Following the US Securities and Exchange Commission’s (SEC) decision to deny the Winklevoss’s Bitcoin ETF application, investors in the cryptocurrency market panicked, taking the bitcoin price below the $8,000 threshold.

The decision, which was first reported by CNBC, stems from a publicly released document that explains their decision to deny the application.

The SEC’s Reasoning on the Bitcoin ETF Ruling

A widely recognized cryptocurrency researcher better known by the Twitter handle of @AureliusBTC broke down the intricate application, offering a well-reasoned explanation of what occurred and how this could affect future applications.

Aurelius began with an explanation of the Winklevoss ETF proposal, explaining its intentions:

“The Winklevoss ETF was intended to do the following: ETF would hold spot BTC bought via Gemini.

NAV would be based on Gemini’s daily auction.

Each share was set to be worth 0.01 BTC.”

In the application, filed by Bats BZX Exchange, Inc. (BZX), the filing party was seeking approval to list and trade shares of the Winklevoss Bitcoin Trust, which would trade at 0.01 BTC based on NAV rates from the twin’s Gemini exchange.

As Aurelius explained, “the main reason for rejection was that the market has too much potential for manipulation in the eyes of the SEC — And thus doesn’t meet the requirements of the Exchange Act.”

The Securities Exchange Act was implemented by the SEC in 1934 in an effort to ensure financial transparency and reduce the likelihood of fraud and manipulation. As the pricing model of the proposed ETF would be based on exchange rates, there is inherently a risk of manipulation stemming from trading algorithms and so-called “whales.”

The fact that pricing would be based on Gemini alone rather than the aggregated markets also proved to be an issue in the application. The SEC cited several application comments that called into question the liquidity, pricing, and trading volume of the Gemini Exchange. The application stated:

“Several commenters claim that the Gemini Exchange has low trading volumes, and one commenter claims that, of all the exchanges, Gemini has the worst pricing. Another commenter asserts that the Gemini Exchange has relatively low liquidity and trade volume and that there is a significant risk that the nominal ETP share price will be manipulated by relatively small trades that manipulate the bitcoin price at that exchange. This commenter states that, while U.S.-based bitcoin exchanges are subjected to stricter regulations and auditing for the holding of client accounts, the trading itself seems to occur in a regulatory vacuum and seems impossible to audit effectively.”

Another interesting point in the SEC filing calls into question the regulatory stature of Gemini, stating:

“The record does not establish that the Gemini Exchange is a ‘regulated market’ comparable to a national securities exchange or to the futures exchanges that are associated with the underlying assets of the commodity-trust ETPs approved to date. Even if the Gemini Exchange were ‘regulated,’ the record does not support a finding that the Gemini Exchange represents a ‘significant’ bitcoin-related market.”

The SEC also questioned the impact of the CME/CBOE futures markets on manipulation, claiming that they are not sizable enough to matter to the market. The statement read in part, “Based on the record before it, the Commission concludes that…BZX has not established that it has entered into, or currently could enter into, a surveillance-sharing agreement with a regulated market of significant size related to bitcoin.”

Aurelius concluded his breakdown of the ruling with a summary, stating:

“SEC believes the spot market has too much potential for manipulation.

States that only using Gemini isn’t good enough & that it’s too low volume/liquidity.

Says that: ‘(No) current trading venue in the worldwide bitcoin spot market is a regulated market.’”

Aurelius also explained the important differences between the Winklevoss and VanEck/SolidX proposals, noting:

“Winklevoss ETF was accessible to retail b/c it was set to 0.01 BTC per share, making it less likely to be approved. The VanEck proposal sets each share to be worth 25 BTC — thus restricting access.”

Investor access to the products is a critical component in the SEC’s decision, as their main intention is to protect unsavvy investors from dangerous investments. Having a high share price will restrict access to wealthy investors who meet the SEC’s accredited investor requirements.

In addition to the high share price, the VanEck proposal’s pricing model will be based on the OTC markets for the NAV, using multiple exchanges for pricing data.

As Aurelius interestingly notes, the Tether controversy was also cited as a concern in the SEC release, saying:

“Additionally, the Commission notes that recent academic papers suggest that the price of bitcoin can be, and has been, manipulated through activity on bitcoin trading venues. One recent academic paper examined whether the growth of the circulating supply of Tether…through new issuances ‘is primarily driven by investor demand or is supplied to investors as a scheme to profit from pushing cryptocurrency prices up.’”

Bitcoin’s price hit a low of $7,848 on Coinbase following the decision and is trading at $7,883 at the time of writing.

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