Cboe Responds To SEC Bitcoin ETF Concerns

March 27, 2018

Cryptocurrency exchange-traded products should be treated much the same way commodity-related ETPs are treated, according to Cboe Global Markets, responding to the SEC about its concerns on bitcoin-related ETFs.

Cboe Global Markets, the parent company of ETF.com, is one of two U.S. exchanges currently trading bitcoin futures ($XBT). The SEC’s concerns, outlined in a January letter, touched on five broad issues that were dissuading the commission from approving any of the more than dozen bitcoin ETFs that have attempted to come to market. The concerns were related to valuation, liquidity, custody, arbitrage and manipulation.

The SEC called on the ETF industry to address those issues, and suggested it would not be approving any cryptocurrency products until they have been satisfactorily responded to. Around the time the SEC had released its letter, multiple issuers withdrew their applications for bitcoin and other cryptocurrency ETFs, resigned to the idea that the commission was unlikely to greenlight their products in the near future.

Treated Like A Commodity

Cboe’s responding letter acknowledges the SEC raises valid concerns that should be explored, while going to great lengths to address them.

“While Cboe shares many of the concerns raised in the Staff Letter, we believe that the vast majority of these concerns can be addressed within the existing framework for commodity-related funds …,” Cboe said.

Such a framework makes sense, according to Cboe, because investors have grown to treat bitcoin in a similar manner to traditional commodities, and because bitcoin is classified as a commodity by the Commodity Futures Trading Commission.

For example, when it comes to valuation, “while there are certain attributes unique to cryptocurrency that need to be addressed by each Cryptocurrency ETP’s respective valuation policy such as forks and air drops, most valuation issues are either very similar or identical to those encountered in valuing other assets,” Cboe said, while adding that there’s reliable price data and indices available to help issuers of exchange-traded products calculate net asset values (NAVs).

Ample Liquidity

With regard to liquidity, Cboe said volumes on the spot market are strong, with notional volume on three of the largest U.S. bitcoin exchanges approaching $1 billion per day. At the same time, volume for bitcoin futures contracts—including those traded on the Cboe Futures Exchange and the CME—are growing briskly.

Meanwhile, Cboe believes custody shouldn’t be an issue as long as cryptocurrency futures contracts are treated the same way as any other commodity futures contracts. In that case, any “regulated AAA credit rated clearing house should be permitted to act as custodian for a Cryptocurrency ETP.”

For ETPs that want to hold cryptocurrencies directly, “firms like Gemini Trust Company, LLC (“Gemini”) and a number of others are establishing themselves as regulated custodians offering custodial services,” Cboe said.

Preventing Manipulation

Importantly, Cboe sees no obstacles for keeping cryptocurrency ETPs’ prices close to their NAVs:
“The arbitrage mechanism for a bitcoin ETP would function identically to other commodity-related ETPs, providing market participants with strong economic incentive to take advantage of arbitrage opportunities in, thereby keeping the price of the ETP in line with the price of bitcoin.”

A successful arbitrage mechanism will also prevent manipulation of the shares of any cryptocurrency ETPs, Cboe explains: “The bitcoin marketplace has become so interconnected that manipulation of the price on any single venue would likely require manipulation of the entire bitcoin marketplace, rendering such manipulation cost-prohibitive.”

Not Appropriate For All

In its original letter, the SEC was particularly concerned about the potential misuse of cryptocurrency ETFs by retail investors.

“Would investors, including retail investors, have sufficient information to consider any cryptocurrency-related funds and to understand the risks?” the SEC asked.

Cboe responded by saying that cryptocurrency funds would not be appropriate for all investors—something that must be spelled out thoroughly in risk disclosures—but that they may serve a purpose in the reasonably constructed investment portfolios of some investors.

“Investors currently have access to ETPs that track the price of sugar, corn, and even livestock, among other less traditional commodities that present similarly difficult questions about suitability and appropriateness for investors,” Cboe pointed out, but that hasn’t stopped the SEC from approving those products, and they can in fact be useful for some investors.

The Case For Crypto ETFs

In concluding its letter, Cboe asked that the SEC allow cryptocurrency ETPs to come to market for the benefit of investors and the U.S. markets in general.

“… An ETP would provide a more transparent and easily accessible vehicle for gaining such exposure, and the market and infrastructure for the underlying reference asset and its associated derivatives do not give rise to significant concerns in any of the five overarching issues raised in the Staff Letter, then the Commission should not stand in the way of such ETPs coming to market,” the company said.

Contact the author at [email protected]. Follow Sumit Roy on Twitter @sumitroy2.

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