be true today, it’s unlikely to remain the case for long. As we have seen, several other major markets have made moves to regulate their cryptocurrency exchanges, and we will most likely see this trend pick up steam.

Even if the SEC were to insist on most exchanges being US-based (which I think even they would agree is an unreasonable condition), it’s not totally out of the question. Almost 40% bitcoin trading now happens in US$, making it the largest market, according to Cryptocompare.

via Cryptocompare - Bitcoin ETF
via Cryptocompare

Although only two of the top five US$-BTC exchanges are based in the US (Poloniex and Coinbase), one of them (Coinbase) already has a New York BitLicense. Poloniex, on the other hand, pulled out of New York rather than have to apply for a BitLicense. But that might change, either because Poloniex shifts priorities or because the requirements become less costly and cumbersome.

In the bitcoin sector, regulation is a trend that can only move forward.

With increasing exchange oversight and greater liquidity in the major trading markets, bitcoin prices will become more reliable and transparent, solving another of the SEC’s concerns.

So, I’m more optimistic than Moe that we will see a listed bitcoin ETF in the near future.

I don’t, however, think it will happen in the US first. Another country is far ahead in terms of regulation and acceptance by the financial system, and its regulators are more likely to approve a liquid, listed bitcoin investment vehicle in the short term.

Where?

Japan.

 

Bitcoin funds – alternatives to ETFs

by Steve Buissinne via StockSnap - bitcoin funds
by Steve Buissinne via StockSnap

Now that the Winklevoss Bitcoin ETF is off the table, it’s worth looking at the alternatives, present and future. What can you invest in if you want exposure to bitcoin without holding bitcoin?

In chronological order of listing, we start with a couple of Scandinavian funds.

The first publicly traded vehicle was an Exchange Traded Note (ETN), not an Exchange Traded Fund (ETF). An ETN is a debt note designed to provide investors with a return linked to a certain benchmark. On maturity, the investor will get the initial cash back, plus or minus the change in value of the underlying asset. An ETN can be liquidated before maturity by trading it on an exchange, or by handing in the relevant amount of the underlying asset to the issuing bank.

ETNs and ETFs are similar in that both track an underlying asset, both have lower expenses than actively managed mutual funds, and both trade on major exchanges. The main difference between them is that with an ETF, you’re investing in a fund that holds the underlying asset. With an ETN, you’re not – the return is tracked and calculated. Since an ETF is not backed by an asset, its credit worthiness is tied to the reliability of the underwriting institution.

In May 2015, Stockholm-based XBT Provider launched the first bitcoin-based ETN, on the Stockholm Stock Exchange (part of Nasdaq Nordic). It was called Bitcoin Tracker One and was denominated in kronor. Bitcoin Tracker EUR, denominated in euros, followed a few months later.

Trading of the two was briefly suspended a year later when XBT Provider’s parent company – KnC Group (which also owned bitcoin miner KnC Miner) – declared bankruptcy ahead of the bitcoin halving. XBT Provider was swiftly bought by Global Advisors (Jersey) Limited, a Jersey-based investment manager (of which more down below).

Both notes are now available in 179 countries (if investors have an account on Nasdaq Nordic), and both prospectuses have been approved by the Swedish financial supervisory authority.

In December 2016, Global Advisors (Jersey) Limited listed the Global Advisors Bitcoin Investment Fund on the Jersey Stock Exchange. While the vehicle had been created in 2014 and had received regulatory approval from the Jersey Financial Services Commission, this listing made it the first regulated bitcoin fund to trade on a recognized, regulated exchange. Rather than just hold bitcoin, it actively manages holdings in order to outperform the underlying asset.

The custodians for the fund are Gemini and itBit, both regulated bitcoin exchanges. Although the fund is pitched as a pure bitcoin play, its charter allows it to hold up to 25% of its wealth in non-bitcon assets.

The Bitcoin Investment Trust (BIT) was the first US-based private investment vehicle to invest exclusively in bitcoin. While technically it is a fund that can be traded and is available to certain segments of the public, holders can only sell one year after purchase.

BIT began raising capital on SecondMarket, an alternative exchange for private stock owned by Digital Currency Group CEO Barry Silbert, in September 2014. SecondMarket made a $2m seed investment in the fund. BIT is aimed exclusively at institutional and accredited individual investors, with a minimum investment of $25,000.

In 2015 it launched a new sponsor, Grayscale Investments. It also moved its trading to the OTCQX, the leading over-the-counter exchange in the US, where it resides today. The fund usually trades at a significant premium to the underlying asset, largely due to the low liquidity.

