The recent dissent letter by Democrat Commissioner Caroline Crenshaw was deeply flawed, but I, and the industry, was prepared to move forward and ignore it. Unfortunately, with multiple large broker dealers blocking access to clients trading Bitcoin ETF products listed on National Securities Exchanges, it seems important to deconstruct that dissent and expose its myriad flaws.
Her main argument starts in the second paragraph where she states:
“Despite an ample and growing body of evidence indicating that the proposed rule changes are not reasonably designed to prevent fraudulent or manipulative acts and practices, or to protect investors or the public interest, the Commission’s Order finds that this standard is met. For the reasons discussed below, I strongly disagree.”
Before delving into the specific arguments she makes to back this up, it is vital to remember that the SEC allowed Greyscale Bitcoin Trust (GBTC) and BITO (and other) futures backed Bitcoin ETFs, to trade freely in brokerage accounts. The claim that spot bitcoin ETFs would be more subject to manipulation than these products was rejected by the courts as “arbitrary and capricious”, mostly due to the correlation between spot bitcoin and futures being 99.99%. (I will debunk her specious rebuttal to that fact in line with her specific arguments.) Each one of the following sections corresponds to a section in her letter
Manipulation Arguments:
In the next section of her letter, she cites studies that purport to show manipulation in the spot Bitcoin markets. Almost all of the citations were from before 2020, which is a market whose structure is almost entirely different from that of today. In 2020, the average time for professional market makers to move Bitcoin between spot exchanges such as Coinbase and Kraken, for example, was 40 minutes. As a result, there were numerous examples of wide crossed markets between exchanges, some of which were likely due to manipulation. I wrote about these events at the time, explaining how execution quality was impacted. Today, however, and for several years, all major participants use networks such as Fireblocks to quickly move Bitcoin between exchanges to keep prices in line. This has dramatically changed the market structure and is completely unaccounted for by Commissioner Crenshaw.
Next, she discusses wash trading, citing a 2021 paper that looks at activity on non-U.S. exchanges at that time. Once again, this analysis is irrelevant in both scope and time frame, which was several years ago. While I will not vouch for the integrity of all non U.S. exchanges, they are as irrelevant to the spot Bitcoin ETF filings as they were to the CME Futures based filing. U.S. based exchanges, including Coinbase and Kraken, along with US regulated exchanges such as LMAX and Bitstamp all have self trade prevention and sufficient KYC and internal controls to control wash trading. None of these programs were cited by Commissioner Crenshaw.
The next paragraph cited the example of SBF suppressing the price of Bitcoin. While this is unproven, it may well be true. That being said, there are multiple examples and billions of dollars in fines that have been assessed in traditional markets for price manipulation and related activities. Further, the blockchain allowed for forensic investigations that helped SBF to be investigated, tried and convicted, in a far shorter timeframe than most cases from traditional finance.
It is also worth noting the SEC is somewhat complicit in the FTX affair. While they refused to engage with other, more principled, industry participants at the same time they were meeting with FTX repeatedly, they never used those meetings to question FTX. The fact they failed to investigate FTX, will forever be a black eye on the SEC resume.
Her next argument, that the SEC hack post showed how volatile and, therefore risky, Bitcoin can be takes real “chutzpah”. It is as outrageous as it is false. The only reason that post had such impact was the SEC’s years of delay. As Hester Pearce stated in her recent statement: (which, incidentally, is one of the best SEC statements ever delivered )
“by failing to follow our normal standards and processes in considering spot bitcoin ETPs, we have created an artificial frenzy around them. Had these products come to market in the way other comparable products typically have, we would have avoided the circus atmosphere in which we now find ourselves.”
The SEC is supposed to be a neutral arbiter of the markets, without opinion on the merits of investments or impact upon their price, while ensuring sufficient and timely investable information is provided and fair and orderly markets. They failed miserably on all fronts. By delaying for so long, the SEC became the story, so their decision was bound to move markets. By shoddy security, they allowed material information to be disseminated prematurely, and sloppily in a way that maximized price impact. If anything, this episode proves strongly the SEC should NOT intervene to ban products the marketplace has decided to offer broadly.
