On March 28, 2017, the U.S. Securities Exchange Commission (“SEC”) issued a second denial of a bitcoin exchange-traded fund (“ETF”), following its rejection of the Winklevoss Bitcoin Trust earlier this month (Reed Smith commentary is available here). SolidX Bitcoin Trust would hold bitcoin as its primary asset, together with smaller amounts of cash.  Theft of bitcoins would be protected against through insurance coverage.

The SEC again cited lack of regulation in the bitcoin spot market as a key driver of its decision to reject the ETF. The SEC’s order explains that the agency “believes consistent with its conclusion in the [Winklevoss ETF] Order that the bulk of bitcoin trading occurs on markets where there is little to no regulation governing trading, and thus no meaningful governmental market oversight designed to detect and deter fraudulent and manipulative activity.”

The SEC explained that such ETFs must satisfy two requirements: “First, the exchange [that lists the ETF] must have surveillance-sharing agreements with significant markets for trading the underlying commodity or derivatives on that commodity.  And second, those markets must be regulated.”

This causes us to ask how many regulated markets listing bitcoin products are necessary to provide the SEC sufficient comfort to approve a bitcoin ETF.   If one of the exchanges registered with and regulated by the Commodity Futures Trading Commission (CFTC) lists a bitcoin option, swap or futures contract, would that suffice? Or would there have to be multiple bitcoin products traded on more than one regulated exchange?

The normal evolution of a product begins with bespoke deals between the parties over-the-counter. As products become traded more often, the terms become more standardized.  Once terms are sufficiently standardized, and there is sufficient demand that could entice market maker participation, an exchange would then consider listing a contract on that product.  The questions will be whether bitcoin trading is at that last stage yet and whether a bitcoin contract would bring sufficient volume of trading to an exchange.  If we are close to the answers to those questions being yes, then that first contract could potentially be the trigger that would allow the approval of many soon to follow regulated digital currency products.

The SEC Order is available here.