There has been a lot of talk lately about the Securities and Exchange Commission (SEC) potentially approving a Bitcoin Exchange Traded Fund (ETF). But this discussion is not new, as the SEC had already ruled negatively on two requests for Bitcoin ETF licenses in 2017. So what’s with all the hype around this now, and why is it so important?
What is an ETF and where do they come from?
Put simply, an ETF is a fund that holds ownership of an underlying asset, say, gold. The fund owns one ton of gold, which is worth whatever gold is worth at any given time, and then issues shares of the fund, which should be valued relatively to the price of the underlying asset itself. The shareholders do not own the gold, but simply the shares in the “company” (read fund) that holds the gold. The shares are easily tradable granting a large level of flexibility to investors.
From a technically point of you, an ETF can be described as a marketable security that tracks financial assets like funds, indexes, bonds or commodities. They are traded like common stock on regulated exchanges with price discovery throughout the day depending on market demand.
They first showed up in the US in 1990s and spread like wildfire in the 2000s allowing traders to greatly diversify their portfolio with relative simplicity and security. From agricultural crops, to gold, oil and other commodities, ETFs allowed traders to easily diversify their investments while granting constant access to liquidity.
What difference do Bitcoin ETFs make?
The licensing of Bitcoin ETFs could have considerable repercussions in the profile of crypto-markets today. First and foremost, it would bring a sense of security to the market as ETFs are insured and collateralized. This means investors are not at risk of losing their investment due to hacking or lost private keys, a very different scenario than the one faced by crypto traders today. In turn, this added sense of security would attract a larger pool of investors that have so far been skeptical of putting their money in such an insecure and volatile market.
However, the true change that a Bitcoin ETF would bring would be the opening of the crypto world to institutional investors. A mechanism like the ETF would finally give major investment funds the risk-mitigation and regulatory certainty they would need to jump in on the crypto-wagon. Many expect that if the ETF license is approved, we could see an explosion in interest for crypto assets like we have never seen before, with many speculating of Bitcoin and Ethereum prices in the 6 and 5 digits respectively, on the back of the wave of investor money brought by this financial mechanism.
It is naturally hard to sustain if these estimates will take place or not, and even historic looks at the impact of issuing ETFs for other assets can’t really be taken as predictions of what would happen to the price of Bitcoin. However, taking a look at a graph can at least give a glimpse of what might be in store.
Since we are talking about “digital gold” let’s look at what happened to actual gold when ETFs were introduced.
Before Gold ETFs, investors were mostly limited to buying actual coins or bars of gold, an admittedly impractical investment mechanism. The first ever gold ETF was launched on 28 March 2003 and started trading on the Australian Securities Exchange. In the US, the GLD was the first Gold ETF to receive approval for trading, and went live on November 18th, 2004. This is the historical graph for gold prices:
As you can see, the launching of Gold ETFs preceded an enormous rally in the price of gold. Some analysts suggest that the ease of access to Gold price exposure mixed with the excitement of the new financial product was behind, at least partly, the incredible bull run that the asset witnessed between 2004 and 2012.
It would be unwise to take too much out of this single standing piece of evidence. Historically, there have been a number of different variables that have justified mass investment in gold, with political and economic instability being strong drivers for the climbing price of the precious metal, like the 2007 Sub-Prime Crisis. However, ETFs do seem to have potentiated that growth by making it easier for institutional investors to gain exposure to it. If the issuing of a Bitcoin ETF would have a similar impact in the price of “digital gold” remains to be seen, but the idea has certainly excited many in the crypto sphere.
Who is behind the request for the ETF?
There have been several requests for a Bitcoin ETF license from the SEC over the last few years. Amidst some of the best known names are the Winklevoss Twins, better known for their dispute with Mark Zuckerberg over the initial idea for what is today Facebook and becoming crypto billionaires after investing in Bitcoin back in 2013. They put forward two of the most spoken of Bitcoin ETF license requests so far, but have, like everyone else, failed to appease the concerns of the SEC, and saw their request denied.
