Why are bitcoin ETFs so important and U.S. regulators so against them?

by Jonathan Adams
bitcoin ETFs

Last week the London-based and Guernsey-registered Jacobi Asset Management listed Europe’s first spot bitcoin exchange-traded fund (ETF) on Euronext Amsterdam. The ETF gives European investors real-time exposure to the spot price of bitcoin without having to buy or hold the cryptocurrency directly.

The ETF buys and holds the bitcoin and investors buy units in the ETF – a regulated exchange-traded product.

Trading under the BCOIN ticker, Jacobi’s spot bitcoin ETF was actually approved nearly two years ago. The originally planned 2022 launch date was delayed by market conditions a year ago. Cryptocurrencies saw significant value declines last year as markets turned away from risk against a backdrop of soaring inflation and rising interest rates and Jacobi chose to wait for better market conditions.

bitcoin etf chart

Source: EuroNext

But now Europe does have its first spot bitcoin ETF, adding to ETNs (ETFs represent ownership in an actual pool of assets, while ETNs represent a promise by the issuer to pay a return based on a specific index or benchmark) by WisdomTree and 21Shares. More will almost certainly follow.

Jacobi’s BCOIN is Europe’s first spot bitcoin ETF – but Canada’s are 2 years old

Jacobi’s spot bitcoin ETF is not, however, the first in the world. Purpose Investments launched a spot bitcoin ETF (BTCC) on the Toronto Stock Exchange in February 2021. The world’s first Bitcoin ETF backed by physically settled bitcoin, it crossed $1 billion CAD ($740 million USD) in assets under management a month after coming to market.

Despite being the first spot bitcoin ETF, BTCC has always had competition in Canada and internationally. Evolve Funds Group’s EBIT spot bitcoin ETF listed in Toronto just a day later and CI Galaxy’s BTCX and 3iQ CoinShares’s BTCQ followed in March and April respectively.

In Brazil, QR Asset Management launched its QBTC11 ETF in June 2022 and Galaxy Digital and Itau Asset Management partnered to list the Sao Paolo stock exchange’s second in November last year.

None of those spot bitcoin funds has suffered from any notable issues in their now 2 years plus of history – something that advocates hold up as evidence that the U.S. regulator, the Securities and Exchange Commission (SEC), is being overly cautious in its refusal to approve any of the multiple applications for U.S.-listed equivalents.

What is the SEC’s problem with spot bitcoin ETFs?

The SEC has rejected dozens of spot bitcoin ETF applications over the past few years. There are currently 8 active fillings waiting on a decision, including one from Blackrock – the world’s largest asset manager.

There are bitcoin futures ETFs listed on U.S. exchanges. But the SEC has so far steadfastly resisted approving spot price equivalents, citing the belief the bitcoin spot price market suffers from fraud and manipulation.

Crypto analytics firm Santiment says there are currently 15,870 Bitcoin addresses that hold at least 100 BTC. Collectively, these whales own 11.5 million BTC, making up over half of the total existing supply (59.2%). Within that group of thousands of bitcoin ‘whales’, there is a smaller group of ‘mega’ whales – entities that hold 10,000 or more bitcoin. At the end of last year, there were around 120 of these ‘mega whales’.

That concentration of supply, says the SEC, means that a small number of entities have the power to meaningfully shift the spot price of bitcoin by placing large buy and sell orders. And it believes market manipulation of this kind has been a common event over the history of the original and still market-leading cryptocurrency.

However, a growing number of market analysts and observers believe it is now only a matter of time before the SEC follows the precedents set by Canada, Brazil and now Europe to approve its first spot bitcoin ETFs.

That’s especially the case now that the might of Blackrock, a huge and mainstream asset manager, has been thrown behind the push for U.S.-listed spot bitcoin ETFs.

Will the SEC relent and approve the first U.S.-listed spot bitcoin ETF this year?

But even Blackrock’s size and reputation alone won’t be enough to convince the SEC to shift its stance on spot bitcoin ETFs. Having rejected dozens over the past few years, any ETF filling that does win approval will have to do something different – allay the SEC’s fear that bitcoin’s spot price is vulnerable to manipulation.

