Why Doesn’t The SEC Like Bitcoin ETFs?

Each week, we answer questions we think will help you learn about investing in pre-IPO startups and cryptocurrencies. Here, Early Investing co-founders Adam Sharp and Andrew Gordon explain why the SEC has a problem with bitcoin ETFs.

Early Investing Co-Founder Andy Gordon

Q: ETFs have been around for a long time. What problems could the SEC have with bitcoin ETFs?!

A: The SEC is basically worried about market and price manipulation. Other ETFs follow assets in established and regulated markets that aren’t easily manipulated.

The SEC says bitcoin doesn’t have such markets, though they could develop in time. (That assertion is now being challenged by the VanEck bitcoin ETF proposal and others.)

The SEC also worries about bitcoin ETFs participating in an ecosystem that doesn’t adhere to anti-money-laundering and know-your-customer rules, or worse, encourages non-adherence. (Again, that’s rightfully being challenged.)

It’s also worried about an ETF having enough liquidity to cover daily redemptions. For example, if an ETF has $1 billion worth of bitcoin in its fund, can it cover 10% of it being redeemed in a single day?

A 10% redemption level, by the way, is very high, and it’s extremely unlikely to occur. But let’s be very conservative and go with that level in our example.

That means an ETF would have to sell $100 million worth of bitcoin into the market within seven days (which is the government’s definition of a “liquid investment”).

That’s very doable – $100 million is about 8% of bitcoin’s daily trading volume (of more than $1 billion).

The SEC is also concerned with custody issues, as it should be. An ETF with a few hundred million dollars’ worth of bitcoin in its coffers would be a tempting target for hackers. ETFs are tackling this issue by proposing to hold their bitcoin offline and provide insurance coverage to investors.

From my vantage point, at least some of the ETF applications address the SEC’s concerns with practical solutions that can be put into effect immediately. The SEC is running out of reasons – and excuses – to deny bitcoin ETFs.