Bitcoin has started to rebound, approaching $8,000, and its resurgence in the market is giving credence to the idea of a bitcoin exchange-traded fund (ETF), but regulators have several concerns about such a financial instrument.
At Consensus 2019 , an annual event discussing the latest developments in cryptocurrency and blockchain technology, Nasdaq's Head of Marketplace Regulatory Technology Tony Sio joined the panel, When ETF? Market Manipulation and How to Cope With It . The conversation centered on the obstacles surrounding the development of a bitcoin ETF, including market surveillance and data integrity.
There are numerous ETFs on the market, but it's essential to understand what they are. An ETF includes multiple securities, which track an underlying index. The fund can be divided into shares, which can then be sold as a security. The ETF can be industry-specific or cross-sector.
A government-approved bitcoin ETF, the panel argued, would garner trust in the digital asset space and, in turn, open up the market to institutional investors. However, before any of this can happen, firms must gain ETF approval from the U.S. Securities & Exchange Commission (SEC).
The SEC has outlined four concerns that firms must address to gain ETF approval, including:
- Valuation: Is there sufficient information to value crypto, given the volatility of the market? Can sellers vouch for the credibility of pricing?
- Liquidity: How do funds consider liquidity risks? Are crypto ETFs liquid?
- Custody: How is ownership tracked and transferred? What are the settlement processes to minimize risks when buying/selling digital assets?
- Manipulation: How are firms monitoring for market manipulation of digital assets? What are the regulations surrounding this and what are the key behaviors digital asset exchanges should be looking for?
Focusing on the last concern, it is important to understand that ever since the markets have existed, so has market manipulation, and digital marketplaces are no exception. As with any market, there is a need for market operators to ensure investors are always protected. When prices are manipulated, investors can get the perception that there is a lack of fair treatment, which can result in a lack of trust.
Compared to well-functioning, traditional marketplaces, digital asset exchanges can seem a bit daunting. However, digital exchanges are placing more importance on monitoring for market abuse and a better understanding of surveillance controls and processes. For example, in order to receive a BitLicense, which is a business license for conducting activities surrounding virtual currencies, firms are required to have proper surveillance processes in place.
The SEC has set stringent specifications around these crypto assets, and rightfully so. It is critical that there is enough information to ensure investor protection, and it can often be challenging to prove market manipulation because one needs to demonstrate intent or cause. Take the case of the CFTC v. Wilson in December of 2018, where the court ruled against the CFTC that open-market bids and offers, which are made with an honest desire to trade, should not be liable under the Commodity Exchange Act. The court further stated the "defendants made bids with an honest desire to transact at th[e] posted prices, and that they fully believed the resulting settlement prices to be reflective of the forces of supply and demand."
As firms race to meet regulators' bitcoin ETF requirements, regulators will continue to place investor protection at the forefront of their decisions. This is the industry's chance to implement surveillance controls and lead the way in building investor trust in the digital asset space. Confidence in digital asset exchanges will open the markets to a more diverse group of investors and drive further growth.