Written by
Katie Pollock
Regulatory Landmark
Earlier this month, the Securities and Exchange Commission in the US (“SEC”) approved the first-ever spot Bitcoin exchange-traded funds, offering investors exposure to the world’s largest cryptocurrency without directly holding it. This approval came signposted with the regulator’s skepticism towards cryptocurrencies, and the general belief this market is still seen as somewhat dangerous for investors. The SEC had refused to approve cryptocurrency-related products for over a decade but was finally forced by a U.S. federal appeals court ruling last year to reconsider, with the court deeming the SEC as “arbitrary and capricious” in its decision to reject Grayscale’s attempt to convert its roughly $17 billion Grayscale Bitcoin Trust (GBTC) into a spot ETF, which paved the way for the recent landmark approval for the trading of 10 spot bitcoin ETFs, with sponsors ranging from established players such as Fidelity and BlackRock, to more digital-focused businesses including Grayscale and Ark Investors. Some industry experts believe the bitcoin ETFs could also pave the way for other innovative crypto products; however, among other controversies, one of the biggest debates in the regulatory conversation is whether cryptocurrency should be classified as a security, a commodity, a currency, or something else. As of now, this is very much an unanswered question.
Background
Cryptocurrencies were created as an alternative to fiat currencies, which are defined as currencies established by and backed by a government such as the U.S. dollar and the euro. Cryptocurrencies are largely used as speculative investments due to their volatility but have no evidential correlation to fiat currencies. If crypto is deemed a commodity like crude oil, coffee or natural gas, its primary U.S. regulator would be the Commodity Futures Trading Commission (“CFTC”). This agency regulates currency trading, and it would cover crypto trading as well if cryptocurrencies are deemed currencies. SEC Chair Gary Gensler has made clear he believes that cryptocurrencies are securities (e.g., akin to bonds, equities, and ETFs), based on the Howey Test, which comes from a 1946 Supreme Court ruling in the SEC v. W.J. Howey Co, and accordingly charged 124 defendants or respondents in cryptocurrency enforcement actions in 2023. Of those 124, 54% were individuals and 46% were firms. During his speech, Gensler also repeated his long-held position that bitcoin is a commodity not a security, and as such, Wednesday’s approval was in “no way” a signal that the SEC would be easing up going after the crypto players it says are contravening its regulations. Further, he stated that this was “the most sustainable path forward” but added the SEC did not endorse Bitcoin, calling it a “speculative, volatile asset” also used to fund crime.
Regulatory Reasoning
The SEC’s argument against spot bitcoin ETFs historically is that the cryptocurrency trades on largely unregulated markets, and thus, its price is prone to manipulation. SEC Commissioner Caroline Crenshaw, who dissented from the approval earlier in the month, warned that spot markets remained open to fraud and manipulation. The approvals come a day after an unauthorized person published a fake post on the SEC’s account on social media platform X, saying the agency had approved the products for trading. The post was immediately deleted, with the SEC announcing its coordination with law enforcement and own internal watchdog to investigate the incident.
The adverse impacts of trading manipulations in these unregulated markets have the potential to inflict irreparable damage, furthering the skepticism and scrutiny that already exists. While some manipulative practices are evident, others are subtle, demanding expertise to detect. A lot of these manipulative practices mirror those seen in securities markets, thus, firms need to have a solid understanding of the inherent risks and the adoption of effective strategies to mitigate them.
Bio
Katie Pollock has over 14 years of experience in various cross-asset class trading/trading operations roles for several large Investment Managers in London and the U.S. She began her career on the sell-side working for JP Morgan Cazenove as a Business Analyst in the U.K. and Pan European Equity Sales Desk. Katie received her BBA from the University of Missouri – Kansas City, her M.B.A. from Regent’s College (Webster Graduate School – London), and her Masters in Law and Finance from Queen Mary University of London.