The CFTC approved a Bitcoin Derivatives exchange “LegderX” several weeks back. Because Van Ecks ETF will rely on that rather than Bitcoin it means that clearing and moving funds will arguably be more transparent and secure because the derivatives settle in cash. The SEC and CFTC understand cash better than they do Bitcoin.
I personally thing the challenge the SEC has with the Winklevoss ETF is that they cannot wrap their heads around how the storage of Bitcoin will take place and where the funds will held. There are lots of security issues here which needs to be addressed and that makes for a lot of challenges.
There is “GBTC” which is not actively managed and usually trades at a very high premium to Bitcoin – see here.
The CBOE is now launching Bitcoin Futures in a plan with the Gemini exchange. I am not certain what the implications are of this for the Bitcoin ETF that the Winkelvoss were working on. Launching Futures is a much easier task for the CFTC and/or SEC to wrap their heads around as the Future just has to track the Bitcoin price. Whereas with ETF the SEC has to figure out how actual trading and settlement of the Bitcoins underlying the ETF would work.
One could argue that the Bitcoin ETF would have had a much bigger impact on price that the Future. But inevitably there will be players in the market which are arbitraging Futures versus the underlying. This means more capital flowing into the cryptocurrency space. It also means more legitimacy for Bitcoin wherein regulators and stock exchanges are grasping and embracing the products.
Therefore, if you buy 1 share of GBTC at 388, you are paying ~$41 for ~$23 worth of Bitcoin. Thats an absolutely absurd >150% premium. Not to mention the 2% annual fee GBTC charges.
This premium is not the GBTC’s fault. Its investors that need their heads checked. GBTC cannot reweight their Bitcoin holdings in anywhere near real time. The Winklevoss ETF, should it make it through the SEC, would reweight much more often giving investors a vehicle which more closely tracks the actual price of Bitcoin.
In addition to the continuous trading order book, each of the order matching engines conducts two Auctions (or “crosses”) every day, one at 4:00 p.m. Eastern Time (20:00 UTC during EDT and 21:00 UTC during EST) and one at 7:00 p.m. Singapore Time and Hong Kong Time (20:00 JST, 11:00 UTC). This provides an opportunity for both buyers and sellers to trade in an instant of elevated liquidity and price discovery. All active orders (including resting limit and MOC orders) may interact with the Auction and influence the final auction price, which is determined by finding the price at which the greatest aggregate buy demand and sell demand are fulfilled. All participating, eligible orders are fulfilled at the final auction price. (We use a mechanism similar to the New York Stock Exchange’s Arca marketplace, Nasdaq, Bats, and other large stock exchanges throughout Europe and Asia, which is sometimes called Walrasian equilibrium.)
In the stock trading world Auctions are useful because it allows you to trade “size” (aka large orders) without (hopefully) having much impact on the stock price. If you are a large hedge fund and need to offload 5 million shares you can really push the price of a stock down, especially if you are a large part of the volume. Theoretically the auction might allow you to cross (aka match in the auction) with a large buyer without having a major impact on the price of the stock.
There are a bunch of stats on the Gemini Auction here.
On the stats page, there are a few interesting things. There are about 340 data points and the average “Absolute Difference” between the midpoint on the “continuous market” (aka normal price) vs where the Auction Matched price is 0.27%. With Bitcoin at ~$2,500 thats about $7. The highest spread though was 3.83%, with a standard deviation of 0.41%. Remember, these are ABSOLUTE numbers, so you don’t know if the auction price is higher or lower.
A real statistician would rip my math apart here, but basically this says that you have a 66% chance of achieving a price thats almost 1/2 a percent from where the continuous market is trading.
For the average joe, this isn’t worth much. The price of Bitcoin or Ethereum can move 1/2% in a few seconds so you’re opportunity to lock in an arbitrage seems a random. But, if you are a market maker or an arbitrager using an API to trade instantly its pretty interesting. Not only could I use the difference in price between the “continuous” exchange on Gemini and the Auction mechanism, but I could also arbitrage between any one of the other exchanges like GDAX, kraken, OKCoin, etc.
