Photo by Nikos Pekiaridis
The concept of a spot bitcoin Exchange-Traded Fund has long been a topic of interest within the bitcoin and investment communities. While the U.S. Securities and Exchange Commission has yet to green-light such a fund, understanding the modernized regulatory framework proposed by the SEC can provide insights into how a spot bitcoin ETF could finally gain approval.
A spot ETF sets itself apart from a conventional ETF by focusing on tracking the real-time price of a particular asset and offering enhanced liquidity options and more favorable tax implications for investors. These additional benefits make spot ETFs an increasingly attractive investment vehicle for a diverse range of market participants.
Traditional Application and the Modern Twist
Typically, a financial institution interested in launching an ETF must submit a comprehensive application to the SEC. This proposal outlines the fund’s structure, objectives, and risk factors. The SEC's 2018 proposal aims to streamline this process by replacing hundreds of individual exemptive orders with a single rule. ETFs satisfying specific conditions can come directly to market without obtaining individual exemptions, thereby expediting the time-to-market.
SEC Review in a Rules-Based Framework
After the application, the SEC traditionally scrutinizes the proposal focusing on investor protection and market integrity. Under the modernized framework, a standard set of conditions would be applicable to all ETFs. This "rules-based framework" aims to level the playing field among most ETFs and protect investors.
While the SEC's mandate is to protect investors, its approach to spot bitcoin ETF has raised questions about the extent to which it fulfills this role effectively. The SEC has shown a willingness to approve alternative financial products like a bitcoin futures ETFs, which some critics argue does not offer the same straightforward exposure to bitcoin that a spot ETF would. This discrepancy has even prompted members of Congress to pen an open letter to SEC Chairman Gary Gensler, urging for more clarity on the commission's stance.
Evaluation Criteria
During the review, the SEC evaluates key factors such as:
- Custody: The SEC assesses the custodial arrangements for bitcoin, examining how the assets will be securely held to prevent theft or fraud.
- Market Surveillance: The SEC reviews whether the bitcoin market has proper surveillance to prevent manipulation, fraud, or other illicit activities.
- Liquidity: The liquidity of the underlying bitcoin market is examined. The SEC wants to ensure that the ETF can be easily traded without causing significant price discrepancies.
- Arbitrage Mechanism: The application must detail how the ETF's price will track the price of bitcoin. An effective arbitrage mechanism is vital for keeping the ETF's price in line with its net asset value.
The SEC often engages in a back-and-forth dialogue with applicants during the ETF approval process. This is usually to clarify details, request additional information, or discuss potential concerns. The process is iterative and may require multiple rounds of communication before a decision is made.
Public Comments and Transparency Requirements
The SEC often opens a window for public comments, a step that remains crucial even under the modernized framework. Additionally, the proposed rule mandates daily portfolio transparency on the ETF's website, which would likely apply to a spot bitcoin ETF, ensuring that investors have real-time insight into the fund's holdings.
Custom Basket Policies and Website Disclosure
A spot bitcoin ETF operating under the proposed rule would be allowed to use "custom baskets" that do not reflect a pro-rata representation of the fund’s portfolio. The modernized framework also places emphasis on website disclosure, requiring ETFs to disclose historical information regarding premiums, discounts, and bid-ask spreads.
Final Steps: SEC Decision and Post-Approval
After a comprehensive evaluation and considering public comments, the SEC makes a final decision. If approved, the ETF could begin operations immediately and be listed and traded on major stock exchanges. This provides investors with a regulated way to gain exposure to bitcoin and its price movements.
Conclusion
The journey towards SEC approval for a spot bitcoin ETF is moving in the right direction. Approval by the SEC is a meticulous process that considers various factors, including custody, market surveillance, liquidity, and the ETF's arbitrage mechanism. Public input is a critical component, allowing stakeholders to voice their concerns or support. The timeline for approval can be uncertain, but approval will offer investors a more accessible entry point while adhering to regulatory standards.
Cathy Wood suggests that when the SEC finally says yes, it will likely approve all spot bitcoin ETFs at the same time. This could bring some clarity to a confusing regulatory environment.
As bitcoin continues to mature, the likelihood of a spot bitcoin ETF gaining approval seems inevitable, with many experts claiming we could have multiple approvals by the end of the year.