Concentration of Ownership:
In this section, Ms. Crenshaw uses two arguments to claim Bitcoin concentration risks and both are wrong. First, she points to the Greyscale trust (GBTC) owning 3.2 % of Bitcoin. Considering the SEC let GBTC trade as a closed end fund and was one of the only vehicles for American investors to gain Bitcoin exposure in their brokerage accounts, this is hardly surprising. As an aside, it is hardly risky, considering that index funds own a much higher percentage of most US equities, with most estimates being 10 to 15%. That being said, bringing up Greyscale as an argument is quite self defeating. The SEC allowed that product to trade, yet it was far more volatile than Bitcoin with the premium peaking at over 50% to NAV followed by a stunning collapse to over a 50% discount. That discount was responsible for many high profile bankruptcies that harmed retail investors in 2022, but it would not have existed if Greyscale was allowed to convert their trust to an ETF sooner. That may have been the clearest example of the SEC directly harming investors in the organizations history.
Her second argument is based on a concentration of mining hashrate. She claims “scholars estimate that the “top 10% of miners control 90% and just 0.1% (about 50 miners) control close to 50% of mining capacity.” The claim itself is ludicrous, unless it is based on the Chinese control of Bitcoin mining before they banned the activity over 2 years ago. This shows up in the following graphic from Blockchain.com:
Underlying the graphic, is the table of mining pools that now dominate:
Looking at this table, one could potentially see some concentration risk, but the flaw in that argument is these mining pools are aggregations of many institutional mining operations that pool their equipment to smooth out returns. Since block rewards are episodic, pooling ones mining operation with others to get a % of the overall rewards is intelligent business from a risk reward perspective. That being said, there is no reason to believe that mining pool concentration threatens a 51% attack on the Bitcoin network. In the words of Foundry Pool’s head of mining “mining pools don’t control the network and don’t have a lot of clout, because any miner can quickly change pools if there is any hint of foul play, such as censoring bitcoin transactions”
Lack of Unified Oversight:
Ms. Crenshaw next reprises her manipulation argument by suggesting that the reason there is so much (unproven) manipulation in U.S. based spot markets is due to the lack of a single regulator. Frankly, the industry would be happier if there was such a regulator, but it would require new rules to work with the asset class. That being said, this section is a classic example of “begging the question” as it assumes manipulation. It also ignores the fact that the approval order she dissented from actually advances the cause of the SEC, by providing information sharing agreements to allow them to research potential manipulation in spot markets. Such agreements may not be perfect, but are a substantive improvement to the previous situation where the CME futures could be impacted by spot market manipulation without any ability to look for the cause.
Greyscale Case:
This next section is arguably the most illogical in the dissent as it tries to make the argument that the CME futures are a superior product to spot Bitcoin because of its regulator. It ignores completely that the futures are, in fact, derivatives in the truest sense of the word. For reference, Websters defines derivative as “a contract or security (see SECURITY sense 3) that derives its value from that of an underlying asset”. Simply put, any movement in the price of spot bitcoin CAUSES movement in the price of the futures. Her entire argument wrests upon the notion that correlation is not relevant, but she ignores that the actual mechanism is causation; Futures prices move as a result of spot moves far more often than the other way around.
Her next argument is that the correlation between the CME and spot decreases over shorter intervals and that proves they are different. She is correct in a sense. The CME spread to spot prices has been quite volatile, but the simple fact, according to my observations of the market, is that is because the futures are more volatile than spot, and not the other way around. This can be seen recently by a dramatic move in the premium of the futures contract. In January, the premium over “fair” value has moved from four times to an actual discount. In short, her argument is actually a strong one for the superiority of the spot products over the previously approved futures products.
