Future Uncertain After SEC Rejects Bitcoin ETFs

by Goodwin

On March 10, 2017, the Securities and Exchange Commission (“SEC”) rejected the highly anticipated Winklevoss twins’ COIN bitcoin exchange traded fund (“ETF”), causing the digital currency to plummet 18% in value, to $978.76, “the lowest intraday price in a month.”  Then, on March 28, 2017, the SEC rejected a second bitcoin ETF, providing additional guidance that it continued to believe Bitcoin was too easily used for fraudulent purposes.  In explaining its reasoning for denying both COIN and the SolidX Bitcoin Trust, the SEC stated that it rejected the rule changes (for COIN, BZX Rule 14.11(e)(4), and for SolidX, NYSE Arca Equities Rule 8.201) because it did not find them “to be consistent with Section 6(b)(5) of the Exchange Act.”  Specifically, it stated that the proposed exchange-traded products (“ETPs”) had to satisfy certain requirements in order to be approved.  In particular, any “national securities exchange [must] be designed to prevent fraudulent and manipulative acts and practices and to protect investors and the public interest.”  To satisfy such requirements, the SEC stated that “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 SEC found that because “significant markets for bitcoin are unregulated,” the Exchange “would be unable to enter into[] the type of surveillance-sharing agreement that has been in place with respect to all previously approved commodity-trust ETPs.”  In its March 28, 2017 rejection of SolidX Bitcoin Trust, the SEC sung the same tune.  In short, the SEC continues to believe that bitcoin as a currency is too unregulated and that the exchanges seeking to list the ETPs are too exposed to fraud and manipulation for the SEC to approve either one.

The SEC seemed to close the door on future bitcoin ETFs unless and until the ETF exchanges are able to enter into surveillance-sharing agreements with “significant, regulated markets relating to the underlying commodity,” here bitcoin or other digital assets. Right now, the SEC contended, no such markets even exist that would permit any bitcoin ETF to overcome such a hurdle.  Thus, there seems to be a chicken and the egg conundrum for aspiring bitcoin ETFs that the SEC has determined it will not help solve – bitcoin must become traded on “significant, regulated markets” and become less subject to fraud and manipulation in order to satisfy the SEC, but it cannot do so unless and until it obtains the broader market backing that comes with an ETF.  As a result, after the SEC’s decisions to deny both bitcoin ETFs, the price of bitcoin fell dramatically.

Yet, in the two weeks since the SEC’s decisions, Bitcoin has risen to its pre-ETF rejection value, valued as of April 19, 2017 at $1,206.82, and cryptocurrencies have grown even larger in popularity and adoption.  Indeed, while many believed that Bitcoin’s meteoric rise in value prior to March 10, 2017 was due to the expected positive SEC decision, it seems that it may have instead been due to groups around the world accepting digital currencies as valid payment methods (for example, various universities have begun accepting bitcoin as payment for semesters) and adopting wider use of the blockchain.

Still, the SEC’s fears of bitcoin and digital currency susceptibility to market manipulation and fraud gained new traction as Bitfinex suddenly blocked all wire deposits in any fiat without explanation on April 17, 2017. It’s unclear what caused the problem, but many are speculating that it has something to do with its “banking operation” which is Wells Fargo.  Bitfinex recently “dropped a lawsuit against Wells Fargo, accusing it for [sic] pressuring its banks into blocking its outgoing wire transfers,” though it does not appear that the practice has ceased.  A second bitcoin exchange, OKCoin, followed on April 18, 2017 and also cited banking issues.  Bitcoin’s price has remained steady, but many are fleeing the Bitfinex exchange, potentially providing the SEC with cover regarding the apparent fragility of the current state of digital currency exchanges and bitcoin’s potential for market manipulation.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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