SEC Continues to Disapprove Bitcoin ETPs: What Does This Mean for Investor Protection?

On March 10, 2023, the Securities and Exchange Commission (SEC) issued yet another disapproval order for a proposed exchange-traded product (ETP) designed to track the price of spot bitcoin. This marks the sixth consecutive disapproval of such filings since the Commission’s first disapproval in 2017.

The basis for the disapproval remains consistent with prior orders – the inability of the exchange to establish a comprehensive surveillance-sharing agreement with a regulated market of significant size related to spot bitcoin.

The Commission argues that this analysis is consistent with its approach to considering earlier rule filings related to non-bitcoin commodity-based ETPs, where there has been at least one significant, regulated market for trading futures on the underlying commodity, and the ETP listing exchange has had a surveillance sharing arrangement with that market.

However, critics argue that the Commission is using a uniquely burdensome definition of “significant” in its analyses of spot bitcoin ETP filings. The Commission has cited language from prior approval orders for other commodity-based ETPs, arguing that the exchanges seeking these approvals universally had in place a surveillance-sharing agreement with a “significant” futures market.

However, the language quoted by the Commission appears to refer to the significance of a particular venue for trading futures as compared to the overall market for futures in the relevant commodity, rather than the relationship between the futures market and the spot market.

The spot bitcoin ETP disapproval orders represent a sharp departure from this approach, where the Commission has insisted that a bitcoin futures market is “significant” only if it meets two conditions: (a) there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on that market to successfully manipulate the ETP, and (b) it is unlikely that trading in the ETP would be the predominant influence on prices in that market.

Critics argue that the Commission has never adequately explained why it has not applied and still does not apply this two-part test when determining whether a futures market related to any other commodity-based ETP is significant.

The age of a futures market would seem to be a poor proxy for whether price formation occurs on the futures market or for whether the futures market is large enough to ensure that trading in the related ETP would not be the predominant influence on prices in that market.

VanEck’s latest offering is a financial product that is linked to Bitcoin futures. The investment management firm has been pursuing approval for a spot-linked product since 2017. However, the US SEC has held up the decision on VanEck’s current, and third, application for a spot ETP for several months.

The continued disapproval of spot bitcoin ETPs raises concerns about the Commission’s approach to innovation, investor protection, and capital formation in the markets. As the bitcoin market continues to evolve, some argue that the Commission’s reluctance to approve these products may hinder the growth and development of the market.

What is a Bitcoin ETF?

A Bitcoin ETF is a type of investment that tracks the price of Bitcoin without actually purchasing the asset itself. This investment method simplifies the buying process and eliminates the need for users to sign up for a cryptocurrency exchange or manage crypto wallets.

Traditionally, ETFs are used to invest in a group of assets or an individual asset’s price. By investing in a Bitcoin ETF, users can easily profit from Bitcoin’s price movements without having to go through the hassle of purchasing and managing the asset.

Despite its benefits, a Bitcoin ETF has some limitations. The first Bitcoin ETF, ProShares Bitcoin Strategy ETF (BITO), was launched in October 2021, but it invests in Bitcoin futures contracts instead of the asset itself. This means that the ETF’s performance may not directly mirror the actual price movements of Bitcoin.

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