Bitcoin ETFs Approved: What Did You Miss?

The SEC finally approved Bitcoin funds, balancing innovation with the need “to protect investors”. The first trading day is today — January 11, 2024.

The financial world stands at the cusp of a notable evolution with the introduction of Bitcoin-based Exchange-Traded Products (ETPs) as of January 10, 2024. The Securities and Exchange Commission’s (SEC) latest release (№34–99306) is a long awaited decision shaping the landscape of cryptocurrency investment in mainstream markets.

The report outlines the SEC’s examination of proposed rule changes submitted by major exchanges including NYSE Arca Inc., The Nasdaq Stock Market LLC, and Cboe BZX Exchange Inc. These proposals aim to list and trade shares of financial instruments like the Grayscale Bitcoin Trust and the Bitwise Bitcoin ETF, among others.

What is an ETF?

An Exchange-Traded Fund (ETF) is a type of investment fund and exchange-traded product; they are traded on stock exchanges. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold throughout the day on stock exchanges while mutual funds are bought and sold based on their price at the end of the trading day. ETFs are attractive as investments because of their low costs, tax efficiency, and stock-like features.

Imagine you have a fruit basket. This basket contains a variety of fruits — apples, bananas, oranges, and grapes. Instead of buying each type of fruit separately, you buy the entire basket, so you get a little bit of everything in one purchase.

Now, let’s relate this to an ETF:

1. The Fruit Basket = ETF: The fruit basket represents an ETF. Just like the basket contains different fruits, an ETF contains a mix of different investments — like stocks from various companies, bonds, or even gold. This mix is professionally managed to ensure a good variety and balance.
2. Buying Individual Fruits = Buying Individual Stocks: Instead of buying each fruit separately (like buying individual stocks of different companies), you buy the basket (ETF) that already has a variety of fruits (stocks or other investments).
3. Trading on the Stock Market: Just like you can buy or sell your fruit basket at a market, you can buy or sell an ETF on the stock exchange. The price of the ETF can change throughout the day, just like the prices of fruits can change based on demand and supply.
4. Diversification: By buying the fruit basket (ETF), you are not relying on just one type of fruit (or one stock). If apples (a particular stock as well 😉) are not doing well, maybe oranges (another stock or bond in the ETF) are. This reduces the risk because you are not dependent on the performance of just one type of fruit (investment).
5. Convenience and Cost: It is more convenient and often cheaper to buy the basket with a mix of fruits rather than going around buying each fruit separately. Similarly, it is often more convenient and cost-effective to buy an ETF than to buy many individual stocks or bonds.

So, an ETF is like a pre-made basket of investments. You buy the basket to get a diversified collection, which is traded on the stock market, and the value of your basket can go up or down based on how the individual contents (investments) perform.

In the context of our discussion today, Bitcoin ETFs specifically refer to ETFs that track the price of Bitcoin, allowing investors to invest in Bitcoin without having to go through the process of buying and securely storing the cryptocurrency themselves. This makes Bitcoin more accessible to a broader range of investors, potentially increasing its mainstream adoption.

Discussion and Commission Findings

Exchange Act Section 6(b)(5)

In the context of Bitcoin ETPs, the SEC is evaluated how these products comply with the objectives of Section 6(b)(5). The analysis includes whether Bitcoin ETPs can operate in a manner consistent with the rules of national securities exchanges, focusing on the integrity of the pricing mechanisms, the reliability of the underlying Bitcoin market, and the measures in place to prevent fraudulent and manipulative practices.

The SEC concluded that while Bitcoin ETPs present unique challenges in terms of pricing and market manipulation, they can be structured to align with the objectives of Section 6(b)(5). This includes the adoption of comprehensive surveillance agreements and robust market monitoring tools to ensure fair and transparent trading practices.

Exchange Act Section 11A(a)(1)(c)(iii)

For Bitcoin ETPs, the SEC evaluated how their listing and trading would impact market efficiency, the competitive landscape, and investor protection. The focus was on assessing the market maturity for Bitcoin, the transparency of trading activities, and the impact of Bitcoin ETPs on broader market dynamics..

The SEC determined that the integration of Bitcoin ETPs into the securities market could be achieved without significantly disrupting market efficiency or competitive balance. However, this is contingent upon the proper regulatory oversight to ensure transparency and fairness in trading activities.

Other Comments Related to Bitcoin ETPs

In acknowledging the diverse opinions on Bitcoin ETPs, the SEC has shown an awareness of the dual nature of this innovation — the potential for significant investment opportunities alongside notable risks and uncertainties regarding market readiness. While this recognition is commendable, it also raises questions about the SEC’s preparedness to regulate such a volatile and largely untested market segment. The SEC is trying to be open-minded and listen to everyone’s opinions about Bitcoin ETPs. This is a good thing because it shows they want to understand all sides of the story. However, this can also be a bit of a problem. It is like trying to please everyone at a big family dinner — sometimes, in trying to make sure everyone’s happy, you might forget to pay enough attention to the most important things, like making sure the food is cooked right.

Takeaway

The SEC needs to find the right balance. On one hand, they want to encourage new and exciting ideas like Bitcoin ETPs. On the other hand, they need to make sure they have strong rules in place so that these new ideas do not end up causing trouble, like making the market unstable or not protecting investors who put their money into these ETPs.

The SEC’s approval, as additionally announced by Chair Gary Gensler, is a positive step indeed. However, the SEC’s decision comes off as inconsistent and belated, given its previous staunch rejections of similar products. This inconsistency in regulatory approach raises concerns about the SEC’s adaptability and understanding of the constantly changing cryptocurrency market. While the SEC’s concerns regarding market integrity and investor protection are valid, its long-standing reluctance to engage with cryptocurrency products may have hindered the market’s development and regulatory clarity. Cryptocurrencies, especially Bitcoin, have shown resilience and growing acceptance, yet the SEC’s approach has often been overly cautious, potentially stifling innovation.

The SEC’s decision to focus only on Bitcoin also appears narrow and fails to address the broader spectrum of digital assets that are gaining traction. This selective approval process may unintentionally signal a lack of a comprehensive regulatory strategy for the crypto sector, potentially leading to market confusion. Moreover, the SEC’s emphasis on the risks associated with cryptocurrencies, such as their use in illicit activities, while important, often overshadows the potential benefits and innovation that these technologies bring. A more balanced and forward-looking regulatory approach is needed to foster the growth of the crypto market while ensuring investor protection and market integrity.

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