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Over the past 10 years, the Securities and Exchange Commission (SEC) has rejected every application for a Bitcoin ETF designed to track the cryptocurrency’s current market price.

But if you don’t succeed at first, please reapply. On June 15, BlackRock filed SEC approval for a so-called spot Bitcoin ETF.

BlackRock’s application appeared to encourage several other financial firms to resubmit their own applications for a spot Bitcoin ETF. But the SEC reportedly finds BlackRock’s proposal for a “surveillance sharing agreement” not detailed enough. That agreement would help control fraud and manipulation by establishing a mechanism for tracking trading, clearing activity and customer identity. An unidentified SEC representative reportedly said the proposal lacks details. But the SEC told Forbes Advisor it had no comment.

Still, BlackRock’s June 15 filing convinced many Wall Street insiders that the company might just be the one to finally convince the securities watchdog to allow exchange-traded funds that track current market prices — the so-called spot prices — of cryptocurrencies such as Bitcoin. BlackRock is the world’s largest asset manager. The company manages iShares, the largest family of ETFs in the US, with nearly $4 trillion in assets under management.

SEC approval of BlackRock’s ETF would revitalize the Bitcoin and cryptocurrency markets, said Peter Eberle, president and chief investment officer of Castle Funds, which manages three private placement funds with exposure to Bitcoin.

“It would definitely end the crypto winter,” says Eberle.

What gives? Why are industry players cautiously optimistic about BlackRock’s prospects when so many others have failed? Why has BlackRock’s move emboldened its rivals?

What is a Spot Bitcoin ETF?

The SEC has already approved many Bitcoin ETFs and other types of crypto exchange-traded funds. But so far, the market regulator has only comfortably greenlighted funds that track cryptocurrency futures or own shares of companies with indirect exposure to crypto.

Applications from BlackRock, as well as similar applications from Ark Investment Management and Grayscale, aim to provide investors with simple, easy-to-trade funds that directly track the current price of BTC, rather than the prices of futures contracts.

What is the difference? Spot pricing is how derivatives traders in the options and futures markets refer to asset prices for immediate delivery rather than future delivery. In simpler terms, the spot price is the current price of a commodity right now, rather than guesses at what the price might be later.

Spot prices are used as benchmarks for the pricing of derivative contracts. For example, the spot price of a currency pair, such as the exchange rate between the US dollar and the euro, is a reference point for currency hedging.

BlackRock aims to allay the SEC’s fears

What’s different this time? BlackRock is proposing a fund that would follow rules specifically targeting concerns the SEC has cited in rejecting previous applications from others, experts say.

It would close loopholes, such as the lack of a mechanism to ensure that customer assets cannot be diverted through the exchange to an unauthorized party.

“That was one of the problems with the FTX crypto exchange,” says Eberle.

After the spectacular failure of FTX in late 2022, founder Sam Bankman-Fried was charged with multiple counts of fraud and conspiracy to commit money laundering. He allegedly improperly moved client money to his separate trading firm, Alameda Research, where he allegedly mixed and spent the money as if it were his own.

“It appears that BlackRock has been studying the SEC’s lawsuits against Binance and Coinbase Global,” says Eberle. “Then his own application described how it would avoid the problems the SEC had described.”

The SEC filed lawsuits against Coinbase Global and Binance just days before BlackRock’s filing. Coinbase and Binance are the two largest crypto exchanges in the world by market capitalization. The SEC alleges that Binance and its founder violated securities laws by allowing US customers to trade on Binance.com despite the SEC’s ban on such trading.

Building a Bitcoin ETF ecosystem

Less than two weeks after BlackRock’s filing, rival asset management giant Fidelity has resubmitted paperwork for its Wise Origin Bitcoin Trust, also a spot bitcoin ETF. Originally submitted in 2021, that offer was rejected by the SEC in 2022.

Undeterred, Invesco and WisdomTree also reapplied in the wake of BlackRock’s efforts.

