Why is the SEC taking so long to decide on the spot Bitcoin ETF applications?

Nov 22, 2023 – The entire crypto sphere is anxiously waiting for the Securities and Exchange Commission’s (SEC) decision on the dozen applications filed for spot Bitcoin exchange traded funds (ETFs). But why is it taking so long? Let’s look at the process behind this lengthy decision making.

In order to launch an ETF in the US, applicants – in this case leading asset managers – must register their planned fund with the SEC. This filing includes information about the fund's investment objective, strategies, risks, and other relevant information. Most ETFs fall under the Investment Company Act of 1940 and are automatically listed after 75 days (unless the SEC decides to reject or delay the application).

This is not the case for spot Bitcoin ETFs, which fall under the Securities Act of 1933. In this case, the issuer of the ETF must first file a prospectus with the SEC (an S-1 filing), as well as to the exchange where the ETF will be traded (a 19b-4 filing). The SEC has 240 days to make a decision once the 19b-4 application is published in the Federal Register. But unexpected hurdles can be encountered along the way… 

First Bitcoin ETF application was made a decade ago

The first Bitcoin ETF application was made by The Winklevoss twins were the first to apply for a Bitcoin ETF just over a decade ago. This application, along with those made by other asset managers in the years that followed, were all rejected by the SEC.

But in October 2021, the SEC made a U-turn and allowed the first Bitcoin futures ETFs to start trading in the US. These ETFs track the price development of Bitcoin futures contracts. This means there might be significant price differences from Bitcoin’s spot price. They do not hold the underlying asset, contrary to spot ETFs. Issuers of spot ETFs track the real-time price of the underlying asset – in this case Bitcoin – and must buy the underlying asset at the end of the trading day to bring the fund's assets in line with its trading price.

That same month, Grayscale made another attempt with the SEC, filing an application to convert its listed Bitcoin Trust (GBTC) into a fully-fledged spot Bitcoin ETF. The SEC thereafter dragged its feet, eventually refusing to rule on Grayscale’s application. This decision was in turn appealed by Grayscale.

The regulator’s negative stance did not deter other market players, with ARK Invest filing an application for a spot Bitcoin ETF in April 2023, followed by 10 other leading asset managers, including BlackRock, Fidelity, VanEck, WisdomTree, Bitwise as of mid-June. A couple of weeks later, the SEC suffered a major setback. A federal appeals court ruled that it had to review Grayscale’s application.

Looking at the 240-day deadline faced by the SEC, it must approve (or reject) ARK Invest's application by Jan 10, 2024. Experts expect the regulator to announce its decisions on the 11 other applications at the same time to avoid favoring one market player.

The stakes are huge. Analysts expect several billion US dollars to flow into these spot Bitcoin ETFs within the first weeks of their approval. A figure which could reach 100 billion dollars within five years.

Numerous concerns have been raised by the SEC

Over the years, the SEC has expressed numerous concerns over the filed Bitcoin ETF applications. These include the lack of investor protection and the risk of market manipulation and fraud, as a result of custody problems due to Bitcoin’s digital provenance and arbitrage issues stemming from the absence of liquidity in Bitcoin markets.

But the review process is slowly but surely ticking along. As of September, within weeks of the court’s public rebuke of SEC for its handling of the Grayscale application, the US regulator began to request additional input from the asset managers. Reports that they were refiling their applications with additional information have since emerged.

What these refiles seem to have in common is that they describe a surveillance-sharing agreement with Coinbase, aiming at detecting and deterring fraud. Coinbase is the largest crypto exchange in the US in terms of trading volumes. The exchange employs its own trade surveillance team and a proprietary surveillance technology, Eventus, to monitor its trading platform in real time. Eventus is based on artificial intelligence and machine learning techniques.

Bloomberg also reports that the SEC has instructed the asset managers to handle the funds as cash rather than in-kind creations. In a cash create, authorized participants (usually large institutional investors) deliver cash to receive shares of the ETF. In an in-kind creation, the participants deliver the underlying assets, in this case Bitcoin. The ETF issuers would thus be accountable for Bitcoin transactions. This is a problem for ETF broker-dealers, as they typically don’t deal in crypto assets such as Bitcoin. To complicate things further, in-kind creations are more interesting for investors in terms of spreads and taxes.

Earlier this week, some of the asset managers filed new amendments to their S-1 registrations with the SEC. “A good sign” according to Bloomberg’s ETF analyst Eric Balchunas, who ultimately foresees a 90 percent chance of the SEC’s nod in favor of the 12 spot Bitcoin ETF applications.

The Head of Research and Strategy at Matrixport, Markus Thielen, is even more optimistic following Binance’s settlement with the SEC on Nov 21. “With this plea deal, the expectations for a spot Bitcoin ETF might have increased to 100% as the industry will be forced to follow the rules that TradFi [traditional finance] firms must follow. More importantly, the whitewashing of this industry will make the Bitcoin adoption case for institutional players much stronger and will likely become a safe-haven asset in investors’ portfolios.”

As the crypto community eagerly anticipates the SEC's Bitcoin ETF approval, the outcome is poised to redefine the industry landscape and fuel substantial market growth.