Bitcoin ETFs – Notice #2
Published February 1, 2024
On January 10, 2024, the SEC announced its approval of eleven bitcoin exchange-traded products. This marks a reversal of the Commission’s previous denials of similar products between 2018 and 2023. Recently, the U.S. Court of Appeals for the District of Columbia held that, in one case in particular (made by Grayscale), the Commission failed to adequately explain its reasoning for disapproving the offering, and vacated the Grayscale ruling, remanding the matter back to the Commission. Based on those circumstances, the Commission determined to approve the listing and trading of certain bitcoin exchange-traded products.
It should be noted that, in its announcement, the SEC specifically states that this change does not constitute an endorsement of bitcoin shares or derivative products. These products remain highly volatile, speculative assets subject to numerous risks for investors.
Policy
ESI has reviewed the SEC’s position on approving these ETFs, as well as the dissenting position written by SEC Commissioner Crenshaw. Additionally, the Firm has been monitoring the industry’s reaction to the initial news, as well as plans of ESI’s peer firms. Having taken all these factors into consideration, ESI will continue to restrict access to crypto asset-based products, including the recently approved bitcoin ETFs. This decision does not impact third-party managed advisory accounts.
Discussion
The Firm recognizes that news of a new product offering often excites investors who want to participate in what might be perceived as the “ground floor” of a new opportunity. Crypto-based assets have been in existence for approximately fifteen years but remain novel in many respects. However, to-date, these products remain highly speculative, volatile, and subject to fraud and manipulation.
Fraud and Manipulation
Spot bitcoin markets are subject to fraud and manipulation, particularly wash trading – which seeks to increase the appearance of high trading interest by both selling and buying the same products at the same time, then selling to third parties at inflated values. Such activity creates the impression of a false market for these products and artificially inflates values.
An analysis of 157 crypto exchanges found that 51% of the reported daily bitcoin trading volume was likely bogus. One market participant which now seeks to sponsor a spot bitcoin ETP admitted that “approximately 95%” of the data used by many participants is “fake and/or non-economic”.[1]
Concentration of Ownership
Concentration of ownership among spot bitcoin holders leaves investors vulnerable to the trading practices of a few. This concentration can impact price movements in unpredictable ways.
Unregulated Markets
Despite the SEC’s approval of eleven ETFs, the global spot bitcoin market is, itself, unregulated and lacks traditional investor protections. Lack of transparency means investors don’t have the same insight into fees and conflicts of interest that regulated markets provide and facilitates bad actors’ market manipulation.
Illegal Activities
Lack of transparency also creates a preferred means of criminals for funding illegal activities. Many illicit activities, such as money laundering, foster the perception of active markets through high trading activity designed to conceal the origins of illegal funds. Bitcoin values are based on perceived supply and demand. Thus, high trading volumes directly impact market prices, whether legitimate or otherwise.
What to Discuss with Clients
When discussing ESI’s position with respect to offering access to crypto-based assets, the following points summarize the Firm’s research and position:
- Cryptocurrencies are highly volatile and present a significant level of investor risk
- Crypto-based products are not based on traditional commodities or tangible assets.
- Valuations are based solely on perceived demand, as reflected by market activity.
- Valuation is subject to manipulation by a small group of investors.
- The underlying holdings of these ETFs remain unregulated and lack transparency with respect to fees, risks, and conflicts of interest.
- Within the first 5 trading days of the SEC’s January 10th announcement, the eleven approved bitcoin ETFs lost, on average, between 15-20% of their value.
- Crypto-based products are not based on traditional commodities or tangible assets.
- SEC approval was grudging, at best.
- While the SEC approved eleven spot bitcoin ETFs, SEC Chairman Gensler was clear that the Commission didn’t want to do so, but was pressured.
- On CNBC’s “Squawk Box”, Gensler stated (with respect to bitcoin) “…let me talk about this field more broadly…It’s rife with conflicts. It’s rife with fraud and abuse.”[2]
- Indicates that the SEC will be looking for enforcement cases to make examples in this area.
- Industry reaction to the announcement has been tepid.
- Most of the major wirehouses and investment firms continue to restrict access to these types of products.
- ESI will continue to monitor the regulatory and industry reaction to these types of products.
Questions?
If you have questions, please feel free to contact Dan Randall at 802-229-7166 or drandall@nationallife.com.
[1] Statement of Dissenting from Approval of Proposed Rule Changes to List and Trade Spot Bitcoin Exchange-Traded Products, Commissioner Caroline A. Crenshaw, January 20, 2024.
[2] CNBC, Squawk Box, Interview with SEC Chairman Gary Gensler, January 12, 2024
TC139507(0224)1