Full statement from SEC Commissioner Crenshaw: Opposes Bitcoin spot ETF approval, citing potential savings losses for retirement accounts

Author: Caroline A. Crenshaw, SEC Commissioner (voted against in a 3:2 vote)

Compiled by: Wu Says Blockchain

Today, the SEC approved a series of proposed rule changes that will allow for the listing and trading of Bitcoin-based products on national securities exchanges. The SEC's actions are unwise and inconsistent with historical facts. Worse, they put us on a path that may further sacrifice investor protection. I cannot agree that these actions benefit our statutory or fundamental investor protection mission, and therefore, I dissent from today's approval order.

Background

The proposed rule changes are made under Section 19(b)(1) of the Securities Exchange Act of 1934 ("Exchange Act") and the applicable rules thereunder to list and trade shares of trusts that hold spot Bitcoin ("Exchange-Traded Products" or "ETPs"). The SEC must determine whether these proposals are consistent with the Exchange Act to approve them, which requires that the rules are designed to "prevent fraudulent and manipulative acts and practices" and "protect investors and the public interest."

Despite a significant and growing body of evidence indicating that the proposed rule changes are not reasonably designed to prevent fraud or manipulation, or to protect investors or the public interest, the SEC's order finds that this standard has been met. For the reasons discussed below, I strongly disagree.

Fraud and Manipulation in the Global Spot Market for Bitcoin ETPs, High Concentration, and Lack of Adequate Oversight

The ETPs enabled by today's order are inextricably linked to the spot Bitcoin market. Fraud and manipulation affecting the price of spot Bitcoin will necessarily impact the price of the spot Bitcoin held in the ETPs. Therefore, our investor protection inquiry must necessarily begin with the spot Bitcoin market. Are these markets safe? A substantial amount of evidence suggests the answer is no.

The spot market for trading Bitcoin is global. U.S. regulators, such as the SEC, have limited understanding of these spot markets. However, the limited information we do have is not reassuring.

Fraud and Manipulation

The spot Bitcoin market is affected by fraud and manipulation. One common form of manipulation in the crypto markets (especially the Bitcoin market) is "wash trading," where a trader attempts to inflate the price by simultaneously selling and buying the same product, often within the same time frame, and then selling it at an inflated value to unsuspecting third-party market participants. Wash trading distorts prices and volumes, leading to volatility, reducing investor confidence and participation in financial markets, and of course, harming investors. An analysis of 29 major crypto exchanges found that wash trading accounted for an average of 77.5% of total trading volume on unregulated exchanges. The same researchers estimated that in the first quarter of 2020, wash trading occurred in over $4.5 trillion of crypto spot market trading and $1.5 trillion of crypto derivatives market trading. Similarly, the SEC's complaint against Binance and its affiliates alleges that the defendants failed to implement trading surveillance or manipulation controls on the Binance.US platform (despite marketing these controls to investors), and the lack of these controls allowed Binance affiliates to engage in wash trading in certain cryptocurrencies to artificially inflate trading volumes.

Specifically for Bitcoin, an analysis of 157 crypto exchanges found that 51% of daily Bitcoin trading volume is believed to be fake. In fact, despite frequent discussions about the enormous scale of the Bitcoin market, one of the market participants now seeking to sponsor a spot Bitcoin ETP acknowledged that "about 95%" of the data used by many participants is "fake and/or non-economic." Indeed, in a notable example, according to the testimony of one of his co-conspirators, the former CEO of FTX may have engaged in Bitcoin price manipulation to keep its price below $20,000, which could have benefited his company and himself personally. In short, the price and demand for Bitcoin may not be what they seem.

In fact, just yesterday, before we issued the approval order, one of the SEC's social media accounts was hacked, and an unauthorized post falsely indicated that we had approved a spot Bitcoin ETF. Unsurprisingly, the price of spot Bitcoin experienced "sharp fluctuations" within minutes and hours following the false tweet. While we hope that future enforcement actions will reveal the facts of this misconduct, I will be closely monitoring what may be yet another attempt to profit in this market.

Concentration of Ownership

The concentration of Bitcoin ownership among spot holders also makes Bitcoin investors (now spot Bitcoin ETP investors) vulnerable to the whims and trading behaviors of a few individuals. Analysis shows that Bitcoin mining and holding are highly concentrated. This concentration can affect price volatility in unpredictable ways. Investors have little resources to understand these risks and price them accordingly. Additionally, large entities can create volatility and move Bitcoin prices by exploiting arbitrage opportunities between a few interconnected parties. Given that Bitcoin is touted as a product of decentralized finance, this concentration is ironic.

