In the latter half of 2018, few developments have occupied crypto investors’ headspaces like the industry’s indefatigable pursuit of a bitcoin exchange traded fund (ETF).

This conversation lay largely dormant since the Winklevosses’ first attempt was rejected by the U.S. securities regulator in March of 2017. But the twins reignited the conversation when their second attempt at an ETF was shot down by the U.S. Securities and Exchange Commission (SEC) in July of this year.

With the buzz back, the prospect (or failing prospects) of a bitcoin ETF have crowded the headlines of mainstream and crypto media alike. Following the Winklevosses’ failure to secure the coveted first-in-the-industry fund, the ensuing months would see a flurry of decision delays for existing applications, more rejections and revisions of said rejections.

The sheer volume of news surrounding ETFs — and the general complexity of the asset when compared to the simplicity of trading on the bitcoin spot market — makes the industry’s pursuit of one a rich and even abstruse topic.

So let’s see if we can set the record straight.

What an ETF Is and What It Means for Bitcoin

To start, a short explanation: an ETF is a fund that holds an underlying asset or assets, be they stocks, commodities, bonds, etc., which are then divided into shares for investors to buy. In structure, an ETF functions like a hedge fund, the primary difference being that an ETF is traded on a public market like shares of a stock, while a hedge fund is not.

With that primer in mind, we can now unpack the processes and jargon that constitute an ETF’s many working parts.

Typically, an ETF features four primary stakeholders:

a sponsor (the entity who creates the ETF)

a custodian (the entity who stores and manages the underlying asset/s)

authorized participants (financial institutions or accredited individuals who create and redeem a block of the ETF’s shares)

shareholders/investors (those who purchase the shares on the open market)

More or less, authorized participants and sponsors are in charge of the ETF’s supply. The participants create or redeem blocks of shares (called creation units) directly from the sponsor; typically, these creation units are settled in-kind, meaning they are purchased for or redeemed in the underlying asset. Once participants have purchased creation units, these units are then divided into shares and traded on public exchanges.

For bitcoin, an ETF would function similarly to ETFs for other commodities like gold and silver. Its sponsor, most likely a trust of sorts, would employ the help of a custodian to store the physical bitcoins backing the ETFs (or, in the case of futures, the futures contracts) and related cash flow, and it would also rely on eager financial institutions to jumpstart circulation by purchasing shares to trade on a regulated, legacy exchange like the NYSE, CME or Cboe.

Many investors see the bitcoin ETF as the hitherto undiscovered holy grail of institutional-grade bitcoin investments, something that could push the market to new heights. In the broader market, ETFs are considered to be a low-barrier, low-cost alternative to other investment vehicles like hedge funds, and per this rationale, community members in favor of a bitcoin ETF say it would finally give institutional investors easy, reliable access to the crypto market. Supporting this thesis, proponents often point to the impacts ETFs had on the underlying gold market, noting that bitcoin would likely experience a similar price stimulation.

Detractors don’t think this is a good thing. They believe that, by encouraging a flood of institutional money, a bitcoin ETF would drown the market in inflated valuations, an argument critics in other markets have made by insisting that ETFs distort prices and liquidity. So the argument goes: Why would we create an investment vessel that could leave bitcoin susceptible to the same inflationary threats that it was created to avoid?

The Playing Field

The merits of either argument are for another article entirely, but the perspectives are helpful for understanding why so many players are pursuing an ETF and why there’s so much noise surrounding it.

The following list looks at all past and current applications, some of which were refiled or restructured after the initial applications were rejected by the SEC or pulled by their sponsors.

