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No ETFs, No problem; SEC still took a shine to institutional crypto

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How regulators see Bitcoin is more important than how the market sees it.

With Bitcoin surging by over 250 percent this year, 2019 has been a busy year for the cryptocurrency market. One of the busiest parties in the market were the regulators, particularly the Securities and Exchange Commission [SEC].

Unlike the previous year where regulators acted like bouncers, throwing out scam token-issuers and defining who could and couldn’t enter the ICO party, this year saw the SEC act as referees, adding on extra-time but eventually blowing the whistle on the institutional rush into the crypto-market.

Being the gatekeepers to what would become the year institutions arrived into Bitcoin, the SEC had to be mindful of what products and companies could herald this big-money wave into cryptocurrencies.

ICO: Institutional Compliance Onset

Cryptocurrency-wise, the regulators dealt with ICOs and institutions. The former has already been elaborated upon here.

It was evident that institutional interest would dominate the market in 2019 for two reasons. Firstly, analysts pointed to a price increase 12-15 months prior to a scheduled block halving, with a price rise expected to bring in the big-boys with their big-bucks. Secondly, the previous year saw several institutions set-up shop with the intention to launch in 2019.

Many industry players were looking at the SEC over other price-influencers, particularly with so many institutions signaling interest. Fabian Wahle, Chief of Compliance at NASH, told AMBCrypto that regulators will keep a close eye on the market,

Crypto regulations will have a huge effect on the future of the space, so it is positive that the SEC is beginning to take crypto more seriously and grappling with the implications of decentralization.”

Fidelity Investments was the first big-name on the scene. In October 2018, the investment giant announced a separate division dedicated to cryptocurrency trade-execution and custody, with Fidelity Digital Assets meant specifically for institutional investors. This came a few months after it was rumored that Goldman Sachs was looking to set-up a trading desk for cryptocurrencies, a rumor which did not come about.

The next sign that institutions were looking to dive into crypto-trading came in the form of Bakkt. The digital assets platform by the Intercontinental Exchange [ICE], parent company to the NYSE, announced in August 2018 Bakkt, which “intends to leverage Microsoft cloud solutions to create an open and regulated, global ecosystem for digital assets.”

TD Ameritrade, a brokerage company that allows its clients exposure to BTC Futures via the CBOE also announced an investment in ErisX, a cryptocurrency derivatives exchange in a “bid to offer clients digital asset investment options beyond the popular Bitcoin.” Ameritrade even saw paper trading in Bitcoin and Litecoin in mid-2019.

Three Letters: E-T-F

While asset managers were wooing institutions with their custom products, some were looking to pool-together to launch publicly traded products. Despite 9 ETF applications submitted and shot-down by the SEC, including one presented by the Winklevoss twins, the year began with two strong ETF proposals.

Bitwise Asset Management with exchange-partner NYSE Arca and VanEck/SolidX with CBOE BZX filed two separate ETF applications, days apart in January 2019. While the year saw companies like Wilshire Phoenix file for a Bitcoin ETF with US T-Bills exposure to balance out the risk, the tribulations of Bitwise and VanEck set the tone for the SEC’s ETF judgment.

Many in the market believed that the key, from a liquidity standpoint, was an ETF that would bring in fresh money. The stamp of approval from the SEC would also be a sign of market maturity for a fledgling market. VanEck’s Digital Assets lead, Gabor Gurbacs, stated,

While the pros of the Bitcoin ETF were being listed, the SEC’s criticism of a publicly-traded Bitcoin product rested on a plethora of scams and manipulation, criticism that it laid out when ousting Gemini’s ETF application. The SEC has since reiterated this time-and-time again.

“Although the Commission is disapproving this proposed rule change, the Commission emphasizes that its disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment. Rather, the Commission is disapproving this proposed rule change because, as discussed in detail below, 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.”

Jay Clayton, Chairman of the SEC, himself spoke out about the need for investors to be protected from these ‘manipulative acts’ in an interview earlier in the month. The SEC, in its regulations, should aim to strike a balance between investor protection and fostering new technologies, added Wahle, who also said that he was uncertain how this balance would evolve.

Clarity in the clear

With the SEC clearly laying out the premise – ETF only in a mature-market free of manipulation, applicants began levelling with the SEC. Bitwise, in March, presented a 227-page report that spelled out how the market had evolved since the bubble of 2017. While the headlines were grabbed by the claim that 95 percent of crypto-exchange reported trading volume that is “fake or non-economic” in nature, Bitwise presented it insofar as to argue that the real-10 exchange volume depicted the true liquidity of the Bitcoin market, and that wasn’t it.

Bitwise stated that “Volume Is More U.S. Focused Than Is Widely Perceived,” with 30 percent of volume coming from US-centered exchanges, noting that most exchanges purporting fake volume were based overseas. Regulated derivatives exchanges, CBOE and CME, even saw BTC Futures volume just $20 million short of top spot exchange, Binance.

The report stated that the 10 exchanges used to derive Bitcoin’s price for their ETF, the real-10, traded “Extremely Tightly.” Institutional understanding was also on the same level, as every regulated crypto-product in the US or Europe [CBOE, CME, XBT Provider, and AMUN] drew their prices from the real 10-exchanges.

