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Although the value of bitcoin and related cryptocurrencies have been on the downtrend, this has not deterred the ingenuity of market participants’ attempts to bet (or invest depending on how you view it) on bitcoin’s price movement. Besides purchasing the asset directly, market participants can also bet on its price through derivatives, contracts where the value is based on the price of the underlying asset, e.g. bitcoin. Additionally, there have been repeated attempts to form bitcoin-based exchange-traded products (ETP); however, the Securities and Exchange Commission (SEC) has yet to allow it citing, inter alia, fraud and manipulation concerns. In short, ETPs hold the assets themselves then offer securities to the public, the value of which is based on the value of the assets held. This trend might change as money management firm Van Eck Associates, Corp. and blockchain company Solid X have partnered in their attempts to form a bitcoin-based ETP. Although there are blockchain-based exchange-traded funds (ETF) already, this bitcoin-based ETP would be the first of its kind. Offering a bitcoin-based ETP involves two main regulatory hurdles, the second of which Van Eck and others hope to get through this time around.
Exchange-traded funds/products can come in one of the following five variations depending on its legal structure: 1) Open-ended funds, 2) Unit investment trusts, 3) Grantor trusts, 4) Exchange-traded notes, and 5) Partnerships. The first two of the five are deemed investment companies under the Investment Company Act and must be registered with the SEC. Nevertheless, all five are subject to The Securities Exchange Act(s), requiring registration when its securities are offered for sale to the public.
Because Van Eck’s bitcoin product is structured as a grantor trust, it is not subject to the Investment Company Act; however, it is subject to the Securities Exchange Act and Van Eck, in fact, filed an S-1 registration (see here). Additionally, commodity pools and commodity pool operators must register with the Commodities Futures Trading Commission (CFTC) and National Futures Association (NFA), respectively. Because the fund is structured such that bitcoins are purchased and held by the fund itself, the purchase of which does not involve the futures market, it is not a commodity pool and not subject to CFTC registration.
The second and last major hurdle, most problematic, is the notice that must be filed with the SEC by the exchange that will be listing the ETP—in this case, the self-regulatory organization (SRO) Cboe BZX Exchange, Inc. Part of the process for listing new types of securities on an exchange is for the SRO to file a notice with the SEC indicating, inter alia, that such listing is designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and, in general, protect investors and the public interest. The NASDAQ and New York Stock Exchange (NYSE) are more familiar SROs that must go through the same process when listing new products.
One major reason why previous applications were denied was the lack of coordination via surveillance sharing agreements between exchanges. These agreements are meant to increase coordination between market participants, prevent fraud and manipulation, and increase transparency overall. According to the registration statement, Cboe BZX Exchange remedied this by entering into such agreements with the exchanges it will be doing business with, such as Gemini and Coinbase. This is one of many remedial measures taken by the market participants to obtain SEC approval (see here).
The SEC’s decision will likely have a substantial effect on bitcoin’s price. If the SEC gives the greenlight, one could expect similar products to be produced, increasing demand for the underlying product itself (bitcoin) as funds move to purchase bitcoin, hold it, and indirectly offer it as an exchange-traded product to investors. Arguably, this is similar to what occurred to the first gold-backed ETF, launched in 2003, after which the price of gold jumped from mid-$300s to now mid-$1200s due to institutional demand[1].
In the coming weeks, we will see whether these market participants got it right this time.