The plan was to list shares of the Winklevoss Bitcoin Trust on the Bats Global Exchange under the ticker COIN. The ETF, pegged to the bitcoin price on Gemini (their bitcoin exchange site), would offer mainstream investors the chance to hold an asset tied to the value of bitcoin without actually buying bitcoin in the usual way.
The SEC said no—and said it rather harshly. You might say the SEC, with a 38-page letter, rejected friend requests from both the Winklevoss brothers and from bitcoin.
But none of this should have come as any surprise to bitcoin buyers and believers.
In its decision, the SEC said that it does not believe the ETF proposal was “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 SEC also did not believe that the Gemini exchange, which launched in 2015, and which the bitcoin ETF would be pegged to, is secure enough: “The Exchange represents that it has entered into a comprehensive surveillance-sharing agreement with the Gemini Exchange with respect to trading of the bitcoin asset underlying the Trust… however, the Commission does not believe this surveillance-sharing agreement to be sufficient, because the Gemini Exchange conducts only a small fraction of the worldwide trading in bitcoin, and because the Gemini Exchange is not a ‘regulated market’ comparable to a national securities exchange or to the futures exchanges that are associated with the underlying assets of the commodity-trust ETPs approved to date.”
Translation: The SEC believes a bitcoin ETF would be too volatile and unsafe to regulate, and, if pegged to Gemini, the price would not necessarily fairly represent an accurate price across all exchanges.
Insufficiently regulated; concentrated ownership
The SEC also pointed to the high risk of bitcoin writ large, beyond just what the Winklevoss brothers had proposed.
“One commenter states that the market for bitcoin, by trade volume, is very shallow,” the SEC decision reads. “This commenter notes that the majority of bitcoin is hoarded by a few owners or is out of circulation. The commenter also notes that ownership concentration is high, with 50 percent of bitcoin in the hands of fewer than 1,000 people, and that this high ownership concentration creates greater market liquidity risk, as large blocks of bitcoin are difficult to sell in a timely and market efficient manner… This commenter also states that several fundamental flaws make bitcoin a dangerous asset class to force into an exchange traded structure, including shallow trade volume, extreme hoarding, low liquidity, hyper price volatility, a global web of unregulated bucket-shop exchanges, high bankruptcy risk, and oversized exposure to trading in countries where there is no regulatory oversight.”
Translation: Due to concentrated ownership of bitcoins, and to shady dealings at bitcoin exchanges, the SEC sees a similar fundamental problem with digital currency itself.
Of course it does.
The entire original appeal of bitcoin, when first introduced in a 2009 white paper by someone using the pseudonym Satoshi Nakamoto, was its anti-government appeal. Bitcoin is meant to be an unregulated, decentralized, non-fiat currency.
As one DC-based risk-analysis firm, Oxbow Advisory, tweeted: “Don’t ask the fiat to remove the fiat.” (The joke there: don’t expect the government to warm to a currency that undermines it.)
And this is the great irony of recent efforts to bring bitcoin more mainstream, and to obtain various licenses and regulatory approvals: it’s a contradiction of bitcoin’s original, libertarian appeal.
“After reading the response, it really does make sense that they would decline it,” says Brian Hoffman, project lead for OpenBazaar, a peer-to-peer marketplace that runs on bitcoin. “I think so far their concern has been to be able to control it and understand it, and the nature of the market over time has always been unstable. And another point they brought up around large ownerships being controlled by people that we don’t know who they are, I think that is a pretty big question mark.”
The creator of bitcoin, Satoshi Nakamoto, has yet to be unmasked (many leading voices in bitcoin doubt the reports that it is Australian cybersecurity expert Craig Wright) and theoretically still owns somewhere around one million bitcoins of the 16.2 million supply.
So the SEC doesn’t like that it doesn’t know who created bitcoin. And if Satoshi were to unload their coins, it would create a huge market event—and in that scenario, the SEC, if it had approved a regulated bitcoin asset, “could be on the hook for questions around customer losses, and that’s something they want to avoid,” says Hoffman. “So it makes sense, from a conservative standpoint, to just stay away from it.”
To be sure, there is some involvement of mainstream financial institutions in bitcoin exchanges. Coinbase, the leading American bitcoin exchange, is backed by BBVA; Crypto Facilities, a new bitcoin derivatives exchange, was launched by a former Goldman Sachs exec and former BNP Paribas exec. And beyond the exchanges, a number of blockchain-as-a-service companies, such as Chain, have amassed big-bank partners.
But banks and financial institutions have shown less interest in bitcoin as a currency.
You can see bitcoin businesses splitting broadly into two camps. There are those who want it to exist outside of government reach, untouched by regulators, and similarly aren’t excited by banks getting involved in the space; and there are those who feel regulation will bring legitimacy and mainstream usage.
Stefan Thomas, CTO of Ripple (a blockchain partner for banks that also has its own rival cryptocurrency, XRP), is in the latter camp. “I was a contributor to bitcoin early on, I was a bitcoin believer, but over time it just never became more legitimate and serious, and to me, that was the problem.”
The price of bitcoin fell by nearly 20% in the hours after the SEC denial on Friday, then bounced back somewhat. That temporary crash was also ironic, since anyone holding bitcoin as a speculative investment should have anticipated that the SEC would deny the ETF proposal.
Using bitcoin vs. holding bitcoin
As Hoffman of OpenBazaar says, the SEC decision “is only a setback for people that have the mentality that bitcoin is just for holding over time. For me, personally, the thing that’s so fascinating about bitcoin is being able to use it, not just hold it. The price going up is great, but in my eyes that’s just an extra added bonus. An ETF existing doesn’t preclude me from buying or using bitcoin.”
For bitcoin to thrive, it doesn’t necessarily need any mainstream approval or regulation, though such regulation would certainly bring more faith from traditional, cautious investors.
For an example of the divide, look no further than the different regulatory approaches of different exchanges. Two years ago, when the New York Department of Financial Services released the “BitLicense,” its set of regulatory rules that would apply to digital currency transmitters, it had an instantaneous dramatic effect: Coinbase, the leading US site for anyone to buy bitcoin, launched its bitcoin exchange without waiting for a BitLicense; Kraken, a bitcoin exchange that sees most of its trading volume in euros, swiftly halted all operations in New York rather than seek licensing; the Winklevoss brothers, eager to launch their own exchange Gemini, waited until they could obtain proper licensing (not a BitLicense, but a chartered LLC trust license) and did not launch until that happened.
Watch for the philosophical divide to continue to put stress on bitcoin businesses.
Daniel Roberts is a writer at Yahoo Finance, covering technology and sports business. Follow him on Twitter at @readDanwrite.