Two of the U.S.’s top financial regulators, Securities Exchange Commissioners
Hester Pierce and Robert J Jackson, Jr, both say they hope their agency will approve a bitcoin ETF. SEC Chairman Jay Clayton has said he considers bitcoin “akin to the dollar, the yen, the euro—and it operates that way.”
SEC has approved ETFs for dollars, yens, and euros. It has also approved ETFs for all sorts of other commodities—copper, uranium, wheat, cotton, collateralized debt obligations, the list goes on. Seems like it’s approved an ETF for everything and now it wants a bitcoin ETF, too.
Yet it has rejected all bitcoin ETF proposals. Why?
Analysts and commentators point to many reasons. Let’s examine those reasons. At the end of this post, I’ll tell you why SEC will approve a bitcoin ETF eventually.
Reason #1: bitcoin is manipulated.
It’s quite possible bitcoin is manipulated by anonymous forces. Large bitcoin holders can move prices up or down at will. The top 1 percent of bitcoin wallets hold 87 percent of all the world’s bitcoin (though many of those wallets belong to cryptocurrency exchanges). U.S. Department of Justice believes creators of USDT, a cryptocurrency pegged to the U.S. dollar, rigged the market in 2017, though scientific researchers say this is hogwash.
Manipulation is a concern for SEC but not a reason to decline an ETF. Plenty of ETFs provide exposure to manipulated commodities—oil being the most obvious and openly manipulated, but the list is long and includes commodities you’d never think of, like uranium and tungsten. (Two companies determine uranium prices and almost 90% of the world’s supply of tungsten is controlled by China.)
SEC knows this and if it’s concerned about manipulation of bitcoin, it will request ETFs disclose, disclaim, or take other actions to make sure investors understand the risks.
Reason #2: SEC already rejected previous proposals
This means nothing. SEC takes its job seriously and sets a high bar for new, novel products. SEC declined the first copper ETF for two years, it took five revisions before the SEC would approve it. Plenty of other examples over the years.
Reason #3: bitcoin is used by dictators and drug cartels
This is true and proven, but SEC—and all U.S. financial regulators—make this same assumption about all financial assets, currencies, and commodities. Diamonds, anybody? Oil?
Do you know what’s the most common financial asset used by dictators and drug cartels?
While it’s easier to move bitcoin than dollars, it’s also easier for U.S. authorities to track. In fact, federal investigators used bitcoin transactions to identify Russian money laundering related to its attempts to undermine the 2016 U.S. elections. The dollars remain unaccounted for.
It’s safe to assume North Korea, Russia, and all other governments own some bitcoin, even if they probably don’t. You can assume this with gold, real estate, aluminum, and almost everything else on earth. It sucks but it’s no reason to decline an ETF.
Reason #4: ETF proposals come from entities SEC doesn’t trust
I don’t know how anybody could believe this. Some ETF proposals came from companies nobody’s ever heard of but most came from legitimate, well-established investment firms with competent, professional management.
Gemini Trust, New York Stock Exchange, and Chicago Board Options Exchange are global, profitable, well-connected financial firms. They each have immaculate compliance records and demonstrated operational excellence. They each have backed ETF proposals. None of those proposals have been approved.
Other ETF proposals came from lesser-known entities, but I assume these other companies are competent. Simply putting together an acceptable application demands some sort of legal and administrative competence. When SEC gets an application that don’t meet its standards, it withdraws the application from review. Bad applications don’t even make it to the approve/reject stage.
Why hasn’t SEC approved a bitcoin ETF?
If the problem isn’t with dictators, drug dealers, USDT, financial firms, or manipulation…what’s the hold up?
SEC claims the individual proposals each had problems—e.g., poor mechanism for setting price, no safeguards against manipulation or theft, and other technical problems.
Maybe, but I think there’s a more fundamental problem that will make it hard for any bitcoin ETF to meet the SEC’s demands.
The problem is bitcoin itself.
For other ETFs, you have clearinghouses or established marketplaces or well-known entities or some way to assess what’s going on in the markets. You usually also have troves of historical and market data to analyze, plus open markets or derivatives you can use to get a “spot price” — the price that everybody agrees reflects the true global price of the commodity at any time. This allows the SEC and investors some insight to suss out what’s going on with the markets.
With bitcoin, you don’t have any of that. You have a bunch of small exchanges (and many of them aren’t regulated), no central issuer, and no authority over any transaction. At one time, the price of bitcoin in Iran was 600 percent higher than the price in the U.S., and prices can vary as much as 10 percent from one exchange to another at any one time. No government controls bitcoin. Transactions are pseudonymous, peer-to-peer, and settled instantly—no paper involved, therefore no way to track movement of bitcoins within a marketplace unless you have forensic technology. Anybody can send and receive bitcoin from their phone. It’s mobile, decentralized, and private.
That’s a feature of bitcoin, not a bug, but it’s a real concern for regulators whose job is to make sure all investors have fair and equal access to information and markets. At least with uranium you know either Cameco or Kazatomprom (or both) are manipulating the prices. All investors can see that. It’s a level playing field. Investors know what they’re getting into and SEC has enough information to monitor what’s going on, enforce rules, and advise participants.
Bitcoin by nature doesn’t have that and may never have that, it’s designed to NOT have those features. You have a bunch of decentralized exchanges with different prices and practices and zero credibility for an asset that has no central issuer or businesses creating it. Hence the dilemma.
Don’t take my word for it, listen to the SEC: SEC’s Clayton needs to see key upgrades in cryptocurrency markets before approving a bitcoin ETF
This will change. Google has already developed services to help investors and regulators surveil cryptocurrency markets and Gemini has improved its own market monitoring. Supposedly NASDAQ also created a market surveillance team (though this is rumor, it hasn’t come out in the news). I would assume other people are taking similar actions. This activity should ease regulators’ concerns about the lack of transparency in cryptocurrency markets. Also, SEC can request ETF providers share certain data or conduct certain oversight as a condition of ETF approval.
At the same time, financial professionals continue working to make the bitcoin markets more transparent and orderly. They’re building the case for a bitcoin ETF and they will succeed eventually. There are too many wealthy and politically-connected people who want it to happen and too many credible companies laying the groundwork for SEC approval.
It will take longer than you think. Bitcoin ETF is only one of many important decisions in front of the SEC (just look at the SEC Proposed Rules, Orders/Notices, and Enforcement Actions). In the grand scheme of things, it’s not that big a deal compared to the trillions and trillions of dollars worth of other types of investments they deal with and it’s far less likely to create serious and systemic problems within the U.S. investment industry. SEC has their hands full figuring out how to effectively regulate ICOs and protect ICO investors, which is an area of activity that will have far greater consequences for cryptocurrency and financial markets as a whole. It also has some legitimate questions about whether bitcoin’s suitable for a traditional financial product like an ETF.
I worked in Congress and now I work for a government agency. I know politics and bureaucracy. Everything takes time. You have to deal with people, rules, regulations, and timelines that conflict with what you want to accomplish. Even when everything goes your way, your plans can get shut down—literally.
Meanwhile, go easy on the SEC. It exists to protect you, not decide what you can invest in. It may not seem like they’re looking out for you, but they are.
At least, they’re trying.
Mark Helfman is a cryptocurrency commentator and author of Consensusland, a novel about a country that runs on cryptocurrency.
Also published on Medium.