In chronological order:

Winklevoss Bitcoin Trust File date: July 2013 Status: Rejected March 2017 Sponsor: Winklevoss Bitcoin Trust Custodian: Gemini Exchange Listed Exchange: Bats BZX Exchange Price Data Source: Gemini Exchange Creation Unit Size: Basket of 100,000 shares

SolidX Bitcoin Trust File Date: July 2016 Status: Rejected March 2017 Sponsor: SolidX Management LLC Custodian: SolidX Management Other Custodians: The Bank of New York Mellon (cash funds) Listed Exchange: NYSE Arca Price Data Source: TradeBlock XBX Index Creation Unit Size: Basket of 100,000 shares

The Bitcoin Investment Trust File Date: January 2017 Status: Withdrawn September 2017 Sponsor: Grayscale Investments LLC Custodian: Xapo Inc. Listed Exchange: NYSE Arca Price Data Source: N/A Creation Unit Size: Basket of 100 shares

VanEck Vectors Bitcoin Strategy File Date: August 2017 (refiled in December 2017) Status: Withdrawn September 2017 (and again in January 2017) Sponsor: VanEck Custodian: The Bank of New York Mellon Listed Exchange: NASDAQ Price Data Source: N/A Creation Unit Size: N/A

ProShares Bitcoin ETF and ProShares Short Bitcoin ETF File Date: December 2017 Status: Rejected at staff level but appealed for review by the Commission in August 2018 Sponsor: ProShares Capital Management LLC Custodian: Brown Brothers Harriman and Co. Listed Exchange: NYSE Arca Price Data Source: Cboe and/or CME bitcoin futures Creation Unit Size: N/A

GraniteShares Bitcoin ETF and GraniteShares Short Bitcoin ETF File Date: January 2018 Status: Rejected at staff level but appealed for review by the Commission in August 2018 Sponsor: GraniteShares Advisors LLC Custodian: Bank of New York Mellon Listed Exchange: Cboe BZX Exchange Price Data Source: Cboe bitcoin futures Creation Unit Size: N/A

Direxion Daily Bitcoin Bear 1X Shares, Direxion Daily Bitcoin 1.25X Bull Shares, Direxion Daily Bitcoin 1.5X Bull Shares, Direxion Daily Bitcoin 2X Bull Shares, and Direxion Daily Bitcoin 2X Bear Shares File Date: February 2018 Status: Rejected at staff level but appealed for review by the Commission in August 2018 Sponsor: Direxion Asset Management LLC Custodian: Bank of New York Mellon Listed Exchange: NYSE Arca Price Data Source: Cboe and CME bitcoin futures exchange Creation Unite Size: Basket of 50,000 shares Other Info: Direxion’s ETFs would give investors the option to short bitcoin as well as giving them a 200% short leveraging option and a 125%, 150% and 200% long leverage option — they are the only ETF filing that accommodates leveraged shares.

VanEck SolidX Bitcoin Strategy (refiling) File Date: June 2018 Status: Pending Sponsor: SolidX Management LLC Custodian: The Bank of New York Mellon Listed Exchange: Cboe BZX Exchange Price Data: MVIS CryptoCompare Bitcoin Index (MVBTC) Creation Unit Size: Basket of 25 shares Other Info: ETF is backed by physical bitcoin, but they will be redeemed in cash

Winklevoss Bitcoin Trust (refiling) File Date: June 2018 Status: Rejected July 2018 Sponsor: Winklevoss Bitcoin Trust Custodian: Gemini Exchange Listed Exchange: Cboe BZX Exchange Price Data Source: Gemini Exchange Creation Unit Size: Basket of 100,000 shares

Bitwise HOLD 10 Cryptocurrency Index Fund File Date: July 2018 See Also Adoption MicroStrategy Buys Massive 0.1 Percent Of Total Bitcoin Supply Status: Pending https://www.sec.gov/Archives/edgar/data/1746379/000149315218010390/forms-1.htm Sponsor: Bitwise Investment Advisers, LLC Custodian: N/A Listed Exchange: TBD Price Data Source: Bitwise’s HOLD 10 Cryptocurrency Index Creation Unit Size: Basket of 25,000 shares Other Info: Unlike other ETFs, Bitwise’s would be based on the 10 cryptocurrencies in its index fund, not just bitcoin.

