SEC Rejects 9 Bitcoin ETF Proposals

August 23, 2018

Late Wednesday night, the Securities and Exchange Commission officially rejected proposals for bitcoin ETFs from three different issuers, leaving the way ahead for a futures-based cryptocurrency ETF unclear.

Direxion had proposed five bitcoin ETFs, while GraniteShares and ProShares had each proposed two. Notably, all of the proposals included an inverse offering, while the Direxion proposal included inverse and leveraged offerings.

The SEC used the same reasoning—and in some cases even the same language—to disapprove all nine funds.

The rejections came hours ahead of a scheduled deadline for a decision about the ProShares funds, which had already previously been delayed and could not be delayed again.

These aren't the first bitcoin ETFs to be denied this year. Just last month, the SEC decided, after a second round of review, to stick to its original rejection of a proposed bitcoin ETF from the Winklevoss twins (read: "SEC Again Rejects Winklevoss Bitcoin ETF").

Why The ETFs Were Nixed

Each of the nine proposed ETFs rejected last night would have been backed by bitcoin futures contracts, which began trading on the CME and Cboe exchanges late last year. (Cboe Global Markets is the parent company of ETF.com.)

In nixing the proposals, the SEC noted concerns about manipulation and said that the two exchanges on which the ETFs would have listed—NYSE Arca and Cboe—had not demonstrated they had sufficient rules in place to prevent "fraudulent and manipulative acts and practices."

The SEC also cited the still-small size of the bitcoin futures market as a concern, saying there was "insufficient evidence" to determine whether Cboe or CME bitcoin futures were well-traded enough to support an exchange-traded product.

In fact, the SEC even quoted Cboe President and COO Chris Concannon's letter to Dalia Blass on the subject, citing his words: "the current bitcoin futures trading volumes on Cboe Futures Exchange and CME may not currently be sufficient to support ETPs seeking 100% long or short exposure to bitcoin" (read: "Cboe Responds To SEC Bitcoin ETF Concerns").

Trading Data Impossible To Obtain

Because the current U.S. bitcoin futures markets are so small, the SEC said exchanges instead would need to engage in "surveillance-sharing agreements" with a regulated market of significant size related to bitcoin in order to meet the statutory requirement that investors be protected from fraud and manipulation.

That means Cboe and NYSE Arca would have needed to partner with a significantly sized, well-regulated bitcoin market to obtain data about trading and clearing activity in the underlying cryptocurrency, as well as information about traders' identities.

Therein lay the problem. Though the exchanges naturally would have had access to trading data on their own platforms, that information wouldn't provide any insight into the activity or the identities of people trading futures off exchange, or participating in the underlying spot markets—where the vast majority of trading occurs on overseas, relatively new all-digital venues. Reliable data about these unregulated spot exchanges simply doesn't exist.

Furthermore, in Direxion's case, its proposed funds also would have used options and swaps on bitcoin futures to achieve leverage. Yet their proposal hadn't provided any information on the size and liquidity of those derivatives markets, or how it would engage in surveillance-sharing for those derivatives.

Futures Markets Too New

The SEC pointed out that a similar question of trading data had arisen when the first commodity futures ETPs were considered.

Back then, the SEC had only approved those funds because the exchanges were able to share sufficient data with and about the underlying futures and spot markets, which had been trading for a number of years before any commodity ETPs were proposed.

In contrast, bitcoin futures have only been trading since December 2017. Thus, the SEC said it had "no basis on which to predict how these markets may grow or develop over time, or whether or when they may reach sufficient size."

Bitcoin ETFs: Not Dead Yet

Though this latest setback brings the number of bitcoin ETFs rejected by the SEC this year to 10, there are still at least two proposals before the commission to be decided.

In July, Bitwise Asset Management filed an ETF that would track an index of the 10 largest cryptocurrencies. It's the first filing to propose tracking several cryptocurrencies, instead of just bitcoin (read: "1st Crypto Index ETF Filed").

Meanwhile, VanEck and SolidX filed in June for a physically backed bitcoin ETF that would set the initial price of the fund at $200,000 in order to encourage institutional participation. That distinction may be key, considering SEC Commissioner Hester M. Peirce wrote in her dissent on the Winklevoss ETF: "More institutional participation would ameliorate many of the Commission's concerns with the bitcoin market."

Earlier this month, however, the SEC said it would delay its decision on the VanEck fund until Sept. 30 (read: "VanEck, SolidX Team Up On Bitcoin ETF").

Perhaps encouragingly for bitcoin enthusiasts, the SEC took pains in its disapprovals of the Direxion, GraniteShares and ProShares funds to point out that rejecting these proposals did not represent a rejection of bitcoin. The letters stated that "its disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment."

Read the Direxion rejection letter, the ProShares rejection letter and the GraniteShares rejection letter.

Contact Lara Crigger at [email protected]

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