Hedge funds and Wall Street firms have been slow moving into trading and investing in cryptocurrencies such as Ethereum and Bitcoin. There are some
indicators that sentiment is shifting such as JP Morgan (and others) joining the Enterprise Ethereum Alliance and Goldman Sachs initiating research coverage of Bitcoin.
Assume for a second that sentiment is suddenly 100% positive and that all the “scam” and “crime” stigma has left the building. So, whats the problem?
Regulation of Bitcoin, Ethereum
Party of the beauty and attraction of crypto is the decentralization and lack of regulation. There are many reasons why this is beneficial. But if you’re a big bank or managing billions of dollars, regulation matters. First, Bitcoin is not “legal” in all countries. Just look at what China did a few months ago when they started “regulating” Bitcoin. As per wikipedia: “While private parties can hold and trade bitcoins in China, regulation prohibits financial firms like banks from doing the same.” Not only is there (outside) risk of the US doing this, but if you’re a fund thats has Chinese investors or does business with China this clouds the water.
Most assets are also considered collateral. If I have $10 million in gold I can bet that the bank I deal with would consider that an asset against which I can borrow. Does every bank see Bitcoin in that same light?
A lower risk, but still foreseeable is the risks of regulators such as the SEC or FINRA coming after you for engaging in (for example) an investment used to launder money. Maybe you buy Monero and build up a large position and
those assets are seized because the FBI thinks they were used in some hacking blackmail scheme. Probable? Probably not. Possible? Sure.
The facts are that until a regulator “green lights” Bitcoin and/or Ethereum its going to be tough for large institutions to trade or invest.
When Might Regulators Weigh In?
I’ve been watching the SEC’s ruling on the Winklevoss Bitcoin ETF launch. Its taken years for a ruling, and earlier this year it was initially rejected. However in April the SEC decided to take another look. I think its a bit underestimated the impact that approval would have to the price of Bitcoin. This would give not only a regulatory stamp of approval, but paves the way towards clearing and settlement of Bitcoin at an institutional level.
Clearing and Settlement is a Major Problem
Take stock or ETF trading as an example. When funds (or anyone as a generalization) trade publicly listed stock that stock clears through a central clearing house called the DTC. If I am a hedge fund and have my assets at say, Goldman Sachs (your “prime broker”), I can trade stock with JP Morgan. JPM sends the stock to my account at Goldman through the DTC. Its a pretty seamless process and universal to US stock trading.
Now, lets say I’m a hedge fund and I want to buy $1 million Bitcoin. Buying is easy enough – you go to one of the exchanges, wire money and buy your Bitcoin. The problem is there is no way to get your Bitcoin back to your prime broker. No, a wallet even with vaulted cold storage wouldn’t work. The risks associated with that are high, but the mechanics of trading in and out are a huge hindrance. If the fund needs to immediately raise assets by selling Bitcoin they need to have immediate access to those coins. While yes, you can work out the mechanics if you are a small fund or “crypto” is your dedicated business. But for large institutions who want to simply invest in crypto this is a major hindrance.
How Could Clearing Change?
One possible way is for clearing houses/prime brokers like Goldman or Morgan Stanley to have some type of central clearing wallet. Linked to that wallet would be “sub-wallets” for each fund that owns Bitcoin. Therefore if I go to Gemini Exchange and buy 1000 Bitcoin, I tell Gemini to send that Bitcoin to Morgan Stanley on my behalf. Morgan Stanley then has custody and can allocate the Bitcoin to my funds sub-wallet. This “sub-wallet” concept seems to peripherally exist and I’d imagine banks could pay someone to hash it out rather quickly.
If the Bitcoin ETF launched this would circumvent all of this, because you could just buy the ETF and it would clear via the DTC like all other stocks and ETFs. (Yes, I am aware the GBTC exists, but the premium on that product is absurd). To this point I think this clearing/custodial aspect is probably one of the problems the SEC is having with the product.
In the End
I’m confident these issues will be worked out. The fact that they haven’t yet makes (in my opinion) Bitcoin and Ethereum such an interesting investment at the moment. The door is currently cracked open to big investors, but eventually we could see a real flood of assets.