The Winklevoss Standard and the Rationale for Rejection

The Winklevosses were the first to try and first to fail at filing a bitcoin ETF. Naturally, they set a precedent for other contenders to follow, as subsequent filings were submitted with the frontrunner’s shortcomings in mind. For the SEC, the Winklevosses’ first attempt has become something of a touchstone to evaluate the worth of those that came after it, as the first rejection order is cited in every rejection order the SEC has issued since.

And that’s because the SEC keeps running into the same problems.

In sum, these problems are few and simple. You could boil them down to three interconnected areas of concern: risk of fraud/manipulation, market size and lack of regulation.

To create an ETF for a new asset, applicants must propose a rule change to accommodate that asset in the SEC’s legal framework, and this places the onus on the applicant to prove that the asset and its underlying market are consistent with regulations laid out in the Security and Exchange Act of 1933.

As the rejection would indicate, the Winklevosses’ preliminary attempt wasn’t convincing enough to the SEC.

“[The] Commission is disapproving this proposed rule change because it does not find the proposal to be consistent with Section 6(b)(5) of the Exchange Act, which requires, among other things, that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.

“The Commission believes that, in order to meet this standard, an exchange that lists and trades shares of commodity-trust exchange-traded products (“ETPs”) must, in addition to other applicable requirements, satisfy two requirements that are dispositive in this matter. 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,” the order reads.

SolidX’s first crack at an ETF would be scrapped with the same verbiage, word for word, nearly three weeks following the Winklevosses’ rejection.

In 2013, when the Winklevosses’ ETF was filed — and in 2017 when it was summarily rejected — there were no federally regulated markets for bitcoin. Of course, the Winklevosses’ own Gemini Exchange is regulated via the New York State Department of Financial Services through one of the much-coveted BitLicenses. But the scale of this regulation is inconsequential to the SEC, so the twins’ first application was fighting a losing battle from the start.

Though by June 2017, they found an opening. The Cboe and CME exchanges launched the world’s first institutional bitcoin futures in December of 2017. By proxy, these were also the first fully federally regulated bitcoin products to trade in the United States.

So the Winklevosses took another stab at it, submitting a revised proposal and petition for review. This time around, the twins’ Gemini Exchange entered into a surveillance-sharing agreement with Cboe’s bitcoin futures market to appease the SEC’s request in the former rejection. As the name suggests, a surveillance-sharing agreement is a self-regulatory accord struck between two or more marketplaces in the same market to police fraud and manipulation. Sharing data and monitoring practices between Gemini and Cboe, then, would seemingly satisfy the SEC’s major concern with the prior application.

Still, the SEC was not impressed. In their filing, the Winklevosses et al. argue that the bitcoin market’s global nature makes bitcoin resistant to conventional mark manipulation tactics. Ironically, this argument backfired, as the SEC found that because of this global market, the Winklevoss Bitcoin Trust couldn’t possibly shield their potential investors from fraud, especially when you consider that the Gemini Exchange (which would source the ETF’s price data) accounts for a sliver of bitcoin’s daily transaction volume.

“BZX has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that its rules be designed to prevent fraudulent and manipulative acts and practices,” the rejection reads.

Looking Toward the “Futures”

The rejection rationale detailed above would be copy-pasted practically verbatim into the nine rejection orders that would come in the following month, August 2018.

These filings by Direxion, ProShares and GraniteShares, however, didn’t source their price data from the underlying spot market. In fact, the contracts weren’t for physical bitcoin at all — they would be ETFs for bitcoin futures themselves.

The logic here is pragmatic if not a little obvious. Seeing as the Winklevosses were rejected a second time even if they entered into a surveillance-sharing agreement with a regulated exchange, they must have not gone far enough. If the SEC is worried about the regulation status and integrity of the market, then the ETF (and its pricing data) must be based on a regulated market, not just surveillance-shared with it.

So Direxion, ProShares and GraniteShares followed in VanEck’s footsteps, which was the first to file for an ETF based on bitcoin futures, bizarrely, before a mainstream futures market even existed (this is why its proposal was initially withdrawn at the SEC’s request).