Lack of Unified Oversight

The cryptocurrency market—including the spot Bitcoin market—appears to be a breeding ground for fraud, one reason being that these markets have little systemic oversight and lack other adequate mechanisms to detect and deter fraud and manipulation. Spot Bitcoin trading is fragmented across different international venues, many of which are not subject to meaningful regulation. According to the U.S. Treasury, "uneven and often insufficient regulation and oversight internationally allows [virtual asset service providers] and illicit actors to engage in regulatory arbitrage and exposes the U.S. financial system to risks from jurisdictions with weaker regulatory standards and enforcement." Moreover, even within the U.S., the regulation of the spot Bitcoin market is limited.

There is evidence that the spot trading behind these products is highly susceptible to manipulation, that fraud is rampant, that it is vulnerable to volatility, and that regulatory oversight is minimal. Therefore, we cannot convincingly say that the proposed rule changes approved today are designed to prevent fraud and manipulation, nor can we say that there are sufficient investor protection measures in place. The approval order does not meaningfully address or reconcile these critical issues. Instead, the approval order "acknowledges these concerns" and completely sidesteps them, stating (rather cheerfully) that the SEC does not apply the "not manipulable" standard. While this may be true, we also do not adopt a "burying our heads in the sand" standard. The order does not even begin to address these issues in the spot market. Today's analysis completely overlooks important investor protection concerns.

Given the above, it is not surprising that we have consistently disapproved proposed rule changes that would allow for the listing and trading of spot Bitcoin ETPs in the past. The SEC's consistent and decisive judgment over the past five years has been that these products are unsafe for investors without appropriate guardrails. So what has changed?

Grayscale Investments, LLC v. SEC

In August of this year, the D.C. Circuit Court ruled that the SEC failed to adequately explain its reasons for approving the listing and trading of two registered Bitcoin futures ETPs in the spring of 2022, and failed to explain why it rejected Grayscale's proposal to list and trade a spot Bitcoin ETP. The court found that the principle of "like cases should be treated alike" is a fundamental principle of administrative law and determined that the SEC failed to adequately explain its purportedly different actions. Of course, "like cases should be treated alike" is a bedrock principle of administrative law. However, the problem here is twofold. First, there are significant investor protection differences between these two types of products that justify different treatment. Second, the "relevance" analysis relied upon by Grayscale and the court, as well as the SEC's relevance analysis, is insufficient to conclude that fraud or manipulation affecting the spot Bitcoin market price is likely to similarly affect the Chicago Mercantile Exchange ("CME") Bitcoin futures price, and thus that the monitoring sharing agreement established between the exchange listing the spot Bitcoin ETP and the CME Bitcoin futures market would help monitor fraud and manipulation that may affect the spot Bitcoin ETP.

Futures ETPs and Spot ETPs Are Not the Same Class of Products

As the court pointed out, the SEC previously approved certain ETPs that hold Bitcoin futures but did not approve ETPs that hold "spot" or "physical" Bitcoin. There are important distinctions between these existing products that hold Bitcoin futures, which are cash-settled financial contracts betting on the price of Bitcoin at some future point in time, and the ETPs that will be listed as a result of today's order. The parties to these contracts are regulated entities trading on U.S. registered and regulated exchanges.

On the other hand, the exchange-traded products to be listed under today's order hold "physical" or "spot" Bitcoin, rather than Bitcoin futures contracts. Unlike products that only participate in the futures market, the spot Bitcoin market lacks a primary regulator. Spot Bitcoin ETPs will participate in an unregulated, fragmented, continuously trading global free market. Even if there were a primary regulator for this market, many of them may be beyond the reach of U.S. regulation. Therefore, even if the SEC or the exchanges could identify specific instances of fraud and manipulation, investors may have little recourse. As one commentator noted, the difference between purchasing a Bitcoin futures ETP and a Bitcoin spot ETP is "like buying a lottery ticket from New Jersey versus buying a lottery ticket from Tony Soprano."

The D.C. Circuit Court was fundamentally correct in pointing out that the SEC previously approved ETPs that hold Bitcoin futures but did not approve ETPs that hold "spot" or "physical" Bitcoin. These products, however, are different. Today's action departs from solid precedent and is characterized by arbitrary decision-making, which will limit our ability to protect investors in the future.

