Podcast: Recent ETF Developments: Cryptocurrency ETFs and ETPs
Practices: Mutual funds, ETFs and closed-end funds, cryptocurrencies and blockchains, investment management, asset management, asset management ESG
In the final part of the Ropes & Grays ETF podcast series, asset management partner Paulita Pike and advisor Ed Baer discuss some of the latest developments related to cryptocurrency ETFs and ETPs.
Transcript:
Ed Baer: Hi, and thank you for joining us today on this Ropes & Gray podcast. I’m Ed Baer, a consultant in the San Francisco office of Ropes & Gray. Along with me today, my colleague in the asset management practice group, Paulita Pike, is the managing partner of our Chicago office. In this podcast, which is part of a series of podcasts on ETF issues, we will discuss some of the latest developments related to cryptocurrency ETFs and ETPs. I will start with a word about terminology. Paulita, can you explain what we mean when we talk about ETFs and ETPs?
Paulita Pike: Thanks, Ed. Absolutely. Well, we generally use the term ETFs when we talk about traditional 1940 Act exchange traded funds, and we use ETPs, or exchange traded products, when we talk about non-1940 Act funds that invest physical or “spot” cryptocurrencies and also for certain futures-based products. As we will discuss in more detail later, one of the main questions to decide whether a fund is an ETF or ETP that the fund invests in. Mostly ETFs invest in securities (usually equities and bonds), while ETPs invest in ” physical “commodities such as gold or silver, futures or currencies. With cryptocurrencies, there is considerable confusion, or at least a debate about whether cryptocurrencies are actually securities.
Ed Baer: That’s right, Paulita. The status of cryptocurrencies in the United States is quite confusing. A few years ago, the then director of the SEC’s Division of Corporation Finance claimed that bitcoin and ethereum, the two largest cryptocurrencies by market value, were not securities. It has remained the prevailing view, at least with respect to bitcoin and ethereum, but to evaluate other cryptocurrencies, the SEC relies on a decades-old lawsuit involving interests in an orange grove to determine whether cryptocurrencies are “investment contracts” and therefore securities. under federal securities laws. And it seems that the more the SEC looks at cryptocurrencies, the more they look like securities.
Paulita Pike: I totally agree, Ed. I do not think we want to get stuck in the debate about whether different cryptocurrencies are securities, so for the rest of our discussion I think it makes sense to treat physical or “spot” bitcoin and ethereum – the two crypto assets that different companies have tried to launch exchange traded products on – as non-securities. The types of products that sponsors have unsuccessfully tried to market in the US – spot bitcoin or ethereum ETPs – and the cryptocurrency products that have been marketed in the US – funds that invest in bitcoin futures and contracts – imply a distinction between securities and non-securities . Ed, given the role you have played, do you think you can give a little about the history of the efforts to bring cryptoactive products to market?
Ed Baer: I would like. Back in 2013, the Winklevoss twins submitted a registration declaration for an ETP that wanted to invest in spot or physical bitcoin. The proposal involved a type of structure called a grantor trust that would hold bitcoin. This structure sought to recreate the structure of gold or silver ETPs, where the grantor has the physical metal and investors can trade shares in the ETP on a stock exchange. The premise behind this structural approach was that bitcoin was not a security, so ETP could not be registered under the 1940 law. This filing crept through the SEC for several years. When I joined Ropes in 2016, I was hired to help get the project through the SEC approval process. And it looked like we were making progress. To list an ETP on a stock exchange such as the NYSE or Cboe, the ETP must have an effective listing declaration and the shares must be eligible for listing in accordance with the exchange’s listing rules. The registration statement seemed to make slow but meaningful progress in the SEC’s Division of Corporation Finance. However, since there was no precedent in the listing rules for ETPs holding bitcoin or other cryptocurrencies, the proposed listing exchange (Cboe BZX) had to ask the SEC’s Department of Trade and Markets to change the listing rules to allow ETPs holding bitcoin. And that was where the obstacles to launching a spot bitcoin ETP really came into focus.