Other bitcoin ETFs are awaiting their turn in the spotlight. Next up is SolidX, which submitted its proposal in 2016. A ruling is due by the end of this month. And earlier this year, Grayscale Investments filed a proposal with the SEC to list BIT as an ETF in a $500 million initial public offering.

Furthermore, the Winklevoss brothers have said that they will continue to work with the SEC to address its concerns. While the barriers are high, it sounds like they haven’t given up.

The SEC and the Bitcoin ETF – what now?

Well, that was exciting…

source: CoinDesk
source: CoinDesk

The SEC decided to not approve the proposed Winklevoss Bitcoin ETF, citing the lack of regulation on bitcoin exchanges, and the possibility of using protocol forks to manipulate the price.

While disappointing, none of that is surprising.

What is surprising is that the price didn’t plummet further. That it found strong resistance at $1,000 and then started trending back up is testament to the underlying strength of sentiment.

CoinDesk provided an excellent post-game wrap-up, with comments from Tyler Winklevoss (striking an upbeat tone, way to go Tyler) and others, reflecting on the motives and consequences.

Since the rejection was based on the fundamentals of the bitcoin market, rather than on specifics to the proposed vehicle, it looks unlikely that an SEC-regulated ETF will be forthcoming any time soon. It is possible that other jurisdictions will take a more relaxed approach – but following SEC guidance, it’s unlikely.

So where now for the Winklevoss brothers? One option is to change the scope and objectives of the fund, and limit the availability to a certain type of participant, much like the Bitcoin Investment Trust which is only available to “professional” investors.

Or, the twins could choose to continue to “work with the SEC” (as Tyler said in his statement) to get the fund approved in its current form.

This will require unpacking what the SEC is likely to mean the next time around by “unregulated”.

Bitcoin itself cannot be regulated. It was born as an unregulated currency. To regulate it is to control it.

The exchanges, however, can be regulated. In fact, Gemini is. Gemini is the Winklevoss exchange, from which the ETF price would have been determined, and is one of only three companies to have been awarded a New York BitLicense, which authorizes it to carry out bitcoin exchange activities in the state.

And yesterday, an official from the Central Bank of China was reported as saying that the PBoC is looking (again, but apparently more seriously this time) at regulating the Chinese exchanges.

So, hopefully the Winklevoss brothers will try again (although I shudder to think what all this must be costing them in lawyers). It’s unlikely that deliberations will take quite so long next time around, but even so, a couple of years is a long time in bitcoin – it’s only been around for eight.

A couple of years is also a long time in politics, and the current US administration does seem eager to dismantle financial regulations swiftly. It also appears to be bitcoin-friendly, and can no doubt count on serious lobbying by people both within government and without to harness the potential without stifling it.

Let Round 2 begin.

Intriguing public comments on the Bitcoin ETF proposal

by Gemma Evans via StockSnap
by Gemma Evans via StockSnap

While you have most likely heard about the upcoming decision by the SEC on whether or not to approve the proposed Winklevoss Bitcoin ETF (given that most mainstream press is attributing the recent bitcoin price increase to positive expectations), what you maybe didn’t know is this:

Comments sent to the SEC advising on this decision are public. Anyone can tell the SEC what they think. And you can see what they wrote.

It’s fascinating, especially since some sector influencers have sent in their opinions.

For instance, Joshua Lim and Dan Matuszewski of Circle Internet Financial write:

“Both institutional and individual investors stand to benefit from the potential listing of the Winklevoss Bitcoin Shares. Such a listing would create a trusted, safe, transparent and regulated entry point into this maturing asset class, which is growing in importance as an investible store of value globally.”

Chris Burniske of ARK Invest (manager of the first ETF to invest in bitcoin) disagrees:

“After thorough examination, we think it would be premature to launch a bitcoin ETF because we do not believe the bitcoin markets are liquid enough to support an open-end fund, or that an ecosystem of institutional grade infrastructure players is yet available to support such a product.”

Attorney and professor of law Philip Chronakis is in favour:

“Denial of the proposed rule will not stop Bitcoin’s progress, but approval of the proposed rule, and the underlying COIN ETF, will put the SEC in the ideal position to oversee Bitcoin’s development as an investment asset – and provide fair, broad-based investment opportunities for not only the connected (or technologically savvy) few, but to all Americans who deserve the same chance to benefit from this technological breakthrough and financial opportunity.”

Michael Lee is against, and sheds some interesting light on recent price movements:

“The price of bitcoin is being heavily manipulated at this very moment on exchanges which somehow began the day of the SEC’s Feb 14th meeting but before the news of this very meeting was released to the public. Currently, we are at all time highs based on rumors and speculation on this meeting alone and it feels like we are again in a price bubble which could result in a huge loss for new investors. An approval of the COIN ETF at this time would only exacerbate this bubble and result in a price crash even before ETF trading will be fully available.”

