The SEC today rejected nine proposed Bitcoin ETFs, citing a lack of market size and insufficient exchange safeguards required to prevent fraudulent and manipulative practices. But it is the reasoning behind the ruling that may prove far more damaging to future proposals, with the U.S. federal regulator indicating a regulated ETF may never come to fruition whilst bitcoin remains a largely unregulated global market.
SEC Ruling No Judgment on Bitcoin’s Utility
The ruling, which has been hotly anticipated since the SEC began accepting proposals earlier in 2018, “emphasizes that [the SEC’s] disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment”, but rather highlights the tricky regulatory environment that proposed rule changes must navigate before being approved.
The SEC has rejected *all* of the pending derivative-backed bitcoin ETF proposals from ProShares, GraniteShares, and Direxion.
I expected the ProShares rejection this week, but final decisions on GraniteShares and Direxion weren't due until September 15 and 21 respectively. Wow.
— Jake Chervinsky (@jchervinsky) August 22, 2018
In order for the rule change to be approved, the proposed exchange must demonstrate that the market has sufficient size and that there are effective measures in place to deter fraud and manipulation. If these measures are not deemed sufficient, then the exchange must enter into a surveillance sharing agreement:
“if the listing exchange for an ETP fails to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, the listing exchange must enter into a surveillance-sharing agreement with a regulated market of significant size because “[s]uch agreements provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur.”
The size of the market is important because the SEC assumes it to be reasonably likely that, in order to manipulate a market of sufficient size, an entity would have to trade on that market. A surveillance sharing agreement would thereby allow the SEC to track any manipulation.
In addition to that, the SEC noted that if the market is not of significant size then an entity could unfairly influence the direction of the market. To counteract that, a sharing agreement with a larger market would need to be entered into to allow the SEC to investigate any possible manipulations.
The obvious extrapolation from this reasoning then becomes — how does an ETF get approved if the largest trading volumes are conducted on exchanges outside the purview of the SEC?
Largest Bitcoin Exchanges Outside US
Currently the largest crypto based exchanges include Malta based Binance, Hong Kong based Bitfinex, Luxembourg based Bitstamp, and US based Coinbase. The most infamous exchange — which offers highly leveraged anonymous margin trading amidst plenty of volume — is the Seychelles incorporated BitMEX.
It is then quite clear to see the difficulty the SEC would have in forming surveillance sharing partnerships with some high volume exchanges, considering the ease at which some have been able to move between jurisdictions.
The significance of these geographically dispersed platforms was illustrated only yesterday as a planned outage on BitMEX’s leveraged margin trading platform was the catalyst for a spike in the bitcoin price on Bitfinex at the exact time BitMEX stopped trading. At the time, BitMEX held a large amount of open short positions.
The $BTC lightning +7% breakout during Bitmex's downtime shows why odds of SEC approving the CBOE bitcoin ETF proposal should be close to zero. Even if no manipulation (that's debatable) this stresses the importance of Bitmex, a fully unregulated market with 40% market share.
— Alex Krüger (@krugermacro) August 22, 2018
The violent move as the exchange went into downtime rendered users unable to closeout their trades. Twitter went into overdrive as affected accounts screamed manipulation, not realizing they were simply outsmarted by market makers who knew a significant portion of the market would be incapacitated at a publicly announced time. While some traders are aware of this, many aren’t.
If you got smashed over the last 24hrs apply this old school rule:
Do not trade during “events” 📜
They are often associated with extreme volatility in both directions.
— BITLORD (@Crypto_Bitlord) August 22, 2018
The kind of shit that just happened on Bitmex, honestly makes me feel, like crypto should go to hell, you can't honestly really be that shameless…
— Mitoshi Kaku 👨🏻🚀 (@CryptoSays) August 22, 2018
While it is certainly ironic that a movement based on libertarian ideals has been clamoring for approval from regulated finance, this type of occurrence was always unlikely to be accepted within the halls of the SEC. Whilst the commission are ineffective and behind the eight ball in regulated financial markets already, it is the financial behemoths that they are tasked with regulating that would not enjoy playing second fiddle to overseas entities with unknown influences and largely loose regulation.
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Author: Todd Byrne