FX: SEC rejects bitcoin ETF but market remains buoyant

The SEC on Friday rejected a request by Bats BZX exchange to list the Winklevoss ETF, first presented to the SEC several years ago and repeatedly rejected by the regulator on the grounds that much of the market is unregulated.

The rejection this time temporarily knocked bitcoin off what had been a euphoric period of trading, falling nearly $300 in a matter of minutes.

However, after the rapid decline shook out the speculators who had been betting on a surge after a different SEC decision, the price returned to its upward trend, and by Monday was again at $1,242, above Friday’s closing level. 

Keonne Rodriguez, senior manager at Synechron, a digital and technology consultancy, argues the SEC made the right decision.

“The SEC doesn’t make value judgements on underlying assets – they simply want to ensure that procedures and safeguards are in place to protect potential investors,” he says. “I would agree with the SEC that neither they, nor the counterparties who are looking to expand bitcoin to ETFs, are ready or capable to handle a digital bearer asset such as bitcoin.”

Bitcoin’s reaction to the SEC setback shows the level of optimism in the market, where many see its rise and eventual acceptance as a mainstream currency as inevitable.

According to that logic, a bitcoin ETF will eventually get the green light, whether that be a revised Winklevoss offering or one from another provider. Grayscale Investments and SolidX Partners both have their own bitcoin ETFs filed with the SEC, waiting for their own approvals.

The Global Advisors Bitcoin Investment Fund (GABI), a hedge fund dedicated to investing in bitcoin, this week announced it had hired Laurent Kssis, who has worked in the ETF industry for 15 years.

Despite the SEC’s rejection of this proposed ETF, “demand is strikingly evident for bitcoin-based, exchange traded products”, says Danny Masters, co-principal and chief investment officer at GABI.

However, Synechron’s Rodriguez believes that demand might remain unsatisfied for some time, saying: “An ETF will happen eventually, but the timeline is looking more like years instead of months.”

It will take a combination of education at the SEC and greater maturity within the bitcoin ecosystem for the SEC to be sufficiently comfortable to approve such a product, he says.

Notwithstanding this, Rodriguez still believes 2017 “will be the year bitcoin grows up, and the grown-ups start to take notice”.

He is not alone in predicting a big year for the digital currency.

In an annual release of 10 “outrageous predictions” for 2017, Kay Van-Petersen, global macro strategist at Saxo Bank, predicts that 2017 would see huge gains for bitcoin as US fiscal spending rapidly increases the budget deficit, potentially doubling or even tripling it from the current level of $600 billion. 

Such a scenario would likely stoke significant inflation rises, forcing the Fed to accelerate rate hikes, destabilizing emerging markets (EMs) and encouraging them to look for alternatives to the fiat money system dominated by the US dollar, which they would find readily available in bitcoin, says Van-Petersen.

As the banking systems and the sovereigns of Russia and China move to accept bitcoin as a partial alternative to the dollar, the currency could surge to around $2,100, Van-Petersen mischievously predicts.

The prediction is principally intended to be thought-provoking, but the first months of 2017 have set the digital currency up for another strong year based on a number of metrics.

The hashrate – essentially the speed at which the bitcoin network is operating – is high. Liquidity is high on regulated exchanges, and on the peer-to-peer exchanges, where users can bypass anti-money laundering (AML) rules, it is even higher.

And then there is the price, which remains indefatigable. Despite posting returns of 9.5% in February, GABI felt compelled to apologize to investors for a relatively disappointing month, having taken too much risk in a period of high volatility and losing 10% against its benchmark – the dollar price of bitcoin.

On February 9, there had been an explosion in the cash-to-futures basis, mainly due to the increasing attentions of another regulator, the People’s Bank of China (PBoC). That saw the low in futures hit $717, while the low in cash sat at around $940 – a spread of $223 (31%) for a contract which converges in seven weeks.

This dislocation resulted in GABI requiring additional margin, which it took 30 minutes to meet due to congestion on the blockchain. GABI’s position was liquidated at $767, before the market shot back up above $900.

Such dislocations explain why regulators such as the SEC and the PBoC still view bitcoin with some suspicion. The PBoC has been visiting a number of bitcoin exchanges on the mainland in recent months, including BTCC, Huobi and OKCoin to assess leverage, risk disclosure, marketing practice and AML protocols. This has encouraged some bitcoin exchanges to tighten up controls.

Yet while the market can be dysfunctional, the same can be true in some more established markets, and it is from such markets – especially EMs – that a lot of the growth in bitcoin is coming.

In countries such as Argentina, bitcoin provides an alternative to the Argentine peso, which is similarly volatile, but with an apparently greater downside.

In India, interest in bitcoin surged when the government introduced its demonetization measures, scrapping 500 and 1,000 rupee notes, to the point that a considerable arbitrage opportunity temporarily arose, with bitcoin trading at a premium of around 30% in India relative to the US, notes Rodriguez.

Rodriguez says: “Where there is a lack of confidence in a national currency, bitcoin is increasingly seen as a safe haven.”

Jay Smith, a bitcoin trader on social trading platform eToro who says he used Friday’s dip as an opportunity to add to his long position, notes: “The appeal of bitcoin to countries facing high inflation, currency controls and corruption is only growing, as is the infrastructure surrounding the currency. Anything under $1,000 per coin should be considered a discount.”

The effect is evident to a lesser extent in developed markets. Brexit, Trump and the European sovereign debt crisis have all corresponded with moderate but identifiable increases in bitcoin use in affected countries.

Generally, though, where EM investors tend to see bitcoin as a store of value, those in developed markets – which typically enjoy relatively stable domestic currencies – usually regard it as more of a speculative asset. Many have bet its price will continue to trend upwards as it gains increasing acceptance around the world.

GABI’s Masters says the impact of tighter regulation in China on the bitcoin market has been confusing.

“On the one hand, the steps taken, including lowering leverage on the onshore cash markets, imposing trading fees on the onshore markets, the tightening of AML standards and the suspension of certain bitcoin withdrawals are casting a shadow over Chinese bitcoin activity,” he says.

Chinese trading activity is central to the bull case for the market, he adds, so if regulators conclude Chinese exchanges have helped facilitate large-scale capital flight, their days might be numbered, with potentially significant implications for the broader market.

However, Masters adds: “On the other hand, the fact that there is positive engagement between the PBoC and the exchanges at least shows us that there is a willingness to work things through.

“From direct experience we can say that OKCoin AML compliance is now strong: on a scale whose maximum we would define as AML sufficient to open a UK clearing bank account, we’d rate them eight out of 10 currently.”