What will it take for a Bitcoin ETF to get approved?

An ETF is an "Exchange Traded Fund". It is traded just like a stock on a stock market (such as the NYSE or NASDAQ), but instead of representing ownership in a company, it follows the price of a commodity or index.

Now that the dust has settled after Friday’s Security and Exchange Commission (SEC) Bitcoin ETF decision, let’s dig deeper into the challenges of a Bitcoin ETF being approved. The SEC’s ruling states two reasons for disapproval.

[The] Commission is disapproving this proposed rule change because […] First, the exchange must have surveillance-sharing agreements with significant markets for trading the underlying commodity or derivatives on that commodity. And second, those markets must be regulated.

Problem 1: Surveillance-sharing agreements

A surveillance sharing agreement is an agreement between the ETF operator and bitcoin exchanges.

  • Sharing agreement: information about market trading activity, clearing activity and customer identity, without being materially impeded by the non-U.S. entity’s rules, or secrecy or blocking laws.

Bitcoin and it’s exchange markets are being met with well-founded concern, in regards to potential market manipulation. One needs to look no further than this chart to see evidence of this.

This chart outlines the reported global Bitcoin trading volume across all public bitcoin exchanges over the past two years. In January 2017, the trading volume from Huobi, BtcChina, and OKCoin virtually vanish. These three China based exchanges were under Chinese government scrutiny near the end of 2016. Markets with proper oversight do not experience such sudden and precipitous drops in trading volume.

The proposed “Winklevoss Bitcoin Trust” ETF only had a surveillance sharing agreement with “Gemini Exchange”.

The Gemini Exchange conducts only a small fraction of the worldwide trading in bitcoin …Gemini Exchange accounted for just 0.07% of all worldwide bitcoin trading, and 5.16% of the much-smaller bitcoin-USD market worldwide …

In fact, the SEC is correct in assessing that Gemini exchange is by no means a “significant market” for bitcoin trading. In the above chart, we can see quite clearly that over the past 6 months, Gemini has contributed very little to the overall BTC/USD market.

The majority of BTC/USD trading occurs on offshore exchanges. The proposed ETF’s had virtually no surveillance of any Bitcoin trading, and therefore would be unable to properly detect and oversee market manipulation.

Problem 2: Exchange regulation

In the SEC’s analysis, it deals a secondary blow to the Winklevoss Bitcoin Trust’s proposal.

…the Gemini Exchange is not a “regulated market” comparable to a national securities exchange…

Having a look at Gemini’s website, we see that Gemini exchange does not define itself as a “regulated market”.

Is Gemini a licensed and regulated exchange?

Gemini Trust Company, LLC is chartered under New York State Banking Law as a limited liability trust company (“LLTC”). Gemini is domiciled in the State of New York and regulated by the New York State Department of Financial Services (“NYSDFS”). As an LLTC, Gemini is a fiduciary

The Gemini exchange is currently operating in the United states as a trust under the oversight of the New York Department of Financial Services.

What needs to happen for a Bitcoin ETF

Given all these hurdles, significant changes in the market are required before an ETF proposal could fulfill these requirements.

  1. Majority of Bitcoin trading occurring on US Based exchanges

  2. US Based Bitcoin exchanges petitioning for “regulated market” oversight

The first requirement is going to be very difficult, but is likely the only way significant trading activity could ever fall under surveillance-exchange agreements.

As far as exchange regulation goes, until there is significant trading volume occurring on US based exchanges, there it is rather unlikely that exchanges will petition for increased regulation, due to the increase of associated costs.

Institutional investors looking to gain exposure to digital currency markets will likely have to work with regulated brokerages, or, offshore ETF’s, such as the one currently listed in Sweden. A US based Bitcoin ETF is not on the horizon.