(Bloomberg) — First came the judge’s rebuke. Then fresh Securities and Exchange Commission research surfaced purporting to allay doubts about whether trading in Bitcoin could ever be effectively monitored.
Altogether it led the chief US securities regulator to reverse course Wednesday and deliver a landmark decision clearing the way for a slew of new spot exchange-traded funds tracking the digital currency.
Spanked by an appeals court that asked in August how one class of Bitcoin ETFs could be cleared but not another, the SEC was all but forced to capitulate. The agency backed away from its opinion that no regulated exchange had a broad enough view of crypto trading to serve as a back-up to the platforms on which Bitcoin transacts.
In approving almost a dozen ETFs linked to spot Bitcoin prices, the SEC cited new research it conducted showing prices in CME Group futures and on exchanges like Kraken and Coinbase moved close enough to lockstep that any shenanigans would show up on the Chicago venue.
Surveillance Agreements
That was enough to resuscitate previously rejected surveillance agreements with Chicago-based CME — agreements which are now key planks underpinning the permission for the spot ETFs.
“The commission concludes that fraud or manipulation that impacts prices in spot Bitcoin markets would likely similarly impact CME Bitcoin futures prices, such that a surveillance sharing agreement with the CME can be reasonably expected to assist in surveilling for fraud and manipulation that may impact the proposed spot Bitcoin ETPs,” it wrote.
The finding was in some respects compelled upon the agency by an appeals court ruling in August that lambasted the SEC for approving ETFs based on Bitcoin futures but not the cryptocurrency itself.
Grayscale Case
In the Aug. 29 order, Judge Neomi Rao said the denial of a Grayscale Investments LLC proposal for a spot ETF “was arbitrary and capricious because the commission failed to explain its different treatment of similar products,” namely the new ETFs and ones based on futures that were approved years ago.
“There is no doubt that the unanimous decision of a three-judge DC Circuit Court of Appeals panel in Grayscale v. SEC forced the hand of the agency,” said Michael Selig, partner at law firm Willkie Farr & Gallagher LLP. “The SEC ultimately would have had to substantiate its reasoning with market data and the data does not appear to support the view that the Bitcoin spot and futures markets are materially uncorrelated.”
The commission’s chair, Gary Gensler, pointed to the August ruling in his statement about the approvals. He noted that prior to Wednesday’s decision, the SEC had rejected more than 20 similar applications but that circumstances changed after the Grayscale ruling.
“Based on these circumstances and those discussed more fully in the approval order, I feel the most sustainable path forward is to approve the listing and trading of these spot Bitcoin ETP shares,” he said.
Still, Gensler — a Democrat appointed by President Joe Biden — voted with Republican commissioners Hester Peirce and Mark T. Uyeda to approve the new ETFs. The other Democrats, Jaime Lizarraga and Caroline Crenshaw, voted against approval.
‘Petri Dish’ of Fraud
In a statement explaining her dissent, Crenshaw offered a litany of reasons for her vote. Among them, she said the commission “contorts itself” to satisfy the statutory obligation that an exchange’s rules be designed to prevent fraudulent and manipulative acts.
The SEC’s correlation analysis was inadequate to conclude that fraud and manipulation that affects spot Bitcoin prices would have a similar affect on Bitcoin futures traded on the CME, she wrote.
“Among the reasons that crypto markets – including Bitcoin spot markets – appear to be Petri dishes of fraudulent conduct is because there is little to no systemic oversight of these markets, nor other sufficient mechanisms in place for the detection and deterrence of fraud and manipulation,” she wrote.
The logic cited for backing approval stopped short of reversing the SEC’s stance on another point of debate regarding CME surveillance agreements — whether enough trading occurs there versus the cash Bitcoin market for its oversight to be sufficient. The order refers to the Chicago exchange as “a U.S. regulated market whose Bitcoin futures market is consistently highly correlated to spot Bitcoin, albeit not of ‘significant size’ related to spot Bitcoin.”
That view was criticized by Uyeda, despite voting in favor of approval.
‘Missed Opportunity’
“Rather than treating Bitcoin like any other commodity, the approval order doubles down on the novel ‘significant size’ test by continuing to consider whether the spot Bitcoin ETP applications satisfy that test,” he said in a statement. “Today’s action is a missed opportunity to state that Bitcoin ETP applications should be considered under the test used for every other commodity-based ETP.”
To be sure, while Gensler voted to approve the new Bitcoin investment vehicles, his stance toward the crypto industry remains adversarial. He has repeatedly said the industry is rife with fraud and that most firms aren’t meeting registration requirements. His agency has sued a number of high-profile firms, including Coinbase Global Inc. and Binance Holdings Ltd.
He stressed on Wednesday that the decision on the Bitcoin ETFs doesn’t alter the agency’s stance with respect to other aspects of the crypto industry, including trading platforms that he said “for the most part, are non-compliant with the federal securities laws and often have conflicts of interest.”
Bitcoin briefly scaled $47,000 in a generally muted climb following the SEC’s green light for spot ETFs. It was trading at about $46,000 as of 7:40 a.m. in London on Thursday.
–With assistance from Allyson Versprille and Muyao Shen.
(Updates with market prices in the final paragraph.)
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