Relying on the Argument of "Relevance" to Other Regulated Markets Will Not Protect Investors

In considering whether the proposed rule changes to list Bitcoin ETPs are designed to prevent fraud and manipulation under Section 6(b)(5) of the Exchange Act, the SEC has historically considered whether the listing exchange can demonstrate that it has entered into a comprehensive monitoring sharing agreement with a large-scale regulated market that is related to the underlying or reference Bitcoin asset. Today's order concludes that it "cannot conclude" that the CME (the relevant market) is a "significant scale" market related to spot Bitcoin.

Because it could not reach such a conclusion under traditional tests, the SEC contorted itself to find that "other means" have been shown to satisfy the statutory obligation that exchange rules are designed to prevent fraud and manipulation. It relies on evidence of "relevance" between the CME Bitcoin futures market and the spot Bitcoin market to conclude that sufficient investor protections are already in place to approve these proposals. The "relevance" argument theoretically posits that fraud or manipulation affecting the spot Bitcoin market price is likely to similarly affect the CME Bitcoin futures price, and therefore that the monitoring sharing agreement established between the exchange listing the spot Bitcoin ETP and the CME can reasonably be expected to help monitor fraud and manipulation that may affect the spot Bitcoin ETP. In other words, monitoring of the CME Bitcoin futures market should extend to protecting the Bitcoin spot market. The core idea is that if the spot Bitcoin market shows price activity due to fraud, the Bitcoin futures market will reflect that. This is incorrect.

First, today we are creating a new standard, but it is unclear what that standard actually is. We have never before found a proposed rule change to be compliant with the obligations of Section 6(b)(5) because of the so-called "relevance" between two markets. And even now, we do not describe what level of relevance is sufficient, nor what the basis for this finding is. While Grayscale's opinion relies on unchallenged relevance evidence, I do not believe it compels us to adopt a new regulatory standard.

Second, the relevance argument here is nonsensical. Even if we could detect manipulation or fraud in the spot market due to perfect correlation with the regulated CME—what could we do? As discussed above, the global spot market is largely unregulated. This cannot serve as the basis for our investor protection inquiry.

Third, even assuming this argument is valid, the SEC's analysis still relies on questionable data from a "subset" of the spot Bitcoin market to study the price relationship between the CME Bitcoin futures market and the spot Bitcoin market, but fails to explain why such a subset represents all spot markets globally. In fact, the data we rely on is likely subject to selection bias—i.e., the places where we have data are selected to make it easily obtainable; the data we lack may lead to different conclusions about relevance. Even perfect correlation cannot yield much information from incomplete data.

Fourth, the order draws questionable conclusions from this questionable data. The order states that the results of its relevance analysis support the conclusion that prices in the "spot Bitcoin market" (again, emphasizing that there are many spot markets) and the CME Bitcoin futures market are generally ("though not perfectly") closely aligned; therefore, the order concludes that fraud or manipulation affecting the spot Bitcoin market price is likely to similarly affect the CME Bitcoin futures price. But what about when there are price discrepancies between the spot and futures markets? Isn't that itself a sign of fraud or market dislocation (and precisely when market monitoring provides the least information)?

Fifth, the SEC's analysis shows that the percentage of correlation between relevant markets continues to decline as the time intervals shorten. However, many (if not most) market manipulation schemes occur within a matter of minutes. While it may be true that issues or inefficiencies in Market A may be hedged out over the long term (over days or hours), it is equally true that manipulation schemes often occur in short time frames to attempt to evade detection. Such manipulation may manifest as price dislocation over short periods (i.e., spot prices diverging from futures prices). Therefore, significant correlation between markets does not necessarily mean that manipulation schemes will be detectable.

Finally, past correlation between two variables does not necessarily mean that those variables will maintain a correlated relationship in the future. It is conceivable that the new listing of these ETP products will lead to exponential growth in spot market activity, surpassing the futures market, rendering the monitoring function of the futures market meaningless for the unregulated spot market.

Today, we rely on a questionable, fragmented, unregulated spot market's correlation with a futures market that the SEC itself does not regulate. As I pointed out, we are pinning our hopes on the idea that whenever fraud and manipulation occur in the underlying spot market, it should be expected to become evident in the monitoring of the futures market. I am not confident that such transparency will exist. And even if it does, we may not be able to compensate for fraud that we cannot reach. I cannot draw conclusions about investor protection based on such a lack of substantive safeguards.

