Why A Bitcoin ETF May Not Be Coming Any Time Soon

When it comes to the future of bitcoin, the “holy grail” has emerged as becoming the first to have a bitcoin ETF approved by the SEC.

Over three years ago, in 2013, the company of the Winklevoss twins, Cameron and Tyler, Winklevoss Capital Management LLC, launched the first proposed bitcoin ETF, the Winklevoss Investment Trust, looking to trade on the HFT-dominated BATS exchange. The SEC is expected to make a decision on it by March. A second group, SolidX Partners followed last July seeking SEC approval for its bitcoin ETF, SolidX Bitcoin Trust, which also would be listed on the NYSE.

Then on Friday, Grayscale Investments, a unit of Barry Silbert’s Digital Currency Group filed with the SEC to list its own Bitcoin Investment Trust on the New York Stock Exchange: as with the previous two attempts, the fund hopes to get SEC approval to expand the audience for the virtual currency. Initially, the trust will seek to launch with $500 million, the filing said, though the target is subject to change. At Dec. 31, it had about 1.8 million shares outstanding. Based on a net asset value of $89.39 a share, its assets under management totaled $164.2 million.

As the WSJ notes, “Grayscale’s Bitcoin Investment Trust, first launched in 2013, already trades on OTC Markets Group Inc.’s over-the-counter exchange, OTCQX. With the new filing if approved, the trust would operate as a traditional ETF, meaning that specialized traders would create and retire shares based on demand.”

Two Wall Street firms, KCG Holdings Inc. and Wedbush Securities Inc., are in discussions to serve as authorized participants, according to the filing. Additionally, the fund’s trustee will be Delaware Trust Co., and the transfer agent will be Bank of New York Mellon Corp., based on the filing.

The goal of a bitcoin-based ETF is to offer an product that would be easier for investors to access and would mute at least some of bitcoin’s volatility, although it would hardly eliminate all of it, which would still make it a riskier investment than most other ETFs.

More importantly, approval “could prove an early test for how an SEC run by a Donald Trump appointee will greet innovations that may raise investor-protection or other market-structure issues.” Furthermore, the benefits of being first on a major exchange could be big, assuming that bitcoin does manage to establish itself as a viable asset class. The SPDR Gold Shares ETF launched Nov. 18, 2004, has $31 billion in assets. The iShares Gold Trust ETF launched Jan. 21, 2005, has $7.7 billion in assets. Gold, a commodity not backed by any particular government, appeals to investors for some of the same reasons as bitcoin… even if many physical hard-core “gold-stacker” fans mock both the concept of a paper gold representing their physical holdings, while relentlessly ridiculing the idea that “digital money” contained in a server somewhere, is in any way safe (following recent dramatic breaches of a Chinese bitcoin exchange, they have a point).

Earlier this month, Needham analyst Spencer Bogart wrote that “it appears there is significant pent-up demand from the investment public for such a vehicle” although he conceded that “the probability of one being approved in 2017 was very low, expecting the SEC could be cautious about such a risky asset.”

Indeed, as one of the lawyers who helped craft the application for what would be the first-ever bitcoin exchange-traded fund (ETF) told Coindesk, he is doubtful the SEC will approve such a request any time in the near future. The critique, courtesy of former Gemini general counsel David Brill, is particularly relevant as his old employer’s last and final deadline to receive approval for the experimental product is on 11th March.

Though Brill is quick to point out he is a “proponent” of the creation of bitcoin ETFs and pro-bitcoin regulation more broadly, the prognosis does not bode well for its success. In conversation with CoinDesk, Brill explained that he believes factors such as China’s impact on the price of bitcoin make an approval unlikely.

Specifically, he said that “It seems unlikely, among all the other reasons, that the commission is going to want to move forward with a product where the major trading is done on an exchanges that may not be following our AML guidelines.” In other words, China’s domination of bitcoin trading – as much as 98% of recent bitcoin transactions took place in China – would likely force the SEC to deny any of the bitcoin ETF applications.

Blame China: “a career lawyer for 20 years, Brill worked at Thompson Financial from 2003 through 2010, when it acquired Reuters. Prior to departing Gemini last year, Brill worked as the New York-based exchange’s general council, where he said he helped create the legal infrastructure of the exchange and craft a number of responses to amendments to its S1 filing.”

Though Brill does believe that that a bitcoin ETF will eventually be allowed to do business on a major stock exchange, he said the SEC will be unlikely to do so while as much as 95% of all bitcoin transactions are carried out in China.

That, coupled with the China government’s recent crackdown on cryptocurrency exchanges and anti-money laundering practices, makes for an even less likely approval, he said.

“It’s more that the overwhelming majority of trading is not being done in the US, and being done in an area where the rules and regulations are not consistent with the rules here,” said Brill.

According to Brill, one of the big hopes for further acceptance and advancement of bitcoin is none other than Donald Trump. Speaking shortly before Donald Trump’s inauguration as President, Brill said he is “cautiously optimistic about a more promising environment for bitcoin companies in the future.”

From a strictly local business perspective, he predicted Trump would likely take a pro-bitcoin stance. However, considering concerns about a possible “trade war” with China following Trump’s expected policies, Brill said the predominance of bitcoin trading in the nation could be a hindrance.  He concluded: “I want to try to see what approaches might work to make it easier for bitcoin companies to expand across the US. Because right now, it is extremely difficult because every state has something different that they want.”

Ultimately, bitcoin investors may have to make do without a bitcoin ETF for a while, especially if as some suspect, not only Chinese traders, but local HFTs have taken over trading of the extremely volatile product. Still, that may be a good thing: failing to get ETF approval will simply keep bitcoin extremely volatile, which is also why it has become the darling asset of a subset of traders starved for volatility in a world where central banks have eliminated virtually any daily gyrations from the equity class. As such, we would expect bitcoin vol to only grow, not decline, in the process making the attainment of the bitcoin “holy grail” that much more improbable.