The Latest Bitcoin ETF Proposals Have Some Major Red Flags


After getting rejected by the SEC last year, the Cboe BZX Exchange (formerly known as BATS) is leading the latest attempt to get a bitcoin ETF approved.  They have just filed with the SEC to list four new bitcoin ETF’s: the REX Bitcoin Strategy ETF, the REX Short Bitcoin Strategy, the First Trust Bitcoin Strategy ETF and the First Trust Inverse Bitcoin Strategy ETF. In their rejection of the Winklevoss ETF last year, the SEC noted the lack of surveillance of the underlying, unregulated bitcoin markets as one of their main areas of concern:

“Based on the record before it, the Commission believes that the significant markets for bitcoin are unregulated. Therefore, as the Exchange has not entered into, and would currently be unable to enter into, the type of surveillance-sharing agreement that has been in place with respect to all previously approved commodity-trust ETPs—agreements that help address concerns about the potential for fraudulent or manipulative acts and practices in this market—the Commission does not find the proposed rule change to be consistent with the Exchange Act

We took a look at the SEC filings for the four new bitcoin ETF’s to see why the Cboe thinks the SEC might be ready change their mind and approve a bitcoin ETF.  Here are a few red flags that we found in the proposals:

1) Cboe wants to allow the ETF to be exempt from maximum allowable levels of derivative holdings.  Rule 14.11(i)(4)(C)(iv)(b) “prevents the aggregate gross notional value of listed derivatives based on any single underlying reference asset from exceeding 30% of the weight of the portfolio.”

2) Cboe wants the fund to be allowed to hold more than the percentage of non-US component stocks that is allowed.  Rule 14.11(i)(4)(C)(i)(b)(3) provides that “the most heavily weighted Non-U.S. Component stock shall not exceed 25% of the equity weight of the portfolio.”  

3) The ETF will hold some illiquid assets.  According to the filing, “each Fund may hold up to an aggregate amount of 15% of its net assets in illiquid assets (calculated at the time of investment) deemed illiquid by the Adviser under the 1940 Act.

4) Cboe is claiming that bitcoin is not susceptible to price manipulation.  According to the Cboe, “the Exchange believes that the underlying reference asset is not susceptible to manipulation because the nature of the bitcoin ecosystem makes manipulation of bitcoin difficult.”  Cboe thinks that price manipulation would be difficult because there are multiple bitcoin venues around the globe. This is a very strange argument since it does not address the SEC’s concerns of cross-market surveillance of the underlying bitcoin exchanges. 

Based on these red flags, we think investors will have a tough time knowing what components make up the bitcoin ETF. Will risk-averse investors realize that the bitcoin ETF contains derivatives, non-US stocks and illiquid assets?  Will financial advisors who pitch these instruments understand what is inside the bitcoin ETF? What happens if the price of bitcoin crashes and there is a wave of selling in the ETF?