Will Blackrock and Fidelity win the battle against SEC on Spot ETF filing?

The race to launch the first spot Bitcoin exchange-traded fund (ETF) in the US is heating up as two of the world’s largest asset managers, Blackrock and Fidelity, recently filed applications with the Securities and Exchange Commission (SEC) to make an offer such products. However, the regulator has so far been reluctant to approve spot ETFs, citing concerns about market manipulation, custody and investor protection. Will Blackrock and Fidelity be able to overcome these hurdles and win the battle with the SEC?

Spot ETF is a type of fund that tracks the price of an underlying asset such as Bitcoin and allows investors to buy and sell shares of the fund on a regulated exchange. Unlike futures-based ETFs, which use contracts that expire and settle at a future date, spot ETFs hold the actual asset and reflect the current market value. Spot ETFs are considered more attractive by some investors because they avoid the complexities and costs of rolling futures contracts and provide more direct exposure to the asset.

Blackrock and Fidelity aren’t the only contenders in the mock ETF race. Several other companies, such as VanEck, WisdomTree, Valkyrie, and NYDIG, have also filed filings with the SEC. However, a spot Bitcoin ETF also poses major challenges for the SEC, which must ensure that the fund meets the standards of the Investment Company Act of 1940, which regulates mutual funds and ETFs. The SEC must be satisfied that the fund has sufficient liquidity, diversification, valuation and custody of its assets, and that it can prevent fraud and manipulation in the Bitcoin market.

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The SEC has repeatedly rejected or delayed applications for spot Bitcoin ETFs in the past, most notably from the Winklevoss twins in 2018 and 2019. The regulator has also expressed skepticism about the maturity and integrity of the Bitcoin market, stating that it is insufficient oversight and oversight of regulators and self-regulatory organizations.

However, some analysts believe the tide may turn in favor of spot Bitcoin ETFs as the SEC recently approved several futures-based Bitcoin ETFs, which track Bitcoin’s price through contracts traded on regulated exchanges. These ETFs have attracted billions of dollars in inflows since their launch in October 2021, indicating strong investor demand for exposure to Bitcoin.

Bitcoin spot ETFs are seen as a more attractive option for investors looking to gain exposure to the cryptocurrency without having to deal with the complexities and risks of buying, storing and securing it themselves. Unlike futures ETFs, which track the price of Bitcoin contracts expiring on a specific date, spot ETFs would track the price of Bitcoin itself and hold the underlying asset in custody. This eliminates the need for investors to pay premiums or fees associated with futures contracts and also reduces the tracking error between the ETF and the Bitcoin price.

However, Bitcoin spot ETFs also face significant regulatory hurdles as the SEC has repeatedly raised concerns about the lack of transparency, liquidity, and oversight in the Bitcoin market. The SEC has rejected several applications for Bitcoin spot ETFs in the past, citing issues such as market manipulation, fraud and investor protection. The SEC has also stated that a supervisory sharing agreement is needed between the Bitcoin exchanges and the ETF providers.

The SEC has also stated that a supervisory sharing agreement is needed between the Bitcoin exchanges and the ETF providers, which is not easy to achieve given the decentralized and anonymous nature of the cryptocurrency market. This agreement would ensure that the ETF providers can access information about Bitcoin’s trading activity and price movements across platforms, as well as detect and prevent fraudulent or manipulative behavior that could affect the value of the ETF.

Why does the SEC want a Surveillance-Sharing Agreement?

The SEC’s main concern is to protect investors from potential risks associated with investing in Bitcoin ETFs, such as market manipulation, insider trading or cyber-attacks. The SEC believes that a supervisory sharing agreement would help monitor and enforce compliance with federal securities laws and regulations, as well as ensure fair and orderly markets.

According to the SEC, a supervisory sharing agreement would allow ETF providers to:

Identify and report suspicious or illegal trading activities on the Bitcoin exchanges, such as wash-trading, spoofing, or front-running.

Check the accuracy and reliability of the Bitcoin price data used to calculate the NAV (intrinsic value) of the ETF.

Coordinate with other regulators and law enforcement agencies to investigate and prosecute any violations of securities laws or market rules.

Respond quickly and effectively to market disruptions or emergencies that could affect the ETF’s operations or liquidity.

One of the main challenges of entering into a supervisory sharing agreement is that it requires a high level of collaboration and coordination between multiple parties, including the Bitcoin exchanges, the ETF providers, the SEC, and other regulators. This is not easy to achieve given the decentralized and anonymous nature of the cryptocurrency market, which operates in different jurisdictions and legal frameworks.

Some Bitcoin exchanges are reluctant or unable to share their information with the ETF providers or the SEC for privacy, security or technical reasons. Some of them may not have adequate systems or procedures in place to collect, store and transmit their data in a timely and accurate manner. Some of them may not be subject to any regulatory oversight or accountability, which may raise questions about their legitimacy and reliability.

On the other hand, a surveillance sharing agreement can also bring some benefits to both the Bitcoin exchanges and the ETF providers. For example:

It could increase the transparency and credibility of the Bitcoin market, which could attract more investors and liquidity.

It could reduce the volatility and divergence of Bitcoin prices across platforms, which could improve price discovery and efficiency.

It could foster a more collaborative and constructive relationship between market participants, which could promote innovation and growth.

The SEC’s demand for a supervisory sharing deal is one of the biggest hurdles to date that has prevented a Bitcoin ETF from being approved in the US. However, it is not impossible to overcome. In fact, some progress has been made in recent years.

For example, some of the Bitcoin exchanges have joined forces to form self-regulatory organizations (SROs), such as Crypto Rating Council (CRC) or Virtual Commodity Association (VCA), which aim to establish common standards and best practices for sharing of data, compliance, security and governance. Some of them also partner with third-party data providers or analytics companies, such as CryptoCompare or Chainalysis, who can provide independent verification and validation of their data.

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