Crucially, these other players in the crypto industry have also proposed solutions to the SEC’s concerns.

Momentum building?

Technically, the new filing with the SEC was filed by the CBOE-BZX Exchange filing for a proposed new listing rule for Fidelity’s bitcoin ETF. The new filing formalizes Fidelity’s filing with the SEC.

The CBOE-BZX Exchange has made similar recent filings for other companies.

One of the SEC’s main concerns about a spot bitcoin ETF is the potential for market manipulation. The BlackRock filing proposes a surveillance sharing agreement that could minimize that risk. The newer filings contain similar proposals.

Other companies are proposing similar steps to address the SEC’s concerns, Eberle says.

“It is extremely coincidental that all of the proposals came within a few weeks of the SEC lawsuits against Coinbase and Binance,” says Eberle. “Those entities, particularly EDX and BlackRock, are proposing solutions that meet the concerns the SEC has cited.”

BlackRock has plenty of company

The new proposals, according to a report from Eberle’s Castle Analytics, are:

  • EDX Markets has launched an institutional execution trading platform with the backing of Citadel Group, Charles Schwab and Fidelity Digital Assets.
  • EDX has also announced plans to launch a clearing company, EDX Clearing, later in 2023.
  • Deutsche Bank says it plans to “offer digital asset custody services to its institutional clients.”

Those steps could prevent the market manipulation and potential for fraud that the SEC has cited in its opposition to previous proposals for Bitcoin ETFs and for crypto exchanges at cash prices. If these bottlenecks can be removed, it is likely that the SEC will find room to approve BlackRock’s proposal.

For example, EDX’s new exchange for institutional clients would separate broker-dealer activities from each other and from the exchange itself. “It would ensure that the exchange is neutral and does not pocket customer money,” Eberle said, as FTX would have done. “It would ensure that broker-dealers hold client assets in segregated accounts. And it would keep broker-dealers from colluding with each other.”

The clearing company proposed by EDX, EDX Clearing, would separate trading from settlement. “It would provide a mechanism to ensure that both sides of any trade really exist,” Eberle said. It would create a neutral third party guaranteeing traders that there is money to buy assets like Bitcoin and the assets themselves.

Deutsche Bank’s proposal would serve the European cryptocurrency market, helping US traders by increasing the overall global crypto market and increasing liquidity and demand.

BlackRock avoids Grayscale’s mistakes

However, Bitcoin traders need to process some fine print on BlackRock’s file before opening the champagne. Most notably, BlackRock is seeking permission to run a trust, not an ETF.

While many in the crypto community believe that BlackRock’s mock Bitcoin trust will be a de facto Bitcoin ETF, there are significant differences between the two options.

Grayscale Bitcoin Trust (GBTC), a popular investment vehicle that invests in Bitcoin, also operates as a trust rather than an ETF.

One downside to GBTC is that, like many mutual funds, it often trades at a discount to the market value of the underlying asset, Bitcoin. At the end of last year, the discount was about 50%. In the wake of the BlackRock filing, that discount fell to about 33%.

GBTC trades at a discount in part because investors are allowed to sell their shares in the market, but they have no way to buy back their holdings in exchange for the Bitcoin in the trust. And unlike an ETF, GBTC has no redemption mechanism. Like any mutual fund, GBTC shares cannot be created and destroyed as demand shifts. This limits the number of available shares. At the same time, GBTC charges shareholders a fee or expense ratio of 2%.

Would the same problem lure investors into BlackRock’s proposed confidence? Eberle believes that BlackRock has “probably already talked to market makers” to create the arbitrage opportunity for a secondary market in the shares of the BlackRock trust. That could avoid price discounts and premiums, says Eberle, and so BlackRock’s trust could act as an ETF and avoid the kind of price distortions that haunt Grayscale’s trust.

BlackRock said it was unable to comment “due to legal filing restrictions”.

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