SEC Rejects Multiple ETFs: A Thorough Breakdown on Why ETFs Will NEVER Be Accepted

I’m sure that everyone has already seen this headline multiple times before, but I figured that I would put my two cents into the situation while it’s still somewhat fresh.

I mentioned this numerous times before, but the press release that the SEC put out in January, with regards to the Bitcoin ETF applications, made it fairly clear that they had no intentions of accepting any Bitcoin ETF this year.

However, it seems that this (as usual), fell on deaf ears; so, let’s go ahead and check up on that document again and see if we can’t glean more useful information out of it before we move on to analyzing why and how 9 Bitcoin ETF applications were rejected today (August 22nd, 2018).

SEC’s Statements on Bitcoin ETFs in January 2018

In case you aren’t familiar with what I’m referring to, I mean these statements, which can be found here:

Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings (January 18, 2018)

_As you know, the U.S. investment fund market is one of the most robust, varied and successful markets for investment…_www.sec.gov

It’s worth noting that the SEC is not bearish on cryptocurrencies, and they make that clear in this press release, when they state,

“Recently, the growth in cryptocurrencies and cryptocurrency-related products has attrated significant attention, and we have seen interest among sponsors in offering registered funds that would hold these new digital products.

As we have in the past, the Division stands ready to engage in dialogue with sponsors regarding the potential development of these funds.”

Specifically, the last sentence of the quote above underlines the SEC’s ‘open-mindedness’ with regards to cryptocurrency investments.

More or less, what the statement above is saying is, “We’ve noticed that there are a lot of people that have started investing in crypto, and we think it’s interesting too. We aren’t here to get rid of it or shit on it and if you’d like, we can talk about it.”

They do add this caveat at the end though by saying,

“We believe, however, that there are a number of significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors.”

And in this statement, they more or less reveal their major concern — systemic risk for retail investors.

The press release goes on to state that they are more than aware of the potential benefits of cryptocurrency and they are also aware of the risks.

I think this is important because it reflects a tempered, and ‘mature’ perspective on the space rather than the zero-sum, ‘This is going to change the world!’ vs. ‘This is one big scam!’ tug-of-war that you see in some other arenas (governments included).

So, let’s get to the crux of this document.

Valuation

The section titled, ‘Valuation’, is perhaps one of the more important sections contained within this press release.

The passage begins with the following,

I highlighted the last sentence there, because I believe that this is a rhetorical question. I make that assumption because of how presumptive it is to ask whether it’s plausible to build a reliable and accurate NAV (net asset value) in a context where there is virtually no regulation, extreme manipulation, and relatively infantile trading volume (compared to the traditional markets).

The obvious answer to that question is ‘No’, not ‘Well let’s see if we can prove that wrong.’

So, in many ways, the SEC is already warming up their reason for why they’ll be saying ‘no’ to all ETFs.

Further Questions

The questions posed above by the SEC are also all rhetorical in nature, in my opinion and I believe that the purpose for the SEC asking them is to sort of give people an inside view into their mentality to help them understand why Bitcoin ETFs are not going to be accepted (from anyone).

Truthfully, there are some good questions that are posed in the report, such as the question of how firms would handle a forked protocol (since those on the legacy chain typically receive ‘airdropped’ coins).

SEC is Concered About Liquidity

This is actually a point of contention that I have had when debating with others in the space over whether the Bitcoin ETFs would be accepted by the SEC this year.

When we use the word liquidity in this context, most people instantly think back to the availability of a specific cryptocurrency on an exchange.

If you can sell without a lot of slippage, then sure, there’s a lot of liquidity (assuming you sold a lot). If you have trouble getting orders fulfilled at market price, then there’s little to no liquidity in that specific market.

Now, the above two explanations of liquidity are accurate, but this case is remotely different because, by liquidity, I believe that the SEC means accessibility.

Investment Funds Would Need More Bitcoin Than What is Available

The principle of ‘hodl’ is a gift and a curse, and in this situation, it’s a curse.

While there are plenty of people that have dropped their bitcoins like it was hot potato after the bear market seriously got under way, there are still many more that are holding their positions, awaiting the next run.

In addition, there are a number of exchanges and users of said exchanges that keep massive supplies of bitcoins to either fuel their business or serve some other use case.

Thus, if a firm wishes to obtain a hefty amount of BTC, it could be prohibitively difficult to do so when considering the troubles of actually sourcing a serious bulk order, finding a legitimate seller that won’t compromise the firm (remember, we’re in the traditional sector now), and then actually obtaining the bitcoin in a safe and legal manner.

So, when considering it from that perspective, Bitcoin is a relatively illiquid asset in higher quantities at this point in time.

The SEC iterates what I have just been speaking about in the passage above.

Potential Manipulation and Other Risks

This is the part where folks tend to get the most confused.

However, the reality is this: This is the biggest concern of the commission, and it’s just simply not something that any of the ETFs can appropriately address.

“The Commission has also discussed concerns relating to the risk of fraud and manipulation in cryptocurrency markets in orders denying exchange proposals to list the shares of commodity trusts that would hold cryptocurrency.”

That’s a pretty direct statement above and one that appears to summarize the depth of how the SEC feels about cryptocurrencies in general.

They also specifically mention that pegging one’s NAV to a cryptocurrency derivative will not amend this issue either (last sentence).

The passage is then followed by a series of more rhetorical questions:

Once again, these questions read a little closer along the lines of, ‘Ask yourself these questions so that you can really understand how silly the proposal of an ETF sounds’.

Death Blow by the SEC

“Until the questions identified above can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products, and we have asked sponsors that have registration statements filed for such products to withdraw them.”

The last part of the statement quoted above is the most significant, when it states, “We have asked sponsors that have registration statements filed for such products to withdraw them.”

That reveals that the SEC is not saying “Oh, just come up with a better proposal and convince us!”

That’s them saying, “We know for a fact that the underlying market for which the NAV is based is too unregulated and volatile for retail investors. We also do not believe that there is enough accurate and concrete information in the cryptocurrency sphere for investors to make a reasonably informed decision on purchases.”

Conclusion

I know that I have outlined this before in the past, but I wanted to make sure that I really combed through the ETF decision in the most thorough manner possible so that individuals could really understand on a deeper level why the SEC will NOT accept ANY ETF application this year.

And, in light of this current information, it really begs the question of why there are firms that still insisted on submitting an application anyway when the SEC mentioned that it reached out directly to a number of ‘sponsors’ to ask them to withdraw their applications just a few months ago.

As stated before, I’m not a conspiracy theorist, but the amount of market manipulation that has accustomed this whole ETF hype is, ironically, probably another one of the reasons that the SEC is extremely reluctant if not stubbornly obstinate in their refusal to list any cryptocurrency-related (yes, that includes Bitcoin) ETFs.