This time, the latest proposal on everyone’s radar and now being reviewed by the SEC was put forward by VanEck, an active asset manager, and SolidX, a reputable blockchain company, backed by CBOE Global Markets, father company to the Chicago Board Options Exchange (CBOE), which is the US’s largest options exchange. The VanEck SolidX Bitcoin Trust would be a Bitcoin only investment mechanism offering 5-share baskets of 25 BTC (around USD$167,500 today) per share. The trust is, therefore, targeting large registered institutional investors which are believed to have largely remained outside of the crypto market due to its immaturity and underlying volatility. The two companies decided to join forces in June to develop this proposal. Following the announcement of the joint fund in early July, the SEC is now requesting comments on the proposal. This is VanEck’s third attempt at filling for a Bitcoin ETF license and it hopes it now managed to address many of the SEC’s concerns. The trust will be fully insured for both theft and mishandling of funds, granting a considerable level of investment protection, the SEC’s biggest priority. If approved, the VanEck SolidX Bitcoin Trust shares will, naturally, be traded on the Chicago Board Options Exchange (CBOE).
What are the SEC’s concerns with a Bitcoin ETF?
The SEC is mainly concerned with the lack of regulation and the volatility of the crypto-markets, particularly taking into account investor protection. In a letter issued in January regarding the institution’s concerns, the SEC highlighted the need for the fund to adequately assert the value of the underlying Bitcoin assets against such extreme market volatility and its ability to assure market liquidity for investors, as the shares must be redeemable at all times. From a security standpoint, the fund’s ability to provide custodial services of the Bitcoin assets as well as maintain asset security, guaranteeing the safety of the private keys and the Bitcoin they hold, were put into question. The lack of investor-knowledge as well as the possibility of market manipulation and the continued lack of regulation, close the list of issues each proposal must address.
Why would the SEC accept a Bitcoin ETF this time?
It is, at this point, unclear to which side the SEC will lean, or if the present proposal adequately answer the issues first raised by the commission in January.
However, a few things changed since the last ETF proposals were shot down by the SEC. For one, last month’s SEC announcement that Bitcoin, Ethereum and other decentralized currencies will not be considered securities has represented an important step towards the regulatory status of the crypto assets.
Further, in June, the SEC voted to allow companies that sell ETFs to launch ‘plain vanilla versions” without first seeking approval from the regulator, in a move seen as important in reducing barriers to entry.
That said, a case can be made for the existence of alternatives for institutional investors to enter the market despite the lack of ETFs.
The CBOE itself, in December 2017, launched Bitcoin futures trading on its own exchange for accredited investors. Contrary to what was expected, the market’s reaction to the development was lukewarm, and if institutional money was out before then, futures didn’t seem to do the trick to change the trend, even as players like Goldman Sachs and JP Morgan tried their luck with a piece of the action.
Other funds, like the Bitcoin Investment Trust have also come to offer investors other forms of interacting with crypto assets. If the availability of investment alternatives will have a positive or negative impact on the SEC ruling, is difficult to say.
Other issues raised by the SEC, regarding custodial services by the ETF-issuing institutions have also been progressively solved by third parties, such as Coinbase, which has recently started to offer custodial services for its clients.
However, it seems clear that the approval of an ETF license, a familiar mechanism in traditional markets, would open a comfortable door for institutional investors to try the waters in the crypto world with mitigated risk.
While it is impossible to say at this time, it is hoped by most market participants that the SEC’s new outlook on ETFs, paired with an adequate proposal from VanEck and SolidX with the strong backing of a major institution like the CBOE, will be enough to suade the SEC into taking the historic decision of opening the doors of the crypto world to institutional money. Most of the comments made to the SEC on this proposal seem to support the licensing of Bitcoin Funds.
We expect to know the answer on August 16th, when the call for comments is due to close and a decision should be issued, although that could be postponed for another 45 days, pushing the decision date to September 30th.
An approval of the request could change the face of the cryptomarkets forever.
João Gaspar Marques is Content Manager at Coinvision, a market intelligence platform that helps new investors understand the cryptocurrency market and make wiser investment decisions.