Don’t Get Too Excited, but the SEC Approved Bitcoin ETPs

On January 9, a hacker posted from the Securities and Exchange Commission’s (SEC) official X account. The post announced that the SEC had officially approved exchange-traded funds (ETFs) to hold spot bitcoin. Within 30 minutes, the post was deleted and the SEC declared a breach.

The next day, the SEC made an official announcement to the same effect. Specifically, the SEC approved the listing and trading of 11 exchange-traded products (ETPs) holding spot bitcoin.

Background

It’s been over 10 years since the Gemini founders first asked the SEC to approve a spot bitcoin ETP. Since that time, the SEC has denied more than 20 spot bitcoin ETP applications due to market manipulation concerns. Although the 11 recently approved filings are similar to the prior rejected filings, current SEC Chair Gary Gensler noted that circumstances have changed.

The most significant change in circumstances was an August 2023 ruling from the U.S. Court of Appeals for the District of Columbia, for which Morrison Foerster submitted an amicus brief, finding that the SEC violated its own processes in rejecting a crypto issuer’s application to list a spot bitcoin ETF. In particular, the court overturned the SEC’s rejection on the basis that the SEC did not adequately explain why it banned spot bitcoin ETPs, while allowing the listing of ETFs holding bitcoin futures. The court noted that both spot bitcoin ETPs and bitcoin futures ETFs track the market price of a single asset—bitcoin—either directly or through exchange-traded futures contracts. A correlation analysis conducted by the SEC in connection with the approvals confirmed that the bitcoin futures market was consistently highly correlated with the spot bitcoin market over a period of more than 2.5 years.

Approvals

The SEC reconsidered the case in question and approved the application, along with 10 others, on January 10. The simultaneous approvals were calculated to level the playing field for issuers and to promote fairness and competition. Existing rules and standards of conduct—such as the fiduciary duty for investment advisers and Regulation Best Interest for broker-dealers recommending spot bitcoin ETPs to retail investors—will apply. The spot bitcoin ETPs are each listed and traded on a registered national securities exchange, subject to fraud and manipulation controls. Sponsors of spot bitcoin ETPs will need to provide “full, fair, and truthful disclosures” in public registration statements.

A Measured Win

Although crypto advocates were quick to characterize these approvals as a boon for crypto advancement and adoption, SEC Chair Gary Gensler cautioned that the approvals were limited to a single commodity (bitcoin) and did not signal any SEC position on other crypto assets. He reiterated his position that most crypto assets are investment contracts subject to federal securities laws and that most crypto trading platforms operate in violation of those laws. He further reminded investors to be cautious about bitcoin as a volatile asset, popular among criminals for its use in illicit activity.

And yet—Gensler’s was the deciding ballot in a 3–2 SEC vote for approval, joining his Republican-nominated colleagues in a ruling against the Democratic-appointed dissenters.

In her dissenting statement, Commissioner Caroline Crenshaw distinguished between ETPs holding bitcoin futures versus those holding spot bitcoin. Among other things, she pointed out that the former has a primary regulator while the latter does not. She also warned that fraud and manipulation in the spot bitcoin markets could expand through the ETPs and pointed to the high concentration of bitcoin mining operations and holdings and the minimal oversight of the crypto markets as further risk factors.

The Bigger Picture

In the first day of trading, spot bitcoin ETPs saw $4.6 billion in trading volume. And in the short period of time since the SEC approved the initial slate of spot bitcoin ETPs, the aggregate assets under management across all such products has grown to more than $25 billion. But as the hype subsides and fees and trading volumes stabilize, it remains to be seen if the market for spot bitcoin ETPs will continue to grow. To do so, they will need to receive consistent allocations from institutional investors and find a place in model portfolios. It is currently unclear what these allocations might look like—if they materialize at all.

Equally important is the question of whether the approval of spot bitcoin ETPs is a harbinger of opportunities for other crypto assets that least resemble securities—for example, could an ETP holding spot or ETH futures be next?—or whether the SEC will try to hold the line here. Chairman Gensler noted that the SEC is “merit neutral” and doesn’t take a view on particular assets underlying an ETP, but he also cautioned that this very narrow approval should not be seen as willingness to approve listing standards for other crypto asset securities. It seems likely that the SEC will continue to be challenged in this by market participants that believe their products comply with the requirements of the federal securities laws and that wish to participate in the regulated market. How the SEC handles these opportunities will dictate whether the SEC under Gensler facilitates capital formation through a more robust trading market regulated by the SEC or allows the current market uncertainty to persist.