“While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse Bitcoin…. Investors should remain cautious about the myriad risks associated with Bitcoin and products whose value is tied to crypto.”—SEC Chair Gary Gensler
Notwithstanding Mr. Gensler’s warning, he, along with two other Commissioners, voted last week to approve 11 exchange-traded funds (ETFs) holding Bitcoin for the first time since the inception of cryptocurrency. As of January 10, 2024, US securities exchanges may list Bitcoin ETFs for trading. Cryptocurrency enthusiasts hope this decision signals a broader adoption of cryptocurrency in the United States. Perhaps it does, but celebration may be premature—the decision almost certainly means enhanced regulatory scrutiny in this space.
An ETF is a type of investment fund holding assets—like stocks, bonds or commodities—traded on stock exchanges. Previously, for large swaths of American investors, investing in cryptocurrency was not so straightforward. Today, these investments are available on Nasdaq, CboeBZX Exchange and NYSE Arca. This offers the introduction of shares of Bitcoin into mainstream investment plans and creates a new bridge between Bitcoin and centralized finance (CeFi).
The SEC’s decision to approve these ETFs was tepid and followed a losing court battle, which largely forced the SEC’s hand. In August 2023, the SEC lost a DC Circuit appeal with Grayscale Investments over whether the SEC needed to reevaluate its decision to decline Grayscale Bitcoin Trust’s (GBTC) latest application to convert to an ETF. In the announcement, Chair Gensler made it clear that the SEC “did not approve or endorse Bitcoin” but that the ETF approvals were “the most sustainable path forward” after its court defeat.
GBTC’s path to ETF conversion has been a rocky one. Founded in 2013, GBTC operated as a trust, offering its investors shares of Bitcoin exclusively. GBTC is currently valued at nearly $29 billion. Shareholders of GBTC do not actually own Bitcoin—they own shares of a trust that has access to Bitcoin. While GBTC slowly obtained regulatory approval over the past decade, the lack of classification as an ETF came with significant drawbacks for stabilizing the price of GBTC. New GBTC shares were restricted for between six and 12 months from the date of purchase, meaning they could not be sold regardless of the value—whether the shares were trading at a premium or a discount. After the hold period, the shares became unrestricted and holders could resell those shares in the public over-the-counter (OTC) market. Further, the SEC did not allow investors to redeem GBTC shares directly from Grayscale Investments, forcing investors wishing to offload their GBTC shares to sell to another investor. This greatly hampered GBTC’s ability to track the price of Bitcoin since investors would often be forced to sell their shares at discounts to other investors. Now that GBTC is an ETF, the redemption prohibition and hold periods are gone. The day after GBTC’s ETF conversion, it was listed on NYSE Arca.
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The SEC’s reluctance to approve GBTC and the other ETFs should alert the market to likely enhanced regulatory scrutiny in the future. The SEC narrowly granted these approvals following a 3-2 vote by the Commissioners. While Mr. Gensler supported approval, he warned that “investors should remain cautious about the myriad risks associated with Bitcoin and products whose value is tied to crypto.” He further caveated that these approvals were limited to ETPs holding Bitcoin and “in no way signal the Commission’s willingness to approve listing standards for crypto asset securities” or “anything about the Commission’s views as to the status of other crypto assets under the federal securities laws….” Commissioner Caroline Crenshaw had even sharper words about the decision: “fraud and manipulation that impacts the price of spot Bitcoin surely impacts the price of the spot Bitcoin held in the ETPs.” She went on to say that “our investor protection inquiry necessarily begins with the spot Bitcoin markets. Are those markets safe? Substantial evidence indicates that the answer is no.”
The SEC Commissioners’ reluctance forewarns of the SEC’s continued effort to control, through regulation, the cryptocurrency enterprise writ large, and this change most certainly will be followed by an uptick in regulatory actions involving cryptocurrency-related fraud, market manipulation and failure to adhere to existing requirements—particularly now that ETFs offer a larger group of American investors an additional option for their 401(k)s and investment accounts.
Grayscale may have written the playbook for crypto ETFs, but now they, along with others, will have more rules to follow. While a new pool of investors gained access to GBTC, GBTC now must comply with a host of new regulations and requirements, including stringent listing criteria, continuous monitoring of trading activity and periodic financial reporting.
If cryptocurrency-investment firms and exchanges have any chance of surviving the regulatory onslaught to come, they must heed the lessons of the past in their preparation for the future. Compliance should be atop that list of preparation. Building, implementing, and documenting robust compliance programs today is paramount to their survival tomorrow.
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