Spot bitcoin ETF fiasco underlines chequered US regulatory process

The SEC is far from a leading light in crypto ETPs

Jamie Gordon

Bitcoin US court

Bitcoin and ETFs has been a difficult marriage for all regulators to reconcile, however, the Securities and Exchange Commission (SEC) under Gary Gensler has delivered a masterclass on how to be strong-armed into approving a product it is fundamentally unsure about.

For clarity, the SEC Chair is not staunchly against cryptocurrencies or their related technologies. Years before the ‘death by a thousand cuts’ process of approving spot bitcoin ETFs, Gensler was a professor of economics and management at MIT, teaching classes on blockchain and digital currencies, even acting as senior adviser to the MIT Media Lab Digital Currencies Initiative.

However, the SEC has for the most part tried to garner a no-nonsense reputation on crypto since Gensler started his tenure as Chair in 2021. 

Just last year, the watchdog filed 13 charges against separate entities of the largest crypto exchange, Binance, as well as Kraken and Coinbase for failing to register arms of their businesses – the latter of which is now the custodian for eight of the 11 spot bitcoin ETFs coming to market.

In fact, in a laboured statement on the approval of the new ETFs, Gensler said: “Though we are merit neutral, I would note that the underlying assets in the metals ETPs have consumer and industrial uses, while in contrast bitcoin is primarily a speculative, volatile asset that is also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing.

“While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse bitcoin.”

While the Chair and his fellow Democrat SEC commissioners remain wary of crypto assets which trade largely on unregulated markets, with prices vulnerable to manipulation, those concerns are now largely academic, thanks to a series of blunders and pressures – internal and external – which forced spot bitcoin ETFs over the line.

‘Capricious and arbitrary’

After more than a decade and at least 20 denied applications, the death knell for keeping spot crypto out of US wrappers sounded in October 2021, with the approval of the ProShares Bitcoin Strategy ETF (BITO).

A deciding factor in BITO, a futures-tracking strategy, being green lit by the SEC was entities such as the Chicago Mercantile Exchange (CME) and Commodity Futures Trading Commission – where Gensler previously served as Chair – being satisfied the underlying market was not being manipulated.

BITO’s listing and subsequent rejection of the Grayscale Bitcoin Trust (GBTC) being converted to a spot bitcoin ETF then sparked a legal battle between Grayscale and the SEC – a battle the regulator would lose in August 2023.

Deborah Fuhr, managing partner and founder at ETFGI, told ETF Stream approving BITO was the SEC’s “downfall” and had this not happened, “Grayscale would not have had the case to come forward and the whole thing would not have happened”.

While members of the SEC may have contested that bitcoin ETFs could threaten the investor protection and public interest tenets of the Exchange Act, many commentators argued this to be logically inconsistent, given the approval of more complex futures-based ETFs two years earlier.

Agreeing, the US Court of Appeals for the District of Columbia described SEC rejections of Grayscale’s spot bitcoin ETF conversion as “arbitrary and capricious”.

This failure in court may now have longer-term ramifications for the regulator.

“The court case will cause some firms to think about trying to bring new and different types of products to market,” Fuhr suggested. “Are there other areas where the SEC could also be seen as not offering a level playing field?

“One instance which comes to mind is the Vanguard model of bringing ETFs to market through ETF share classes of a mutual fund, which was patented and the patent has gone away. Depending on how that moves forward, you could see how this would be a route that others would explore going forward.”

A political minefield

Of course, any perceived missteps by the regulator have not occurred in a vacuum.

A source familiar with the approval discussions told ETF Stream there is “so much political pressure guiding the decisions”, both from the two major US political parties but also the commissioners they have appointed within the SEC.

With Democrat-appointed Gensler’s vote being the deciding one among the committee of five last week – and 10 months out from the next US election – Athanasios Psarofagis, ETF analyst at Bloomberg Intelligence, said “this seemed more like a political agenda than a securities issue”.

He also noted the importance of BlackRock filing for a spot bitcoin ETF last year, with the world’s largest asset manager having only had one of its ETF filings rejected – for a non-transparent ETF in 2014.

“The involvement of BlackRock makes the transition easier,” he said. “Honestly, I am not sure these approvals would have happened without their involvement.”

Gensler now has plenty of rebuilding to do, having alienated the Democrat commissioners opposing the bitcoin ETFs, while advocates and Republicans would argue the SEC Chair only changed his voting stance to avoid further court tussles.

In a statement, Donald Trump-appointed commissioner Hester Peirce warned “failing to follow our normal standards and processes” around the new ETFs “will continue to harm our reputation far beyond crypto”.

She added the process had “diminished trust from the public”, cost “likely millions of dollars of staff time” and created a “circus atmosphere”.

Capturing the mood of the crypto community, Nic Carter, partner at Castle Island Ventures, commented: “We had to drag the SEC kicking and screaming into what should have been a straightforward approval.”

Across the bench, Democrat commissioner Caroline Crenshaw described the approvals as “unsound and ahistorical” and put the SEC on a “wayward path that could further sacrifice investor protection”.

Meanwhile, prolific Democrat Senator Elizabeth Warren argued there was “no doubt the SEC made the wrong decision here”.

Operational question marks

While the SEC may not have scored many brownie points by choosing to approve spot bitcoin ETFs, it lost several more with the mishaps baked into the announcement process itself.

First, the widely covered ‘hack’ of the regulator’s account and the X post announcing the ETF approvals a day before the SEC made the decision official.

Multiple sources familiar with the approvals process told ETF Stream there was a “reasonable” possibility the post was internally produced but published without necessary approvals.

One said: “Blunders like this make them a laughingstock – they are taken seriously, so incidents like this should not happen.”

Adding to the frenzied onlookers’ excitement, Cboe published listing circulars for six spot bitcoin ETFs – to go live the following day – prior to SEC approval.

On a more benign note, Fuhr said the SEC’s decision to approve several products simultaneously strayed from the past approach of approving a single first mover, which could “modify” how it goes about approving groups of innovative strategies in future.

Lingering unknowns

Fuhr noted following the approvals, a number of questions remain unanswered. For instance, the tax consequences of investing in the new ETFs and whether they are defined as complex products, which raises issues of suitability and which platforms they should appear on.

“We cannot have all these people investing without these questions being answered and people understanding how these will impact their investments,” she said.

Psarofagis added the mechanics and potential scale of trading activity in the new ETFs “test the ETF wrapper to the limits”.

“There will be lots of pressure on these to perform flawlessly – which I think they will for the most part – but any fault could be a bad look for ETFs,” he noted.

Psarofagis also questioned the overlaps and distinctions between US and European regulation.

While he described Europe as “more cut-and-dry” in its language for separating UCITS from “wonky stuff” in exchange-traded notes (ETNs) – which may be harder for retail investors to access – he noted no such separation in the “organised chaos” system of the US, where “there is really no distinction”.

However, much as the US may follow the European model of accepting wrapped bitcoin, then ethereum and eventually crypto baskets, if US regulators can find their feet with crypto ETFs, perhaps Europe could be convinced to consider the role of digital assets within UCITS ETFs in years to come.


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