SPY’s 30-year anniversary isn’t the only big ETF milestone we’ll see in 2023. This summer, a decade will have passed since Cameron and Tyler Winklevoss submitted the first filing for a bitcoin ETF, the Winklevoss Bitcoin Trust.
The history of bitcoin ETFs is still being written, but in a week in which we’re celebrating the birth of the U.S. ETF industry, it’s worth highlighting one of the most tumultuous chapters of the ETF story.
The Long Wait
Though they were remarkably early with their bitcoin ETF filing—the cryptocurrency was trading at a mere $90 when they sought to launch their fund—the Winklevoss twins were never able to cash in on their early-mover advantage.
Their proposed fund was rejected by the Securities and Exchange Commission twice amid concerns about the risky nature of the nascent cryptocurrency market.
The ETF, which would have traded under the ticker symbol “COIN” (now claimed by crypto exchange Coinbase), wasn’t alone. Since then, the SEC has rejected more than a dozen proposed bitcoin ETFs, each time citing issues with inadequate investor protections in the bitcoin market.
The rejected ETFs came in all shapes and sizes, from “spot” bitcoin funds that would directly own the cryptocurrency and futures-based products that would hold derivative contracts on the Chicago Mercantile Exchange to long-only funds to leveraged and inverse products—nothing passed muster with the SEC.
There was perhaps no lower point in the journey to get a U.S.-listed bitcoin ETF approved than in the summer of 2018. That’s when in a single day in August, the commission rejected a whopping nine proposed bitcoin ETFs.
“Rules and surveillance to prevent manipulative techniques do not exist on all of the exchange venues where digital currencies trade,” former SEC Chairman Jay Clayton, who headed the regulator between 2017 and 2020, explained in 2018.
The issue of custody also was a sticking point for the chairman, who said the risk in an ETF should only be the risk of the value of the underlying asset and shouldn’t include the risk of theft or disappearance of said asset.
Clayton’s SEC also took issue with the then-nascent state of bitcoin futures markets.
“While CME and CBOE are regulated markets for bitcoin derivatives, there is no basis in the record for the Commission to conclude that these markets are of significant size. Additionally, because bitcoin futures have been trading on CME and CBOE only since December 2017, the Commission has no basis on which to predict how these markets may grow or develop over time, or whether or when they may reach significant size,” the SEC wrote in one of its orders rejecting a futures-based bitcoin ETF in 2018.
The Time Is Right
Filings for new bitcoin ETFs were few and far between in the aftermath of the SEC’s decisive rejection of multiple bitcoin funds in 2018. But the dream of a U.S.-listed bitcoin ETF never died. After two quiet years, filings for bitcoin ETFs ramped up significantly in 2021 as Gary Gensler replaced Clayton as SEC chair.
In August of that year, Gensler expressed an openness to considering bitcoin ETFs in a speech he gave to the Aspen Security Forum.
“I anticipate that there will be filings with regard to exchange-traded funds under the Investment Company Act [’40 Act],” Gensler said in his remarks. “When combined with the other federal securities laws, the ’40 Act provides significant investor protections.”
“Given these important protections, I look forward to the staff’s review of such filings, particularly if those are limited to these CME-traded bitcoin futures,” he added.
The reaction to Gensler’s comments was immediate. In the two weeks following his speech, filings for half a dozen futures-based bitcoin ETFs entered the pipeline.
The race was on.
If 2018 marked the low point for expectations of a U.S.-listed bitcoin ETFs, perhaps Gensler’s speech marked the high point—or at least the highest point since right before the regulator rejected the Winklevoss Bitcoin Trust the first time in 2017.
Lending support to the idea that the SEC would finally give the nod to a bitcoin ETF was the approval for a handful of U.S. bitcoin mutual funds that summer. Each of those funds invested in bitcoin futures, reinforcing the idea that a futures-based ETF would likely be the first type of bitcoin exchange-traded fund to launch.
Not everyone was happy about that. Handling futures introduces the potential for tracking error as a fund must roll from one futures contract to the next. Some market participants said that was an unnecessary cost to investors, because the SEC could just approve a spot bitcoin ETF that would own bitcoin directly.
Still, after years longing for any bitcoin ETF, many investors were happy that even a derivatives-based product was potentially on the horizon.
On Oct. 19, 2021, the moment ETF investors were waiting for finally arrived: the launch of the first U.S.-listed bitcoin ETF. And as expected, it was a hit.
The ProShares Bitcoin Strategy ETF (BITO) accumulated $1 billion in assets in just two days, faster than any ETF before it.
But then something unexpected happened: After a gangbuster first two days, the ETF hit a wall. It turned out that the timing of BITO’s launch couldn’t have been worse.
Just three weeks after BITO came to market, bitcoin peaked and began a long slide that resulted in a massive 76% drawdown from its high in November 2021 to its low one year later.
From a high point of $1.4 billion, BITO’s assets dropped to as little as $500 million.
For investors in BITO who had waited years to get their hands on a bitcoin ETF, it was a sad twist of fate. The day they got their wish just so happened to be one of the worst days to buy bitcoin, near the top of a massive asset price bubble.
On the plus side, BITO worked perfectly as a product. Its decline was almost exactly in line with the drop in underlying bitcoin prices, so even without the elusive spot bitcoin ETF investors had been clamoring for, investors had a futures-based alternative that performed just as well as a spot bitcoin ETF conceivably would have.
The futures’ “roll costs” some were worried about haven’t been a big factor since the launch of BITO.
Spot Bitcoin ETF Quest Continues
Still, despite the success of BITO, ETF investors and issuers continue to wait for a spot bitcoin ETF.
Such an ETF would hold bitcoin directly. Through a custodian, the ETF would control the private keys that are associated with actual bitcoin on the blockchain.
Under this arrangement, the bitcoin could be held indefinitely, and there would be no need to roll positions forward over time.
To some investors, a spot bitcoin ETF would represent more direct exposure to bitcoin than an ETF that holds cash-settled bitcoin futures. And such a fund might compel many more investors to invest in bitcoin through ETFs.
A Bit Anticlimactic
Indeed, for as successful as BITO was—shattering a 17-year-old asset-gathering record is no small feat—you can’t help but feel it was all a bit anticlimactic.
The first bitcoin ETF was anticipated to be a product that could easily gather $10 billion or more. Yet today BITO has less than $1 billion in assets, and none of the other handful of bitcoin futures ETFs that followed have more than $30 million in assets.
That suggests that even though the economic exposure of a bitcoin futures ETF and a spot bitcoin ETF may be similar, investors still prefer the latter.
Unfortunately for them, there are no indications that the spot bitcoin ETF that Cameron and Tyler Winklevoss envisioned nearly a decade ago will become a reality anytime soon.
Currently, Grayscale is embroiled in a court battle with the SEC for the regulator’s refusal to allow the Grayscale Bitcoin Trust (GBTC) to convert into an ETF. At the same time, the collapse of the FTX cryptocurrency exchange is fresh on everyone’s mind.
Today the prospects of any novel crypto ETFs coming to market appear slim. The crypto industry looks set to go through the regulatory wringer, and until there is more clarity on that front, the SEC is unlikely to allow anything other than bitcoin futures ETFs and blockchain equity ETFs to trade in the U.S.
One day that will probably change, but not in 2023—10 years after the first bitcoin ETF filing.