Ben Elron uses stirring language:

“The Bitcoin ETF represents a rare opportunity for our country to embrace a revolutionary financial technology (the blockchain) with relatively low risk. Indeed, if approved, this fund would arguably be the most transparent, efficient and secure instrument ever offered – requisites enumerated in the Commission’s founding charters.

Blockchain is the future. If American regulators fail to embrace it, others will, and we will then be forced to follow. Let us lead once again.”

And in a somewhat quirky and impassioned comment, Diego Tomaselli implores:

“We understand your role is to protect the American Investor.

Please, just don’t forget to protect also the American Spirit.”

The magnitude of the price bump that approval would generate is uncertain. Given that the bitcoin price has increased by more than 18% since the beginning of the year, a case could be made that approval is already largely priced in.

Today CoinDesk revealed that GABI (currently one of the largest institutional investors in bitcoin) believes that the market is over-optimistic and is therefore reducing its holdings. Since early yesterday morning, the price has been falling, and at time of writing is down almost 8%.

Whatever happens over the next few days, it’s safe to assume that the bitcoin price will be volatile. Which may not be what you want in the underlying asset of an ETF.

That said, I’m hoping that it gets approved. 🙂

The Bitcoin ETF – is Bats the right exchange?

trading 700 - Bitcoin ETF exchange

The Bats exchange has been in the news this week – and not just because it is the preferred venue for the listing of the Winklevoss Bitcoin ETF, also much in the news recently.

Why the extra attention? Because CBOE Holdings Inc., has completed the acquisition of the operator of the Bats exchanges.

The merger represents a major shift in the exchange landscape in the US. CBOE Holdings Inc. is the owner of the Chicago Board Options Exchange, the largest options exchange in the US. Bats is the second largest stock exchange operator in the US, and the largest in Europe.

Could this affect the probability of the SEC approving the Winklevoss’ fund?

Let’s look at why they chose Bats for the listing. They were originally going to go with Nasdaq, but in mid-2016, they filed an amendment changing the exchange to Bats. Press comment at the time stressed the advanced technology of the trading platform, hinting that the Winklevoss brothers were choosing the more forward-thinking option.

No doubt the technology is part of it, but it’s likely that a larger role was played by Bats’ experience with ETFs: it is the largest ETF exchange in the US.

Nasdaq is no slouch in the technology department. Of all the US exchanges, it has invested the most in blockchain exploration. Its Linq platform enables private company shares to trade on the blockchain, and it recently released the results of a blockchain-based voting trial it conducted with Chain in Estonia last year.

But Nasdaq has fallen behind Bats in market share, and does not have its clout in ETFs.

Also, Bats technology is by many accounts the best in the business (all of CBOE Holding’s operations will migrate to Bats’ platform, a strong vote of confidence). However, at its first attempt at an IPO in 2012, the technology failed and the IPO had to be withdrawn at the last minute. The systems have been considerably strengthened since then, but the SEC could see the dependence on technology as a vulnerability.

That is unlikely, though, since the trend for exchanges is to move to electronic trading. Bats was founded in Kansas in 2005 out of frustration at the duopoly of trading markets, shared between Nasdaq and the NYSE. Unlike other, older exchanges that have incorporated technology bit by bit into their operations, Bats was technology-first.

The merger with the CBOE could be interpreted as enhancing Bats’ stability and reputation. The new entity is expected to have a market capitalization of approximately $10bn, close to that of Nasdaq. While Bats is a relative newcomer, the CBOE is over 40 years old. While Bats is known for its technology, the CBOE still operates physical trading pits. And CBOE Holdings is poised to join the S&P 500.

Furthermore, the CBOE is strong in options, and already talk is circulating of the new enterprise developing an exchange for options on ETFs. This could enhance the revenue prospects in a sector suffering from declining volatility, tougher competition and lower fees.

Even if the SEC denies approval for the Winklevoss ETF fund, it is only a matter of time before a proposal is presented that it will approve. When that day happens, the exchange of choice will probably be Bats.

The merger with CBOE is likely to work in favour of the ruling: if the SEC harboured any doubts about Bats’ durability and reliability, the additional clout and growth potential should put those to rest. Furthermore, the expertise in ETFs should facilitate sensible governance and compliance. And the combined entity’s reach across financial products and geographical jurisdictions underscore the potential that innovation in ETFs could bring to a diversifying segment of the economy.

That does not mean that approval is probable – there are a host of other complications to consider. It does mean that the choice of exchange unlikely to be a negative factor.