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Bitcoin ETFs: Taking a Closer Look at VanEck’s Letter to the SEC

Bitcoin

The push for SEC-approved Bitcoin ETF listings has been receiving heavy amounts of news coverage over the last week. As several companies seek to be the first to bring crypto to Wall Street, a letter has been published by New York-based investment giant VanEck refuting many of the concerns laid out by the Commission’s recent ruling over Bitcoin ETFs.

VanEck’s current Bitcoin ETF project is being done in partnership with SolidX and is awaiting an SEC ruling. The published letter, signed by CEO and President Jan van Eck and first sent to the on SEC July 20th, is broken down into 5 sections, each focusing on a different point of SEC concern: Valuation, Liquidity, Custody, Arbitrage, and Potential Manipulation and Other Risks.

Given the implications of what a change in ruling by the SEC regarding Bitcoin ETFs would mean for the future of cryptocurrency, the case laid out by VanEck is worth looking into.

Valuation

The letter begins by addressing the SEC’s concerns over being able to accurately valuate assets in the digital currency market. Valuation is key to ETFs, as it allows all parties to accurately measure a fund’s performance and sets the price for the fund. The SEC has launched several criticisms over complexities underlying cryptocurrency’s spot market, like forks and airdrops, which they contend might make proper valuation for cryptocurrency ETFs impossible. VanEck, however, argues that the potential difficulties prompted by these variables are insignificant.

“While the valuation of cryptocurrencies and digital assets (together, ‘digital assets’) in the underlying spot markets may present some unique issues as raised in the Staff Letter, such as the valuation of forks and airdrops, we do not believe that the valuation of futures contracts in accordance with the requirements of the Investment Company Act of 1940 (the “1940 Act”) presents any novel issues for a futures-based bitcoin ETF.”

Throughout VanEck’s letter, the authors draw comparisons between the proposed Bitcoin ETF and the CME and CBOE—the two BTC futures contracts currently being traded on the Nasdaq. VanEck continually argues that many of the concerns presented by the SEC have already been addressed by the CME and CBOE. They are pointed to as a working example of a cryptocurrency futures contract already in place. As they pertain to valuation VanEck writes,

“These existing bitcoin futures contracts provide real-time reference rates and bid/ask quotes for the price of a bitcoin futures contract. We believe that the prices provided by CBOE and CME afford fund sponsors adequate information to value the bitcoin futures contracts held by a fund for the purpose of determining the fund’s net asset value (“NAV”).”

The letter continues,

“We do not believe that the valuation of futures contracts in accordance with the requirements of the Investment Company Act of 1940 (the “1940 Act”) presents any novel issues for a futures-based bitcoin ETF. The use of futures contracts to gain exposure to an asset is not unusual, and the valuation of futures contracts is a well-established practice. In fact, there are over 100 exchange traded products listed on U.S. exchanges that are based on futures contracts.”

Liquidity

Pertaining to SEC concerns over liquidity, VanEck details a heavy list of figures based on an analysis of the Bitcoin futures market and concludes:

“We believe this analysis supports the case for the market having sufficient liquidity for a futures-based bitcoin ETF. The physical bitcoin market is highly liquid, trading on average with less than a five basis point spread. To date, the bitcoin futures market has been efficient against the underlying bitcoin market. Currently, the total combined daily bitcoin futures volume on CBOE and CME is in the $150 million to $200 million range. The two existing futures contracts have traded in a fair and orderly fashion since their inception.”

Custody

Given that Bitcoin rarely trades as a physical asset, VanEck’s ETF has elected not to invest in physically-settled BTC futures contracts. The company will maintain its own assets and not depend on third-party members to hold underlying ETF assets.

Arbitrage

VanEck argues that cash-settled Bitcoin futures contracts, without the need for physical delivery, create a “natural arbitrage mechanism that enhances liquidity and capacity.”

The letter draws attention to the large over-the-counter (OTC) Bitcoin trading market which allows traders to arbitrage price differences across exchanges.

Here, VanEck also addresses the SEC’s concerns over volatility in the the crypto market by once again drawing comparisons to the CBOE and CME contracts:

“We do not believe that volatility-based trading halts will affect the arbitrage process. To date, there have been 7% and 13% halts for the CME contracts and 10% halts for the CBOE contracts. Each halt lasted for 2 minutes; markets then re-opened trading in an orderly fashion. During a halt, ETF market makers will continue to have access to underlying real-time futures reference prices as well as prices in the underlying physical markets.”

Potential Manipulation and Other Risks

VanEck concludes its case by arguing that SEC concerns over manipulation in the Bitcoin marketplace have been overstated.

“While one cannot rule out manipulation in the underlying spot market, we believe that, due to the diversified ownership and volume of trading, the market does not have major, structural vulnerabilities.”

VanEck also states that much of the perceived risks in the cryptocurrency marketplace would be addressed if the SEC actually donned the responsibility of becoming a regulator within the market.

“The Commission’s increased enforcement and regulatory actions can reduce the number of bad actors in a basically sound market. A regulated fund is a natural extension of this.”

These were the same sentiments expressed in the recent SEC vote against the Winklevoss Bitcoin ETF by dissenting commission member Hester Peirce.

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