Paulita Pike: That is correct. In 2017, the SEC’s trading and marketing staff rejected Cboe BZX’s request to change the listing rules to allow the listing of a bitcoin ETP. Cboe appealed this decision to the entire commission, and in 2018, in a unanimous decision, the commission confirmed the rejection of Cboe’s proposed rule change. The Commission’s reasoning, which has been repeated over and over again in a series of subsequent rejections of rule changes – most recently this week, by the way, when the SEC denied Greyscale’s attempt to convert Bitcoin Trust to a listed ETP – is that the proposed listing was not possible. to demonstrate that the rules are adequately “designed to prevent fraudulent and manipulative actions and practices” and “to protect investors and the public interest.” The question is whether the listing exchange has a “comprehensive monitoring sharing agreement with a regulated market of significant size related to the underlying or reference bitcoin assets.” In Winklevoss and Greyscale denials, and in a number of other SEC denials, the SEC concluded that the global 24/7/365 nature of the spot bitcoin market cannot be adequately monitored by stock exchanges. Greyscale and other sponsors have argued that the existence of a monitoring sharing agreement with CME, which lists bitcoin futures contracts, is sufficient, but the SEC does not agree that it is enough for a spot bitcoin ETP.
Ed Baer: Exact. And this is where things get interesting. The SEC recently approved the listing of Teucrium Bitcoin Futures ETP. Teucrium ETP only invests in bitcoin futures contracts traded on CME. By approving the Teucrium proposal, the SEC recognized that the CME bitcoin futures market is a “regulated market of significant size”, but only with respect to CME bitcoin futures contracts, not with respect to the underlying bitcoin markets. As a result, exchanges such as NYSE Arca and Cboe BZX have monitoring sharing agreements in place with a regulated market of significant size, but not in terms of the assets the bitcoin ETPs will have.
Paulita Pike: So where does that leave things? We know that there are bitcoin ETPs in Canada, Australia and other countries that seem to be working just fine. Will the SEC ever approve a spot bitcoin ETP?
Ed Baer: Well, at some point, the SEC’s hand may be forced. Shortly after the NYSE Arca proposal was rejected, the Greyscale asked the DC Circuit Court to review the SEC’s rejection of the proposal. And while the review request did not mention the Administrative Procedures Act, Greyscale has previously argued that the SEC’s refusal of entries to detect bitcoin ETPs is inconsistent with the APA due to the fact that the 1940 Act ETFs investing in bitcoin futures contracts has received permission from the SEC to launch and list its shares. In addition, they point out that the pricing of CME bitcoin futures contracts is derived from the same group of US-based crypto exchanges used to value Greyscale Bitcoin Trust’s bitcoin holdings.
Paulita Pike: It gives us an excellent opportunity to discuss bitcoin futures ETFs. These ETFs buy bitcoin futures contracts to gain exposure to the price of bitcoin futures. Because most of the assets of the ETFs are US government securities, they are considered 1940 Act ETFs, and they do not require SEC approval to list their shares on a stock exchange. The first bitcoin futures ETF was launched in October 2021 and quickly raised over $ 1 billion in assets. Several others have since been listed. Since these ETFs seek to track the returns of bitcoin futures contracts instead of bitcoin itself, they provide a different exposure than the proposed bitcoin ETPs, but they are still the only exchange-traded products that pass the SEC pattern.
Ed Baer: That is correct. And until the SEC either changes its view of spot bitcoin ETP, the underlying spot bitcoin markets become more regulated or Greyscale or others succeed in suing the SEC, it is possible that nothing will change in the short term. We have heard that there are several US-based crypto exchanges that are considering being registered with the SEC as exchanges or alternative trading systems, so it is possible that one or more US crypto exchanges may become regulated markets of significant size for spotbitcoin. However, the global nature of bitcoin trading, where a large majority of bitcoin trading takes place on unregulated non-US exchanges, suggests that regulation of US cryptocurrencies may not be the deciding factor. And lawsuits against the SEC, even if successful, are likely to take years. It is possible that the greatest hope for breaking the deadlock is that the composition of the commission, or at least the head of the commission, will change, and this is unlikely without a change in the administration.
Paulita Pike: Well, that brings us to the end of the podcast. Ed and I want to thank you all for joining us in this discussion of ETFs and cryptocurrency ETPs. For more information on the topics we have discussed or other topics of interest to asset managers and ETF sponsors, please visit our website at ropesgray.com, where we have links to some additional material regarding these topics. To help you better understand the current ETF landscape, we will be releasing several additional podcasts designed to provide a greater depth of analysis of important and current ETF issues. If you have any questions regarding the topics we covered or anything else, do not hesitate to contact one of us or who you have a partnership with in Ropes & Gray. You can also subscribe and listen to the series of podcasts wherever you regularly listen to podcasts, including Apple, Google and Spotify. Thanks again for listening.