Blackrock and the Nasdaq exchange that has filed to host its proposed ETF, think they have the answer – a surveillance-sharing agreement with the exchange Coinbase. Coinbase, one of the largest crypto exchanges in the world, will monitor its market for any indication of bitcoin spot price manipulation and share that information with Blackrock.

Coinbase has also been recently named as the market surveillance partner for several other proposed spot bitcoin ETFs in the process of applying for U.S. listings. Current candidate ETFs include one put forward by Fidelity, Blackrock’s biggest money management rival in the U.S. market and another behemoth of regulated financial markets.

The Nasdaq’s filing states that Coinbase has represented approximately 56% of dollar-to-bitcoin trading on U.S.-based platforms year-to-date – making it the best-placed market to monitor for any signs of fraud and price manipulation.

The risk is that the SEC will argue that surveillance agreements with just one market for spot bitcoin transactions, albeit a large one, is not enough to monitor for potential bitcoin price manipulation.

But while the risk of market manipulation is the SEC’s biggest concern around spot bitcoin ETFs, it is far from the only one. Custody and security complications around funds holding bitcoin, the crypto market’s immaturity, a lack of appropriate regulatory frameworks and price discovery issues are all also cited.

If the SEC were to approve a spot bitcoin ETF, or several at once (more likely to avoid accusations of favouritism or worse), how significant an event would that be?

Why are U.S.-listed spot bitcoin ETFs so important to bitcoin and the crypto market?

There is a belief that SEC approval for spot bitcoin ETFs would be a major milestone in the quest for the crypto market to become more integrated with mainstream financial markets. It would, many believe, confirm the arrival of bitcoin and cryptocurrencies as a genuine, if still alternative, asset class.

The first U.S.-listed spot bitcoin ETFs would be expected to attract capital of anywhere between $1 billion and $10 billion in assets under management within the first weeks and months of launch. There is currently around $2 billion invested in U.S.-listed bitcoin futures vehicles.

Dave Nadig, a financial futurist at data firm VettaFi, said during an appearance on the ETF Prime podcast, that the launch of the first spot ETFs could be among the biggest ETF launches in history. He is convinced up to half of the $20 billion invested in the Grayscale Investments’ Bitcoin Trust (GBTC), which he describes as “a completely broken pink-sheet trust”, would be quickly transferred to U.S. spot vehicles as soon as they become available.

Spot bitcoin ETFs listed in the USA, by far the world’s biggest capital market, could also lead to the bitcoin price becoming far less vulnerable to manipulation by mega whales. If there were enough interest, and there are signs there might be, big spot ETFs could inject significant liquidity into the bitcoin market.

An April 2022 survey commissioned by Nasdaq found 72% of financial advisers would be more likely to invest client assets in crypto if a spot bitcoin ETF were offered in the US. 32% of financial professionals cited “lack of easily accessible investment vehicles like ETFs and mutual funds” as a barrier to crypto allocation, according to a January report by Bitwise and VettaFi.

An ETF-catalysed influx of mainstream capital and an increase in trading volumes injecting liquidity should make bitcoin prices less volatile. That will in turn make it a more attractive asset class for mainstream investors, creating a virtuous feedback loop that would gradually wear down the influence of whale and mega whales on the bitcoin spot market.

But that would take time and bitcoin spot price market manipulation will be a worry for regulators for some time to come. However, if the SEC can be convinced the market surveillance agreements proposed by Blackrock and others offer enough of a safeguard to approve the first spot bitcoin ETFs this year, it will be a significant moment for cryptocurrencies.

Spot price ETFs for other major cryptocurrencies, like Ethereum’s ether and Ripple’s XRP, would be expected to follow.

Spot bitcoin ETFs listed on U.S. exchanges won’t solve all the issues around the integration of cryptocurrencies with mainstream finance. But it will be a significant milestone – if it happens. The SEC has proven an obstinate obstacle to the growth of the cryptos market in the USA and may not be ready to be convinced quite yet – even by Blackrock.

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