Unlike its counterpart in physical bitcoin ETFs, these products would divide shares of the Cboe’s and/or CME’s futures contracts, while naturally sourcing pricing data from these markets as well.

These ETFs all claim to have established a surveillance-sharing agreement with the CME’s and Cboe’s regulated futures markets. Even so, these agreements must be with a “market of significant size related to bitcoin,” and in the eyes of the SEC, the CME and Cboe aren’t there yet.

“While CME and [Cboe’s CFE] are regulated markets for bitcoin derivatives, there is no basis in the record for the Commission to conclude that these markets are of significant size,” the rejection notices read.

“Publicly available data show that the median daily notional trading volume, from inception through August 10, 2018, has been 14,185 bitcoins on CME and 5,184 bitcoins on CFE, and that the median daily notional value of open interest on CME and CFE during the same period has been 10,145 bitcoins and 5,601 bitcoins, respectively,” it continues.

With this data in mind, the SEC then says that extrapolating any “meaningful analysis” from this market volume is difficult “because reliable data about the spot market, including its overall size, are unavailable.”

Of course, these rejections were made at the staffing level and are pending review by the Commission itself, so while the staff’s decision doesn’t exactly inspire confidence, it could still be overturned by the SEC’s senior decision makers.

Precedents and Disappointments

Almost all arguments against these ETFs make their way back to the spot market.

If the ETF prices its data from spot exchanges like Gemini, these markets are too small in the scope of bitcoin’s global trading to definitively defend against fraud. If the ETF prices its data from a regulated derivatives market, there’s no reliable way to measure the significance of this future’s volume against the overall market.

The SEC’s gravest concern when deliberating bitcoin ETF approvals has been related to fraud and manipulation; market size, asset liquidity and reliability of pricing data are also wrapped up in this primary concern. And these concerns don’t even touch on the custody and settlement difficulties offerings would have to hurdle if they redeemed shares “in-kind” with bitcoin itself (there’s a reason most (if not all) of the filings since the Winklevosses’ own have opted to settle contracts in cash, instead).

Ironically, the biggest obstacle to regulating an ETF into existence, then, is the current dearth of regulated entities and structures in the bitcoin market at large. In an interview with Bitcoin Magazine, SEC Commissioner Hester Peirce hit on the catch-22 that the SEC’s rejection creates, as well as explaining that she feels their rejections set a disconcerting precedent for the SEC’s power to vet or denounce the quality of an investment.

“If you really want this market to be more orderly,” she said, “then you’ve got to let some of these forces in that are going to bring order to it,” like an institution-grade product such as an ETF.

Peirce suggested that the rejection of the Winklevoss ETF in particular set a poor precedent. “It plays into a bit of a thread in securities regulations — at the federal and at the state level — which is that there’s an inclination among regulators to almost step into the shoes of the investor and say whether or not the investor should be making that particular decision, based on our assessment of the actual product — in this case, the actual asset. So yes, that is a disturbing precedent, because I can’t make assessments about those things,” she said in the interview.

So far, ETF news has been punctuated by overarching disappointment, but a number of decision-pending files are still crowding the SEC’s desk. As we mentioned earlier, currently, the ETFs pitched by Direxion, ProShares and GraniteShares are up for review by the Commission; VanEck and SolidX’s joint effort, as well as Bitwise’s sweeping ETF of popular coins, are still being reviewed.

This September, Abra’s CEO Bill Barhydt told CNBC that he would bet on an ETF being approved “in the next year,” and Peirce said she was “a bit optimistic” that one is coming. Barhydt believes the right suitor hasn’t called on the SEC yet, but that once it does, the ETF is inevitable, while Peirce thinks that there’s enough interest in the product for an eventual approval.

Until this eventually becomes reality, though, the industry is stuck waiting on what the SEC will do next — something that’s become a constant for 2018 and isn’t likely to change anytime soon.