Needham's Insights Into Factors Affecting SEC's Decision on Bitcoin ETFs

Following up on their report which estimates a sub-25 percent chance of a bitcoin ETF approval, Needham & Company published a more detailed report on Friday. Citing “intense interest in the bitcoin ETFs that are going through the regulatory process”, author Spencer Bogart offers some insights into what factors the U.S. Securities and Exchange Commission (SEC) are likely considering in order to approve or disapprove a bitcoin ETF.

Also read: Needham: Probability of Approval for a Bitcoin ETF ‘Very Low’

Investment banking and asset management firm Needham & Company focuses solely on growth companies. Since its inception, the firm has acted as lead or co-manager in over 785 public offerings. Recently, the firm received attention for estimating the chance of the SEC approving a bitcoin ETF to be less than 25%, an estimate that has not changed in this latest report entitled ‘Digging Deeper on Bitcoin ETF Filings and Potential Effect’.

Company Filings vs Bitcoin’s Fundamentals

According to the new report, factors affecting the SEC’s decision are either specific to each ETF filing or specific to Bitcoin itself.

Since any problems specific to a company’s filing could be addressed to comply with the SEC’s requirements, Needham believes that Bitcoin-specific issues are the bigger hurdle to the ETF approval. They describe these issues as revolving around “broader concerns about Bitcoin itself and whether it is a suitable asset for a broadly investable vehicle such as an ETF”.

The report then proceeds to discuss two main factors which are potentially the most important to the Commission; suitability of bitcoin as the underlying asset of an ETF, and the state of the Bitcoin market.

Is Bitcoin a Suitable Underlying Asset?

Based on their analysis, Needham believes that the Commission is considering whether a digital asset like bitcoin is a suitable underlying asset for an ETF since it is different from a commodity, security or derivative. “Furthermore, the SEC appears to also be evaluating the risk that ownership of bitcoin could, theoretically, be changed by a coordination of a majority of the network’s hashing rate”, the report explains.

While reiterating that the SEC’s view may be different from their own, it is Needham’s opinion that being different from other asset classes does not make Bitcoin fundamentally unsuitable for an ETF. Bogart also noted that:

We think the risk of a change in ownership from a coordination of a majority of the network’s hashrate is a known risk that is reflected in the market price of bitcoin.

State of the Bitcoin Market

“The other major group of concerns that the SEC has published revolve around market dynamics”, the report reveals, drawing attention to questions such as:

Are the markets on which bitcoin is traded stable, fair, resilient and efficient?

Does the structure of these markets and corresponding liquidity and transparency enable market manipulation?

Could there be prolonged dislocations between the ETFs Net Asset Value (NAV) / Intraday Indicative Value (IIV) and the share price of the ETF?

Can an Authorized Participant maintain a tight market?

“Published comments from the SEC suggest the Commission is also evaluating the risk of loss from theft and computer hacking”, the report reveals.

While citing that liquidity is always a reasonable concern, Needham wrote that “there are ETFs for assets that are far less-liquid than bitcoin and these investment vehicles function well, so we don’t see any reason to disapprove on these grounds”.

Regarding market manipulation, the firm sees risks in any assets, not just in bitcoin. “Even the deepest and most liquid market in the world (e.g. Gold and LIBOR) have recently been the target of sophisticated manipulation from the most highly regulated entities”, the report describes. The firm believes that market manipulation is “largely independent of the actual underlying asset”, adding that:

Overall, we reiterate our prior comments that we do not see any specific reason to disapprove the ETF but believe the SEC is likely to do so primarily out of an abundance of caution and in the name of investor protection.

What reasons do you think the SEC will give for its decision on a bitcoin ETF? Let us know in the comments section below.

Images courtesy of Shutterstock and SEC

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