The Decision Fails to Consider Broader Public Interest

Section 6(b)(5) of the Exchange Act requires that exchange rules proposed are designed to protect the public interest. But the SEC has also not adequately considered broader public interest factors. For example, there is ample evidence that many criminals use Bitcoin to evade U.S. financial sanctions. Many ransomware attacks demand payment in Bitcoin, and analyses show that these payments may ultimately fund our geopolitical adversaries or enemies. The ability of malicious actors to freely use these assets could have catastrophic consequences for our interests and those of our allies, from funding rogue weapons programs to supporting attacks on civilians. In approving these products for trading on U.S. exchanges, are we potentially undermining the goals of other agencies of our government? Will increased liquidity in the spot Bitcoin market make it easier for criminals and terrorists to quickly move funds, evade sanctions, and use their money to harm civilians? Will increased trading volumes make it harder for other government agencies to track these flows of funds? If one of the funds approved today trades with criminals or terrorists when they are sanctioned, will investors be harmed?

Just a few years ago, the SEC unanimously disagreed with a proposed rule change from an exchange, citing concerns about the potential for money laundering and unresolved questions about the ownership structure of the exchange. Given that the proposed exchange approved today raises similar issues, further consideration of these matters is necessary.

Additionally, when FTX collapsed in November 2022, many of us breathed a sigh of relief that the collapse of one of the most core participants in the crypto market did not have a significant impact on global markets. Will the products approved today provide a previously mitigated connection to traditional markets, allowing the crisis in the largely unregulated crypto market to spill over elsewhere? These questions were not considered in today's order.

Potential Issues Tomorrow

There are other concerns about how these ETPs will operate once approved. For example, how will custody handle the process of physical creation and redemption as the market continues to push for it? Given Bitcoin's historical volatility, funds holding volatile assets like Bitcoin may also be considered volatile. What happens if the price fluctuations of the spot Bitcoin ETP cause it to enter a trading halt due to the exchange's limit-up and limit-down mechanisms? In that case, the underlying asset will not be affected by the trading halt—instead, it will continue to trade peer-to-peer globally and on various exchanges. If the price of the underlying asset further diverges from the market price of the spot Bitcoin ETP shares, will investors be harmed when they suddenly become unrelated, exposing them to risks they did not intend to take? These are just some of the questions my agency may encounter in the coming days, weeks, months, and years. It remains unclear whether we have sufficient answers.

Shouldn't Bitcoin Solve This Problem?

I understand the grand claims made by supporters of these and similar products. They are eliminating intermediaries from the financial system. Serving the unbanked. Enhancing freedom. Changing the world. When I read the white papers, it is hard not to be persuaded. Many of the goals of the crypto ecosystem are goals I support. Who could be against freedom and prosperity? But as I look at the products approved today, I have a simple question: shouldn't Bitcoin solve this problem? If this technology is so revolutionary, why do its many uses seem to revolve around recreating the existing financial system, just with less regulation, more opacity, less investor protection, and increased risk?

Bitcoin is a peer-to-peer system. Individual investors in the U.S. who want to invest in this product can do so by mining it themselves or setting up a wallet and purchasing it from others, both of which they can do from their homes. That is precisely the purpose of creating a new, censorship-resistant digital currency. So why spend so much energy tying it to the existing financial system? I worry that our actions today do not provide investors with access to new investments but rather provide these investments themselves with a pathway to attract new investors to maintain their prices. While this serves the interests of the ETP sponsors and the law firms and service providers that will profit from it, my responsibility is to consider the interests of investors, the markets, and the public, and I believe their overall interests are not well served today.

Conclusion

I am deeply concerned about today's actions. I worry that these products will flood the market, directly entering the retirement accounts of American families who can least afford the losses to their savings caused by the widespread fraud and manipulation in the spot Bitcoin market, which will impact the ETPs. I worry that today's actions will provide the stamp of SEC approval and oversight to the underlying spot market, when in fact there is no such oversight. I worry about the confusion over what these products actually are—(they are not ETFs registered under the Investment Company Act of 1940, which are ubiquitous products used by millions for retirement savings)—and that investors may infer protections that do not actually exist. I worry about what will happen in the future—when new, potentially more speculative, and riskier products seek to list, we will hear a chorus of voices claiming that the SEC's hands are tied by the new standards we have set. I worry that today we are setting the stage for tomorrow's failures, and the ones who will ultimately pay the price are the investors we are responsible for protecting.