Assessing the Prospect of a Bitcoin ETF As Deadline Looms

For the last 3 1/2 years, the U.S. Securities and Exchange Commission has been considering whether to approve placement of the Winklevoss Bitcoin Trust ETF (Nasdaq: COIN) on the Bats exchange. The Bats exchange is currently the largest U.S. equities market operator, and placement of COIN on the exchange would essentially allow anyone to buy bitcoin just like a common stock. However, on March 11, the SEC must either approve COIN as the first bitcoin exchange-traded fund in the United States, or reject it, because the SEC is finally out of extensions to make a decision.

The SEC’s approval of COIN would likely be a game changer for both the digital currency and the global financial markets, and could cause hundreds of millions of dollars flow into it in the first week alone from traditional investors who have remained on the sidelines. Were traditional investors to purchase COIN, quantitative analysis and value research firm Emerita Capital estimates that the price of bitcoin could skyrocket, to as much as $3,678.

At least some signs in late February pointed to SEC approval of the ETF, and saw the price of bitcoin climb to over $1200. On Feb. 22, 2017, the SEC disclosed a Feb. 14 meeting it held with the Winklevoss twins, entrepreneurs Cameron Winklevoss and Tyler Winklevoss. The meeting “concerned Bats BZX Exchange Inc.’s proposed rule change to list and trade, pursuant to BZX Rule 14.11(e)(4), shares issued by the Winklevoss Bitcoin Trust.” This has led some analysts to believe that the ETF is bound for approval. Indeed, the meeting was attended by “all of the organizations and officials related to the approval” as well as “outside advisors in KCG Holdings and Susquehanna International … to offer unbiased insight into the launch of the COIN ETF.”  KCG Holdings and Susquehanna International are both trusted independent financial services firms that engage in the institutional sales and trading market, and ETF trading, among other financial services.

Of course, if it not approved, the price of Bitcoin has been projected to  plummet to $551, which is less than half of its current price. Many analysts, from Needham & Co. to Willy Woo to Emerita Capital, predicted in mid-February that digital currency was simply too volatile for the SEC to approve COIN, but prediction markets seem to have changed their tune in light of the SEC meeting, and current estimates assess the likelihood of approval at around 50 percent.

The reasons previously cited by others that COIN is likely to be rejected by the SEC are as follows: (1) it is not safe enough; (2) the market is not big enough; (3) the price remains extremely volatile; and (4) the SEC may feel that its inability to control bitcoin would hamper its main job of protecting consumers. Further, the market may be too small to absorb so many additional investors upon the approval of COIN, and could instead create a bubble. The SEC may decide to wait for more direction from the new administration to determine which direction it wants to take with respect to the regulation of bitcoin before approving COIN. Other factors that could go against approval include the fact that there are several bitcoin ETFs still in the pipeline that the SEC could approve at a later date, such as Bitcoin Investment Trust and SolidX Bitcoin Trust.

In addition, at least one commentator from The Hill holds the opinion that if the SEC approves COIN, or any bitcoin ETF, it would essentially “constitute an endorsement of bitcoin that would further its use in money laundering, ransomware, tax evasion and other criminal activities.” He notes that because most of bitcoin trading is occurring in China, U.S. regulatory authorities will have more trouble “investigat[ing] and prosecut[ing] market manipulation of the bitcoin price,” which in turn would affect the ETF, which in turn would make the SEC unable to protect consumers from potential abuse. He goes on to explain that all of the supposed potential benefits of bitcoin itself have not materialized, and because the main purpose of bitcoin is criminal, the SEC should not endorse an ETF trading on a product “whose only application is criminality.”

However, the SEC may be bold enough to approve COIN, and if not COIN, then another ETF in the near future. First, bitcoin has improved by leaps and bounds over the past 3 1/2 years on two of the above fronts (safety and volatility). Two-factor authentication and cold storage have vastly increased the safety and security of bitcoin since the digital currency came on the scene eight years ago. Moreover, the Winklevoss twins have been working diligently to ensure that COIN satisfies all of the SEC’s requirements, amending their “S-1 filing multiple times over the years to address regulators’ concerns.” And, they have already engaged State Street Bank & Trust Co to be the administrator of the trust. Together with the meeting they had with the SEC on Feb. 14, it is clear that if the bitcoin ETF is approved, it will be due in no small  part to the Winklevoss twins’ efforts to bring the cryptocurrency mainstream.

The strength, stability and resilience of bitcoin have also been borne out by the markets despite several scandals over the past year. Moreover, Japan and Singapore’s financial markets have continued to deepen their involvement in bitcoin exchanges, with a bill set to go into effect in Japan legalizing bitcoin as a method of payment and implementing certain regulations.

There are other arguments in favor of approval as well. It is notable that 72 percent of the public comments on the SEC website have been in favor of approval. As one public commenter noted, “Denial of the proposed rule will not stop Bitcoins [sic] progress, but approval of the proposed rule and the underlying COIN ETF, will put the SEC in the ideal position to oversee Bitcoins development as an investment asset — and provide fair, broad-based investment opportunities for not only the connected (or technologically savvy) few, but to all Americans who deserve the same chance to benefit from this technological breakthrough and financial opportunity.”

If approved, mainstream investors could put hundreds of millions of dollars into COIN, which could make many of the drawbacks and criticisms of bitcoin wane as it gains more popularity and usability into the future. But, if the critics are right and bitcoin’s security is breached after the ETF launches, the SEC may  take the lion’s share of the blame for any consequences that will no doubt be borne by a much larger investor base than if it doesn’t approve COIN.

Ultimately, regardless of the SEC’s decision on March 11, other bitcoin ETFs are still in the pipeline, so its ultimate response is not necessarily a make-or-break event for the digital currency. With the new administration signaling plans to cut regulations, and installing pro-bitcoin nominees in the cabinet and other areas of government, there are plenty of reasons for bitcoin enthusiasts to be optimistic in the long term, even if they may not be successful in the short term.

Featured on Law360, Thursday, March 9, 2017. To view the article on Law360, click here.
Authored by Nicole Tate-Naghi, an Associate in Goodwin’s Silicon Valley office.