An Announcement Disguised as Rejection?

A few days ago, the SEC disapproved the application of the Bats BTX Exchange for admission of the Bitcoin ETF of the WINKLEVOSS brothers. Many market participants had expected (and urgently wanted) an approval as an important step in the shift towards crypto assets. The Chicago Board Options Exchange (CBOE) also filed an application for admission of a Bitcoin ETF at the beginning of July 2018, which is still under review.

The price increase of the Bitcoin (BTC) from less than USD 7,500 to almost USD 8,500 was partly due to the expectation that these ETFs would soon be approved thus opening the gates for fresh liquidity. Accordingly, the market reacted fiercely to the SEC’s rejection. Bitcoin dropped sharply and fell below USD 7,900 in the short term. It soon recovered as it became clear that the cancellation could be a disguised announcement of early admission and was therefore not so bad. On the contrary.

It was already the second attempt of the WINKLEVOSS to get the SEC approval for their ETF venture. However, the SEC’s explanation for denial may lead us to expect that a Crypto-ETF may be approved in the 3rd or 4th quarter of 2018. How do we come to this conclusion?

The Knighting of Bitcoin

Indeed, the cryptocurrency Bitcoin (BTC) is already accepted by many of the financial analysts as a new asset class and seen as a commodity such as gold or oil. Consequently, it is regulated in the USA by the U.S. Commodity Futures Trading Commission. A Bitcoin ETF would make it easier for investors to invest into this new asset class. You buy the shares of a listed Bitcoin ETF and you are there. Management is done by the respective ETF manager who (should) understand their job. In recent years, ETFs have proven to be the most suitable financial instrument for the commodities sector. A SEC-approved Bitcoin ETF would thus officially raise Bitcoins to the rank of gold and attract billions of investments from institutional investors.

Until now, the only crypto-instruments approved by the SEC and CFTC were Barry SILBERT‘s Crypto Investment Trusts and the crypto-futures of CMOE and the CME Group. CMOE operates the largest options exchange in Chicago and hte CME Group is one of the world’s largest operators of options exchanges. This means that two instances of the US securities industry are definitely moving into the crypto-world, and for good reason. Despite (or because of) many disparaging statements, the financial establishment definitely wants to be part of the crypto-transition.

So how can one interpret and explain the SEC’s decision against this background?

Extra Time for the Financial Establishment

First of all, one has to understand the role of the SEC as a watchdog for the entire US securities market and its investors. The SEC is, of course, very well networked with the Wall Street establishment and thus a kind of informal “seal keeper” of what already exists (“invented here”). In addition, the SEC as an authority is also subject to political influence and must take this into account.

In this respect, when deciding on the admission of a ground-breaking new financial instrument such as a Bitcoin ETF, the SEC must take into account not only the interests of the applicants but also those of the US securities industry. And these interests could have been damaged by the approval of the WINKLEVOSS ETF. Wall Street’s “old” financial services providers are not yet prepared for the crypto-world. In this respect, the approval of the WINKLEVOSS ETF’s would have brought massive disadvantages for the establishment and would have given the newcomer a headstart. Quite a few investors would very likely have shifted parts of their portfolio towards Crypto and WINKLEVOSS ETFs. Usually, regulated institutional investors may only invest in listed and/or regulated financial instruments and the WINKLEVOSS ETF would have provided them with such a vehicle.

Currently, institutional investors can only invest in crypto via the fairly unregulated OTC transactions. This is why large trusted OTC traders such as CIRCLE TRADE have correspondingly high trading volumes. A listed Bitcoin ETF would undoubtedly support the shift towards crypto assets but the “old” institutional investors are not prepared for this disruptional shift at present. The SEC’s rejection has bought these incumbent players more time to prepare for the change.

In essence, the rejection of the proposal is based on the already known arguments and focused on some specific elements in the WINKELVOSS proposal. Among other things, the SEC criticized the involvement of the New York GEMINI stock exchange and other points of the application. The decision was in no way to be read as a general rejection of Bitcoin ETFs. This is what Joseph YOUNG interpreted in an initial analysis on the FORBES blog. Bloomberg, on the other hand, is rather negative and regards the rejection of the ETF as an indication of possible further rejection.

Bloomberg, on the other hand, is rather negative and sees the SEC’s rejection as an indication of possible further rejections. We don’t think so.

The decisive point here is that the rejection was also accompanied by a publicly expressed contradiction to the rejection by SEC Commissioner Heister M. PEIRCE. It was therefore essentially less a rejection of Bitcoin ETF’s than an announcement of the imminent approval of a Bitcoin or crypto ETF’s
The clear signal to the market

The Dissenting SEC Commissioner

Heister M. Peirce - SEC Commissioner
SEC Commissioner Heister M. PEIRCE

Heister M. PEIRCE, appointed SEC Commissioner by the Donald Trump government in January 2018, subsequently announced that she

“respectfully dissent from the Commission’s order disapproving a proposed rule change, as amended, to list and trade shares of the WINKLEVOSS Bitcoin Trust on Bats BZX Exchange, Inc. (“BZX”).

The world’s leading supervisory authority SEC has shown in a remarkable positive attitude how discussions can be conducted officially and in a smart political way. In many countries, it would actually be inconceivable that individual members of an admissions committee publicly announce and justify their dissent. However, it is precisely the public dissent of the SEC Commissioner and her detailed reasons that lead us to expect an approval of a Bitcoin ETF in the very near future enabling the further development of the crypto market.

In fact, listed crypto-ETFs would be important to enable regulated institutional investors to enter the crypto-scene. This would provide the market with new liquidity and new investors, thus ensuring the sustainable development of the crypto-scene and the existing financial industry. This was also the argument put forward by the SEC Commissioner.

In her dissent, the SEC Commissioner outlined that it’s not SEC’s job to act as the gatekeeper of innovation:

By withholding approval of a bitcoin-based ETP because the underlying market insufficiently resembles the markets for other commodities, we set ourselves up as the gatekeepers of innovation. Securities regulators are ill-equipped to fill this particular role.

Their mission would be to protect investors and would be ensured by identifying the risks and subsequently monitoring the SEC on an ongoing basis. Prohibiting Bitcoin ETFs would both patronise investors and hinder the sustainable development of a new asset class. According to the SEC Commissioner, the points criticised by the SEC in particular could be resolved by the entry of professional investors.

In addition, I am concerned that the Commission’s approach undermines investor protection by precluding greater institutionalization of the bitcoin market. More institutional participation would ameliorate many of the Commission’s concerns with the bitcoin market that underlie its disapproval order.

Quo Vadis Bitcoin?

Against the background of the statements of the SEC Commissioner in connection with the reasoning behind the rejection of the WINKLEVOSS ETF, we can therefore very probably expect the SEC to approve a Bitcoin ETF. It could be the ETF of the Chicago Board Options Exchange (Cboe).

Following the collapse of the ICO hype, this also suggests that the Bitcoin (BTC) share price will develop accordingly and that the crypto scene will recover. In this respect, the SEC Commissioner’s public opposition could also be seen as an invitation by the SEC and the financial establishment to prepare for this approval. Institutional investors urgently need this preparation. With this decision and the public appeal, the SEC has given them some extra time for preparation.