A Spot of Bother for Bitcoin
“Give me a lever long enough and Bitcoin on which to place it, and I shall move the world.” – Michael Saylor
There’s a bureaucratic civil war ongoing within the US Government to regulate Bitcoin. In the broadly pro-Bitcoin camp sits the Commodity Futures Trading Commission (CFTC), which takes a favorable stance toward convertible digital currencies. In the trenches on the other side, the Securities and Exchange Commission (SEC) is assembled and making battle increasingly difficult for the maxis.
In December of 2014, the CFTC determined Bitcoin to be a commodity under the Commodity Exchange Act (CEA), and since that time has brought a mix of enforcement actions against clearly fraudulent behavior while simultaneously working to develop a legal framework to allow for trading in Bitcoin futures. Here’s a key passage from a summary article in The National Legal Review (emphasis added):
“Consistent with the ‘do no harm’ regulatory approach of his predecessor, current CFTC Chairman Heath Tarbert has recently declared the importance of U.S. leadership in development of digital assets because ‘whoever ends up leading in this technology will end up writing the rules of the road for the rest of the world.’ Mr. Tarbert called for a principles-based approach that would allow the market to develop ‘under sound regulation but with market participants, not the regulator.’”
Because of the CFTC’s support and its desire to provide regulatory clarity, there exists in the US today a vibrant futures market in Bitcoin. There are even several Bitcoin futures ETFs that trade on the stock market, including the popular ProShares Bitcoin Strategy ETF (NYSE Arca, Symbol: BITO), which has over $1 billion in assets under management. Since its launch last fall, BITO trades with a 95%+ correlation to the spot price of Bitcoin, giving regular investors the opportunity to speculate in their favorite digital commodity using their brokerage accounts, like they would any other stock.
Missing from the suite of US investor options is a direct Bitcoin spot market ETF, and getting one approved has been a high-priority goal of the heavy hitters in the Bitcoin community for many years. Given the existence of ETFs like BITO, why is this an urgent issue for them and why doesn’t one already exist? The answer to both is revealed in understanding the nature of the Bitcoin Ponzi scheme. With SEC Chair Gary Gensler steadfastly declining Bitcoin spot ETF applications almost as fast as they come in, he is signaling what he already understands.
In January of this year, we described our mental model for understanding the crypto space in a controversial piece called Dollars Ex Machina. Here’s a key passage (emphasis in the original):
"We distinctly recall drawing two circles on a piece of paper. In the circle on the left, we wrote ‘real economy,’ while in the circle on the right we wrote ‘crypto universe.’ We drew two pipes between the circles – one flowing into the crypto universe and the other flowing back to the real economy – and labeled both pipes with ‘fiat currencies.’ While we understood how fiat currencies from investors could flow in, we failed to grasp what could be occurring within the crypto universe that would create more fiat currency for investors to take out at a later date.”
We then went on to use a “follow the fiat” approach to explain why the behaviors of Michael Saylor, Chair and CEO of MicroStrategy, and Nayib Bukele, President of El Salvador, were potentially risky to the Bitcoin ecosystem. If we use that same framework to understand the critical difference between Bitcoin futures and spot ETFs, the mystery over why spot ETFs are urgently needed becomes apparent.
While Bitcoin futures contracts reference the price of Bitcoin and can be used to speculate on the commodity, they are settled in cash. Here’s how the CFTC describes the process (emphasis added):
“CME’s Bitcoin futures contract, ticker symbol BTC, is a USD cash-settled contract based on the CME CF Bitcoin Reference Rate (BRR), which serves as a once-a-day reference rate of the U.S. dollar price of bitcoin. The BRR aggregates the trade flow of major bitcoin spot exchanges during a one-hour calculation window into the U.S. dollar price of one bitcoin as of 4 p.m. London Time.”
When an investor takes a position in a futures contract, they deposit US dollars in their account as margin. So too does the investor on the other side of the trade. As the price of Bitcoin fluctuates, one side wins and the other side loses, but at no time do US dollars leave the real economy as a direct consequence of this trade. The winning side collects more US dollars, and the losing side ends up with less, but the direct flow of fiat never enters the crypto universe.
Now consider the flow of fiat for Bitcoin spot ETFs. These products are designed to buy and hold Bitcoin directly, injecting much-needed US dollars into the crypto universe. As long as funds flow into spot ETFs faster than they are redeemed, the net effect provides US dollar exit liquidity to those looking to cash out their Bitcoin. And therein lies the critical difference between the two products, and why, in our estimation, Gensler is blocking these applications.
Last week, the latest denial was handed down to a proposed Bitcoin spot ETF led by Cathie Wood of Ark Invest. In its 55-page order rejecting the application, the SEC pulls no punches. Here’s a key passage that begins on page 22 (emphasis added):
“… does not sufficiently contest the presence of possible sources of fraud and manipulation in the bitcoin spot market generally that the Commission has raised in previous orders. Such possible sources have included (1) ‘wash’ trading, (2) persons with a dominant position in bitcoin manipulating bitcoin pricing, (3) hacking of the bitcoin network and trading platforms, (4) malicious control of the bitcoin network, (5) trading based on material, non-public information, including the dissemination of false and misleading information, (6) manipulative activity involving the purported “stablecoin” Tether (USDT), and (7) fraud and manipulation at bitcoin trading platforms.”
Gary Gensler can be accused of many things, but being ignorant of how crypto markets work is not one of them. After all, he used to teach a class at MIT’s Sloan School of Management titled Blockchain and Money. Gensler knows what really drives the “price” of Bitcoin, and what is driving the need for a constant supply of new fiat. It is all right there in the filings for everyone to see.
We suspect most Bitcoin enthusiasts simply do not want to look.
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Love the article. I think you leave out a much bigger story which is the Fed's holding up Custodia's application for two years. Had Custodia & Kraken been allowed to gain access to Fed window they would have on boarded an insane amount of institutional capital in 2020 and 2021 before the blowups. And the fact that Custodia intends to offer a stable coin and do no lending means it will be THE FIRST BANK IN THE US TO NOT DO FRACTIONAL RESERVE LENDING. That is huge. Instead of "Don't Be Evil" their business model is "Can't be evil." In addition, the state regulatory scheme for digital assets gives customers a bailment. {Bailments are when you give your car keys to the parking attendant.] THAT IS ANOTHER EARTH SHATTERING WAY OF TREATING FINANCIAL ASSETS. No rehypothecation. THAT IS THE REAL THREAT AND THE FED KNOWS IT. Had BlockFi or Celcius been based in WY they would have had to treat their customers digital assets as bailments. In bankruptcy, if those digital assets were bailments, then THE CUSTOMERS GET THEIR DIGITAL ASSETS BACK FIRST. The lenders and equity holders come after. And the suit Custodia has against the Fed is the first time the Fed has ever lost a case of this type. This is the most interesting story in bitcoin BY FAR and no one is covering it.
I think SEC's denial includes misinformed arguments. In my opinion, and to an extent of my knowledge, points (3) and (4) are not correct:
"(3) hacking of the bitcoin network and trading platforms, (4) malicious control of the bitcoin network"
In Bitcoin (or any other PoW network, unlike PoS), controlling big amounts of tokens (BTC) does NOT allow for manipulating the *network* (network, not price) nor it allows for "hacking" it.