She then proceeds to claim that the CME is a market of significant size, but the relevant spot markets, Coinbase chief among them, are not. Once again, she has the facts wrong. The CME, according to industry data, has less than 10% market share of dollar denominated futures trading, when perpetual contracts are included. By comparison, Coinbase has a roughly 40% market share in Bitcoin-USDollar spot market trading.
Public Interest:
Her next paragraph really goes off the rails by arguing that Bitcoin is a bad investment. While it is not the SEC job to make such a determination, her claims that Bitcoin is only used by criminals has been roundly rebuked. Even Hamas told its donors to avoid using Bitcoin as it is too easy to trace its movements. The share of criminal activity conducted in Bitcoin continues to drop and is well below that of US Dollars, but no one is calling for banning the use of the dollar.
More important, however, is that the SEC has already approved Bitcoin products, so this entire paragraph is nothing more than poorly supported political grandstanding.
Tomorrows Problems:
Next she ponders a few issues that have nothing to do with the approval order, yet manages to make more arguments that support approval if one looks deeper. First, she questions the custodial issues if these ETFs are changed to support in-kind creation. That is amusing, as the trusts involved would have no change to their custodial operations at all. In kind creation, as I discussed in a recent article in Bitcoin magazine, would simply be a more efficient way to operate these ETFs.
Her next argument is that Bitcoin is volatile and, as a result, the ETFs could be suspended by Limit Up Limit Down rules while the spot continues to trade. This is both flawed and irrelevant as there are already international product ETFs that can be suspended while the foreign market trades and also trade while the foreign market is closed. Since Bitcoin is 24/7/365, there will never be a time when ETFs trade while the underlying is closed. That dramatically decreases the risk of investors trading at stale prices.
Wasn’t Bitcoin Supposed to Solve This:
I suspect this last section was written to troll the crypto crowd, who uses that expression often. She phrases this as follows:
“If the technology is so revolutionary, why do so many of its uses seem to revolve around recreating the existing financial system, except with less regulation, more opacity, fewer investor protections, and more risk?”
The answer to her first question is that Bitcoin is a financial product. It is certainly true that the spot markets for Bitcoin took its template from traditional finance, but, in many ways, improved upon it. Those markets all provide their full order books in real time and one can always determine the cost to buy and sell Bitcoin in any size, in real time. CoinRoutes has published information that shows this liquidity cost and will continue to do so. One of the conclusions of our article, which continues to be true according to recent data, is spot trading of Bitcoin, in institutional size, is actually more efficient than all but the most liquid equity products.
The second point she makes, less regulation, is squarely the fault of the SEC and their allies on Capital Hill. The crypto industry has repeatedly asked for regulatory clarity in the form of rules that work with the technology, instead of the current regulations that are based on paper certificates being held in a vault under 55 Water street in NYC. In fact, the FIT act, advanced out of committee on a bipartisan basis this summer, has met with scorn and derision from the SEC chair and presumably Ms. Crenshaw as well.
The third point, opacity, is simply false. Crypto, and Bitcoin in particular, are the most transparent market on Earth. In addition to the market data from spot markets previously discussed, the on-chain data from Bitcoin empowers firms to track ownership and movements to a level unmatched in the traditional financial system.
Her fourth claim about investor protections is true, but, once again, is an argument against the SEC approach. The biggest issues for investors were with regard to other products than Bitcoin trading itself. In 2022, we witnessed several centralized lenders effectively defraud investors of their Bitcoin and I, along with most of the industry, want better disclosure rules to prevent this from happening again. Unfortunately, as discussed with regard to regulation, the SEC has continued to block such new regulations from being written.
Lastly, she tosses out the words “more risks”, but the implication is truly sobering. It is true that Bitcoin is volatile, but so was Apple computer, Amazon, Google (now Alphabet) and other major innovative investments. Denying or making it difficult for investors to allocate capital to innovations is a very bad idea, yet that seems to be her conclusion…
Conclusion:
Basing decisions to block these products from investors will not age well. The arguments are based on old data, inaccurate claims and in many cases proves the value of Bitcoin spot ETFs. Brokerage firms should heed these arguments.