SEC Rejects Bitwise ETF

SEC says No, but is it no, or just not yet?

This week’s biggest news is that the decision came down on the Bitwise ETF from the SEC. The answer is No. We’ve given the Bitwise ETF lots of coverage here and believe an ETF will happen. Their proposal included:

  • Lots of excellent research including the Real 10 of exchange volume and how much exchange volume is fake

  • Unlike other proposals, they chose to take it all the way to a decision

  • They made some excellent arguments about how price discovery is improving. Bitwise believes manipulation of the market is less likely now and over time

Here is the coverage from the big crypto information sites like The Block, Coindesk, and Cointelegraph.

The Block’s piece goes into the 2 main reasons they believe the ETF wasn’t approved: manipulation concerns and lack of ‘market surveillance sharing agreements’. Manipulation is easy to understand. The SEC did not buy that the Real 10 comprises the real Bitcoin market. They told Bitwise if 95% of the volume is fake, how can we be sure the other 5% is real? The market surveillance sharing agreements really are about cooperation and monitoring of markets for illegal trading. The ETF and the largest crypto exchanges like Bitstamp, Coinbase and Binance would not/do not have such agreements. The reality is that the 2 items are related as selling and buying patterns on certain exchanges could affect the price of both Bitcoin and of a new Bitcoin ETF. This is a good article by @FintechFrank and you should read it.

The Coindesk piece focuses exclusively on the lack of mechanisms to stop price manipulation, stating that NYSE ARCA did not meet the legal requirements against manipulation. NYSE ARCA was Bitwise’s partner in the proposal for the ETF.

The CoinTelegraph piece focuses on the manipulation as well and includes the SEC quote (all 3 pieces did) with the exact language of the rejection.

"Rather, the Commission is disapproving this proposed rule change because, as discussed below, NYSE Arca has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of Exchange Act Section6(b)(5), and, in particular, the requirement that the rules of a national securities exchange be 'designed to prevent fraudulent and manipulative acts and practices.'" 

The SEC Statement

The SEC released a 112-page statement along with the rejection. We found some interesting tidbits in the statement. You already know the reason why it was rejected but Page 3 cites a positive for the cryptoeconomy.

…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

This is a good starting point of at least seeing that there’s value in the technology and investments in digital assets. Hey, you have to crawl before you can walk, right?

The SEC has a concern about whether Bitcoin is a “significant market” and “market of significant size” to uphold an ETF while preventing market manipulation (Disapproval order, p.5).

They get more specific about the significant size argument on pages 11-12 where they discuss the CME Bitcoin Futures market.

The Commission then examines whether the record supports the Sponsor’s assertion that the bitcoin futures market, as represented by bitcoin futures listed and traded on the Chicago Mercantile Exchange (“CME”), is a significant, regulated market, such that a surveillance sharing agreement with that market would provide a necessary deterrent to manipulation because it would facilitate the availability of information needed to fully investigate a manipulation if it were to occur. See infra Section III.B.3. The Commission addresses the Sponsor’s comparison of the size of the bitcoin futures and spot markets and the Sponsor’s representations about the correlation of prices between these markets, as well as whether the record establishes that there is a reasonable likelihood that a person attempting to manipulate the proposed ETP would also have to trade on the bitcoin futures market to manipulate the proposed ETP. The Commission concludes that—because NYSE Arca has not demonstrated (emphasis mine) that the bitcoin futures market is “significant,” as the Commission has interpreted that term in this context.

So the Merc’s Futures contract is not big enough to be ‘significant’. So having a surveillance sharing agreement with the CME is not relevant as a way to stop price manipulation.

One argument that we’ve made here that the SEC agreed with us is about the complete exclusion of some markets especially the OTC market (p.46). Here they spell out the volume claim (p.66).

NYSE Arca and the Sponsor have not provided sufficient data to substantiate the Sponsor’s claims that it has identified the ten platforms that have “real” volume, as distinguished from those platforms dominated by fake or non-economic trading

They go on to say (p. 68) that they do not believe that Bitwise found or represented the real true spot market for Bitcoin. And if they haven’t captured the spot market, then they can’t protect the spot market from manipulation.

Lastly, in pages 82-85, the SEC mentions Bitfinex. They discuss how Bitfinex does enough real volume to be included in the Bitwise Daily Price Index for the ETF, yet it was removed due to speculation about its relationship with Tether. The SEC used this ad hoc removal as evidence that Bitwise can’t contain market manipulation, only do something about it afterward. I’m not sure how much I agree but this is an argument Bitwise had no answer for.

The Bitwise Reaction

Bitwise is telling the world they will adjust their ETF project and refile it with the SEC ‘when appropriate’. Here is the press release with the initial reaction. They will rework it and refile it.

One of my favorite legal minds in the cryptoeconomy thinks the delay will go a little longer than people think….

Conclusion

Our thoughts from the very beginning were that the Bitwise ETF was a good attempt but probably would not pass. And that is what happened. We believe an ETF is inevitable, that it’s only a matter of time.

Some of the best and most profitable businesses in the cryptoeconomy are exchanges. As exchanges grow, improve, and new ones form with real, auditable volume, the concern about arbitrage and price discovery will go away. We also believe that the CME futures contract and the new Bakkt contract will grow in volume and institutional interest. All these things point to an eventual ETF. But for now we must wait…..

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