Gu Yanxi: Bitcoin ETF application is a question that the new SEC chairman needs to answer immediately

On December 28, 2020, I published an article ("Ten Predictions for the Development of the U.S. Crypto Digital Financial Market in 2021"), predicting 10 development trends of the U.S. crypto digital financial market in 2021. One of them is that the application for Bitcoin ETF will be submitted again. And the chance of approval will increase. Just two days later, on December 30, VanEck again applied for Bitcoin ETF. One of the main reasons why VanEck applied for Bitcoin ETF so early is that the current SEC Chairman Jay Clayton has just left office. When the new SEC Chairman takes office, the application for Bitcoin ETF is very likely to be approved.

Given the current market enthusiasm for Bitcoin, Bitcoin-based ETFs will surely be welcomed by the market. The issuers of Bitcoin ETFs will receive very good commercial income. In fact, in the past few years, there has been a very strong demand for the establishment of Bitcoin ETFs in the market. Issuers have been applying to establish Bitcoin ETFs (see the figure below). However, such applications have been rejected by the SEC. The main reason given by the SEC recently is that the issuers of ETFs cannot guarantee that the price of Bitcoin will not be manipulated by the market, and that Bitcoin currently has no suitable custody mechanism.

According to media reports, the Biden administration will nominate Gary Gensler as the new SEC chairman. If Gensler's appointment is approved, one of the issues he needs to solve immediately is the application for a Bitcoin ETF. For Gensler, this will be a very challenging issue.

Retail and institutional users have begun buying Bitcoin

Bitcoin as a trading product is now gaining popularity in the US market. Both institutional investors and retail trading users in the US have begun to buy Bitcoin. However, due to different regulatory restrictions and trading convenience, different types of users use different ways to buy Bitcoin. For retail users, they can trade on existing cryptocurrency exchanges in the US market. These exchanges include Coinbase and Kraken. They can also purchase through third-party tools, such as Square and PayPal. For institutional users, due to the amount of funds they can use to buy Bitcoin and the restrictions on compliance, their purchase channels are more limited. This is why Grayscale's Bitcoin Trust has a high premium and MicroStrategy's stock has a large premium (see my article "What does Bitcoin's compliance premium indicate?").

For retail users in the United States, the existing ways to buy Bitcoin are still not convenient. ETFs are products in the U.S. stock market that are very convenient for ordinary investors to buy. Therefore, if ETFs based on Bitcoin are listed and circulated, more ordinary investors will participate in the buying and selling of Bitcoin.

Among the reasons why the SEC rejected the Bitcoin ETF application, the Bitcoin custody mechanism has been greatly improved. In addition to existing specialized crypto digital asset custody companies such as Fidelity, federal banks under the supervision of the OCC can also begin to provide Bitcoin custody services. Therefore, for the custody of Bitcoin ETFs, the solutions provided in the market should be able to meet regulatory requirements. The most important issue now is that the Bitcoin market transaction price is not manipulated. This should be the biggest challenge facing Gensler.

There are already Bitcoin-based trading products in the US market

There are already financial products based on Bitcoin in the US trading market. The market prices of Bitcoin they are based on are different. The price of CME's Bitcoin futures is based on a comprehensive index. This index is based on the Bitcoin trading prices of five cryptocurrency exchanges. These exchanges are Bitstamp, Coinbase, Gemini, itBit and Kraken. The price of Grayscale Bitcoin Trust is based on the trading prices of four cryptocurrency exchanges. These four exchanges are Kraken, Coinbase, LMAX Digital and Bitstamp. However, the trading price of Bitcoin is influenced by the prices of cryptocurrency trading venues around the world. Therefore, whether it is the exchange based on CME's Bitcoin futures or the exchange based on Grayscale Bitcoin Trust, the spot trading volume of Bitcoin in these exchanges cannot completely determine the market price of Bitcoin. Therefore, even for the existing Bitcoin-based trading products in the US market, their underlying price basis is not so stable.

For Gensler, his options for applying for a Bitcoin ETF include: first approve the establishment of a Bitcoin ETF, then implement a regulatory mechanism to thoroughly ensure that the spot price of Bitcoin is not manipulated by the market; first take regulatory measures to ensure that the spot trading of Bitcoin is not manipulated by the market, and then approve the Bitcoin ETF. Now it seems that Gensler is more likely to adopt the first approach. This is because there are already products such as Bitcoin futures, Bitcoin options and Grayscale Trust Funds in the US securities market. Secondly, American mass investors have already purchased Bitcoin spot directly on exchanges such as Coinbase and Kraken, or through Square and PayPal. Therefore, in the US market, whether there is a Bitcoin ETF or not, mass investors have already bought and sold Bitcoin under the existing market conditions. What the SEC can do is to implement regulatory measures as soon as possible after approving the establishment of a Bitcoin ETF to prevent the spot price of Bitcoin from being manipulated. If we look at it from another perspective, preventing the market price of trading products from being manipulated is a continuous task, not a one-time job after reaching a certain stage. Therefore, even if the current Bitcoin market is imperfect, it is still possible to launch a Bitcoin-based ETF. At the same time, in the process of market operation, the market should be constantly regulated and price manipulation in the market should be cracked down.

Given the characteristics of global Bitcoin transactions, in order to effectively regulate Bitcoin, U.S. financial regulators need to cooperate with other financial regulators to formulate corresponding regulatory policies. I believe this is also the consensus of major global financial regulators. For example, European Central Bank President Lagarde recently once again proposed the importance of cooperation among major global financial institutions in regulating Bitcoin (see my article "Interpreting the European Central Bank President's Attitude and Influence on Bitcoin Regulation"). In fact, global financial regulatory cooperation in this regard will not be limited to Bitcoin regulation. Due to the characteristics of blockchain and the stablecoins and encrypted digital assets running on it, the future of encrypted digital finance must be carried out on a global scale. Therefore, the corresponding supervision must also require the cooperation of global financial regulators. So for Gary Gensler, international cooperation in regulation will also be a major feature of his term.