In order to decrease the risk of market manipulation, Bitwise would calculate the Net Asset Value [NAV] of Bitcoin according to the prices of the 10 exchanges in a 30-minute window, broken into 5-minute intervals, which they argued,

“The use of a Volume-Weighted Median Price means you cannot manipulate the price by contributing a single outlier trade; you must manipulate the majority of global spot bitcoin volume in a five-minute window to have any influence on the NAV.”

Despite presenting a detailed analysis of the degree to which the market was resistant to manipulation, in not one but two reports [second published in September 2019], the SEC struck down the Bitwise ETF application, weeks after VanEck withdrew their own application. However, in the hope for a Bitcoin ETF, Bitwise looked at the brighter side, which was – a scrutinized look by regulators at a crypto-product, rather than a half-glance.

The SEC clearly stated that the application did not meet the rules “designed to prevent fraudulent and manipulative acts and practices.” In a Twitter thread, Bitwise added that the order added clarity to ongoing issues and while the market has matured over the past two years, there’s a lot that needs to be “overcome.”

In terms of market maturity, Capriole’s Charles Edwards described the problem as “a bit of chicken and an egg.” In his opinion, the more Bitcoin traded, the more liquidity was generated, and in that endeavor, derivatives can only help.

“An ETF is probably inevitable, and the more time that passes, the more liquid and established Bitcoin will become (assuming no major government counter-movements or Bitcoin security breaches). Derivatives, Options and smaller funds entering the space will help this process, as does the growing stability of exchanges and other infrastructure in the space.

Derivatives and Options

The other essential facet of crypto-trading is contractual i.e., in Futures. While ETF saw delays and rejections, derivatives enjoyed a massive high.

Right from the off, CBOE pulled out of the BTC Futures market due to its dwarfed volume compared to its cross-town rival, with CME’s volume soon ascending. Coupled with Bitcoin’s rising price in Q2 of 2019 and as the only avenue for regulated BTC Futures, CME’s volumes soared throughout the year, averaging close to 6,000 daily contracts.

Later in the year, Bakkt finally launched to a cold welcome. Averaging 70 BTC worth volume on its first day, Bakkt’s partially physically-delivered contracts saw rising volumes. However, considering its large backers and the institutional fervor that preceded it, it didn’t come any close to expectations.

From a regulatory standpoint, the approval of the next stage of derivatives saw much more market delight. In November, the CME Group stated that from the first quarter of the next year, Bitcoin Options will be rolled out, pending regulatory approval. With both CME and Bakkt coming out with Bitcoin Options, Edwards stated that this would begin the “onboarding process of institutional money.”

With regulators keen on the reduction of Bitcoin’s price volatility, for it to be suitable for investment, Edwards stated that Options would help,

“We can speculate that the heavier involvement of institutions, and Bitcoin Options, will dampen Bitcoin’s volatility in the longer-term, and hence permanently change the trading dynamic altogether.”

Smaller Funds

The cream was not all concentrated at the top, however, as smaller funds plying BTC products saw the green light from the SEC as well. Towards the end of the year, the New York Digital Investment Group LLC [NYDIG] had their Bitcoin Strategy Fund approved by the SEC, something which Chainanalysis’ Chief Economist Philip Gradwell graded as ‘the most significant regulatory decision of 2019.’ He told AMBCrypto,

“From an institutional perspective, the most significant regulatory decision by the SEC was the NYDIG/Stone Ridge approval to establish a bitcoin futures fund targeted at institutional investors.”  

NYDIG described its fund’s primary investment as cash-settled Bitcoin Futures traded on exchanges regulated by the CFTC in its October filing. A month before the SEC approval, NYDIG’s subsidiary, NYDIG Execution, received a BitLicense from the state of New York to offer custody solutions for five cryptocurrencies – BTC, ETH, XRP, LTC, and BCH.

While not attracting as much attention as it deserved, in Gradwell’s opinion, this showed the SEC’s dedication to “institutional cryptocurrency space, while delivering on that commitment.” Moreover, the custody decision by New York regulators, in addition to the Federal body, indicated that regulators are looking at two sides of institutional investment in digital assets – custody solutions and fund development.

Institutions on the Rise

At the close of 2018, Bitcoin’s price was on a knife’s edge. Institutional investors were planning on pouncing, but they waited for the SEC to make things clear. With the close of this year, a lot of uncertainty has been done away with.

The three fronts of institutional interest – ETFs, derivatives, and custom crypto-products have seen significant development. ETFS came and went, with regulators stating that the market was still highly manipulated and immature, derivatives saw a new layer of speculation in options trading, while Bitcoin funds broke through and several companies like Fidelity and TD Ameritrade signaling their intention of launching crypto-products in the space.

While 2018 saw interest but no structure, 2019 brought greater structure into the institutional market and both market players and regulators are to be credited for the same. Gradwell stated that the involvement of institutions was primarily for building the “infrastructure” owing to the likes of Fidelity and Bakkt. However, compared to the larger spot and retail trade, institutional volumes are “likely still small, so they are unlikely to have really affected price discovery yet.”

Edwards added that if one were to look at the bigger picture, the SEC was level-headed in confronting issues that needed confrontation while approving products with a strong-backer or the necessary prerequisites. Looking at their regulatory history, things could be worse. He closed by stating,

“Generally speaking, I think the SEC has been relatively neutral to Bitcoin. It could be a lot worse. “


Aakash is a full-time cryptocurrency journalist at AMBCrypto covering primarily the US market. A graduate in Finance and Economics, his writing is centered around regulation and institutional investment within the cryptocurrency space. He is also an aspiring triathlete.
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