The Current State of a Bitcoin ETF: SEC Announcement and XBX Price Performance

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On Wednesday August 22, 2018 the United States’ SEC disapproved a proposed rule change related to the listing and trading of several bitcoin based ETFs. The SEC order effectively rejected nine applications for an ETF put forth by three different companies: Direxion, GraniteShares, and Proshares. The Direxion and ProShares listings were to be traded on NYSE Arca while the GraniteShares listing was to be traded on the CBOE. After the announcement, the price of bitcoin slid modestly at all major US exchanges. The XBX index value at 9:00 ET was 6,665.40, before selling off down to 6,250.69 at 18:11 ET, before recovering to 6,426.23 by the end of the day at 21:00 ET. SEC commissioner Hester Pierce shortly after ordered a review of the rejection, which has allowed prices to continue to recover.

Among the proposals, Direxion sought approval for five applications, and GraniteShares and ProShares sought approval for two each. While GraniteShares and Proshares sought vanilla offerings, Direxion, known for providing alternative ETFs, offered leveraged and inverse leveraged financial products tied to the price of BTC.

One of Direxion’s proposed ETFs offered leveraged short exposure (2x) and three offered leveraged long exposure (1.25x, 1.5x, and 2x). While often the SEC will reject ETFs that are over-levered, given such products are higher risk instruments, there was no indication that this was a factor in the SEC’s decision to reject these varying ETFs. According to SEC documents released by the commission’s office, the primary reason for the rejection was that none of the exchanges that these products were to be listed on was able to provide evidence that a bitcoin spot market was free of fraudulent and manipulative practices or that a bitcoin futures market was of significant size to satisfy this requirement for regulatory oversight.

An excerpt from the SEC highlighting this concern is below:

  • “the Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.” https://www.sec.gov/rules/sro/cboebzx/2018/34-83913.pdf

 

  • “National securities exchange’s rules (must) be designed to prevent fraudulent and manipulative acts and practices. Among other things, the Exchange has offered no record evidence to demonstrate that bitcoin futures markets are ‘markets of significant size.’” https://www.sec.gov/rules/sro/nysearca/2018/34-83904.pdf

 

XBX Price Performance

TradeBlock’s XBX index is designed to provide a reliable, institutional-quality reference rate for the USD-denominated price of bitcoin. The index value is calculated every second by weighting each of its constituents based on their short-term and long-term volume, their price variance in relation to other constituents and the frequency of their trading data. Constituents that deviate significantly from the set are de-weighted in real time in order to minimize their impact on the index.

Despite the negative announcement, bitcoin prices managed to hold above a key support level at $6,000. The post announcement sell-off was relatively muted as much of the market had baked this news into asset prices after the Winklevoss Bitcoin Trust ETF was rejected in late July. As shown below, XBT prices began declining around 16:00 ET and volumes spiked when media sites began publishing the negative news. At 18:00 ET there was another leg down as several major news outlets ran the story and we saw prices bottom at $6,250.69. Shortly after, prices began to recover and volumes (shaded in blue) spiked again (shown in the figure below).

 

To note, it was interesting to see that the most significant bitcoin drop occurred at 11:59 ET when the index lost 2.70 percentage points–this was before the SEC announcement came. This initial sell-off could have been traders betting on negative news prior to the announcement or traders simply taking some risk off the table.

On August 23, 2018, just one day after the rejection announcement, SEC Commissioner Hester Pierce ordered a review of the rejections which has been a boon for the market. In the days since Commissioner Pierce ordered a review, bitcoin prices have rallied. At the time of publishing, the index value was at  $6,902.50.

 

Future Bitcoin ETF Possibilities

The recent rulings have dampened investor speculation but by no means closed the door for future bitcoin ETF approval. The recent rejection ruling still requires a decision given it is under review as well as additional proposals which are still pending. An approval will likely be dependent on Commissioner Pierce’s ability to change the commission’s views on bitcoin exchange traded products. Commissioner Pierce has been an outspoken proponent of a bitcoin ETF and an advocate for financial de-regulation and innovation more broadly. She was the only opposing vote in the SEC’s 3-1 decision to reject the Winklevoss Bitcoin Trust ETF on July 26, 2018. Notably, following the Winklevoss Bitcoin Trust ETF rejection, Commissioner Peirce dissented from the commission’s stance in a public Twitter message:

Her ordered review, while a positive step forward, is ultimately unlikely to result in a reversal of the SEC’s position on a bitcoin ETF without greater evidence that bitcoin markets are free from manipulation. As in the Winklevoss Bitcoin Trust ETF which was rejected with a 3-1 vote, it is likely that a similar outcome will occur post the review with Commissioner Pierce the sole dissenter. While it does not look promising that a near term proposed ETF will be approved, the SEC has yet to decide on the fate of perhaps the most anticipated ETF this year, the VanEck SolidX proposal. The SEC has delayed a ruling on this proposal until September 30, 2018.

Asset management firm Van Eck Securities and the blockchain company SolidX Partners joined a partnership to submit a bitcoin ETF proposal to the SEC on June 5, 2018. The VanEck SolidX Bitcoin Trust will issue shares, which represent fractional undivided beneficial interest in and ownership of the Trust. The investment purpose is for these shares to reflect the performance of the price of bitcoin, after subtracting the  expenses of the Trust’s operations.

This proposal was touted as having the greatest chance of approval. First, the product is intended for institutional investors and not for retail investors–there is a minimum purchase price of $200,000 per share. Additionally, the ETF is physically backed by bitcoin and will thus be under the purview of financial regulators at the CFTC. Lastly, media reports have stated that some CBOE insiders have claimed that the product has as high as 99% chance of approval. (https://bitcoinexchangeguide.com/credible-cboe-insider-vaneck-solidx-bitcoin-etf-has-99-chance-for-approval-after-secs-delayed-decision/)

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