SEC commissioners remain leery of crypto; still approve spot bitcoin ETFs

Long-anticipated approvals come following SEC loss in court, not change in regulatory opinion of crypto, making intense compliance reviews more likely

The SEC shook up cryptocurrency markets Wednesday by approving the first spot bitcoin funds, but made clear the approvals were granted based on limitations imposed on the SEC by federal courts, not a wholesale reversal of its nearly decade-long refusal to allow cryptocurrency funds in U.S. markets.

On Jan. 10 the commission approved 11 applications for spot bitcoin ETFs from sponsors ranging from traditional players including BlackRock, Fidelity and Invesco to newcomers Grayscale and Ark Invest.

The funds will give U.S. investors wider access to bitcoin without the risk or complications of owning bitcoin directly, through products that are regulated and controlled in ways that reduce the potential for manipulation, fraud and the use of cryptocurrency for illicit activity – tendencies that SEC officials have cited as the basis for their opposition in the past.

The approvals came just one day after a bogus announcement that the SEC had approved bitcoin ETFs appeared on the SEC’s X (formerly Twitter) account. The statement was made by “an unknown party” who took control of the account shortly after U.S. markets closed on Jan. 9, according to an SEC spokesperson who said the agency had regained control of the account and would work with law-enforcement agencies to pursue those responsible.

SEC chair Gary Gensler voted with Republican commissioners to approve the 11 applications but made clear in his public statement that he still considered bitcoin a “speculative, volatile asset” and considers cryptocurrencies in general to be commodities too volatile, risky and poorly managed to be included in mainstream investment funds.

The bitcoin ETFs approved this week represented “the most sustainable path forward” for the agency following a federal court ruling last August that found the SEC had been arbitrary in denying Grayscale Investments’ application for a spot bitcoin ETF without explaining why surveillance agreements designed to prevent fraud were not acceptable for spot bitcoin funds but were acceptable for bitcoin futures-based ETFs the SEC had already approved.

“Today’s commission action is cabined to ETPs holding one non-security commodity, bitcoin. It should in no way signal the commission’s willingness to approve listing standards for crypto asset securities,” Gensler wrote.

Statements posted by other commissioners show a wide gap and almost adversarial intensity in the positions staked out by both Democratic and Republican commissioners, however.

Approvals for spot bitcoin ETFs are long overdue for reasons that are inexplicable, especially considering previous approval of bitcoin futures ETFs that are registered under the 1933 Act rather than the 1940 Act and “are more complex and more difficult to manage than the spot product, which can translate into higher costs for investors,” Republican commissioner Hester Peirce argued.

Years of denials have “driven retail investors to less efficient means of attaining bitcoin exposure in securities markets,” she wrote.

And when the spot bitcoin ETFs were eventually approved, “rather than admitting error, [the commission] offers a weak explanation for its change of heart,” she wrote.

Democratic commissioner Caroline Crenshaw called the approvals “unsound and ahistorical. And worse, they put us on a wayward path that could further sacrifice investor protection.”

She cited studies showing as much as three quarters of the bitcoin trading volume on unregulated exchanges is due to “wash trading” techniques that distort price and volume totals, increase volatility and reduce investor confidence. Another study she cited found that 51% of daily bitcoin trading volume is “likely bogus.”

Republican commissioner Mark Uyeda, who voted for the approvals, nevertheless criticized the way they were given for “improperly” applying a “significant size” test to identify the ETPs that could or should be approved under the ruling in the Grayscale case. He also called out the commission for not admitting that it had accelerated most of the approvals to put enough ETPs on the market simultaneously to keep Grayscale from turning its victory in court into a lasting first-mover advantage among spot bitcoin ETP sponsors.

New spot bitcoin ETF sponsors
• Bitwise (BITB)
• ARK Invest/21Shares (ARKB)
• Invesco Galaxy Bitcoin ETF (BTCO)
• iShares Bitcoin Trust (IBIT)
• VanEck Bitcoin Trust (HODL)
• Franklin Bitcoin ETF (EZBC)
• Fidelity Wise Origin Bitcoin Trust (FBTC)
• WisdomTree Bitcoin Trust (BTCW)
• Valkyrie Bitcoin Fund (BRRR)
• Grayscale Bitcoin Trust (GBTC)
• Hashdex Bitcoin (DEFI)

Gensler, who sets the priorities followed by the SEC’s Examinations and Enforcement divisions, made clear in his statement that the approvals do not include approval or endorsement of “crypto trading platforms or intermediaries, which, for the most part, are non-compliant with the federal securities laws and often have conflicts of interest.”

He also listed a series of requirements for spot bitcoin ETPs that match closely with enforcement priorities that have figured prominently in high-profile enforcement actions during the past two years.

Sponsors of any bitcoin ETPs that get approval will be required to provide full disclosure of risk to investors, for example. They will also be allowed to list and trade the products only on registered national securities exchanges whose rules are designed to prevent fraud and manipulation.

Sales of the newly approved products will also have to follow all “existing rules and standards of conduct” including Regulation Best Interest and the fiduciary duty under the Investment Advisers Act, Gensler wrote.

“While we approved the listing and trading of certain spot bitcoin ETP shares today, we did not approve or endorse bitcoin,” Gensler wrote in his public statement. “Investors should remain cautious about the myriad risks associated with bitcoin and products whose value is tied to crypto.”

“The federal government has the cryptocurrency market in its crosshairs,” according to an October, 2021 report from the law firm Dechert LLP following the launch by the Dept. of Justice of a crypto-specific investigative division called the National Cryptocurrency Enforcement Team and a rising level of scrutiny from federal agencies including the CFTC and SEC.

The report – which came out just as Gensler was beginning to intensify the SEC’s focus on crypto as a major source of risk – recommended that companies involved in crypto treat compliance with crypto rules as a major crypto-related risk to be mitigated. Compliance officers, the report said, should evaluate and expand, where necessary, their compliance programs, policies and procedures, and search for gaps in their ability to demonstrate compliance with an expected onslaught of new federal crypto-related or crypto-adjacent laws and regulations and the investor-protection goals that inspired them.

“Although reasonable minds can agree to disagree on the precise role that cryptocurrencies will take in our national and international economies and topics of discourse,” the Dechert report concluded, “one fact appears rock solid: enforcement and regulation of cryptocurrencies are here to stay— especially at the federal level. To that end, cryptocurrency market participants should be proactive in preparing for what comes next whether from the DOJ, SEC, and/or CFTC.”