WEEKLY, July 1, 2023

Hi everyone! So much for quiet summer weekends – this is the second one in a row that has turned out to be somewhat more drama-laden than I was expecting. Ok, the SEC pushback and the swift response happened yesterday afternoon my time, but here in Europe that already counts as the weekend, so it’s close enough.

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MARKETS

In yesterday’s newsletter, I said that I thought BTC would settle into some range-bound trading around current levels with a possible uptrend now that the June expiry was out of the way, and I was partly right – we have the sideways behaviour, just at a lower level than before yesterday’s SEC pushback.

(chart via TradingView)

According to a report in the Wall Street Journal, yesterday the SEC told Nasdaq and Cboe that the spot BTC ETF proposals they filed on behalf of BlackRock, Fidelity, WisdomTree and other issuers were “inadequate”, and requested more information. Specifically, it wants to know the name of the spot exchange with which the listing exchange (Nasdaq or Cboe) plans to enter into a surveillance sharing agreement (SSA).

This triggered an almost 5% drop in the BTC price, which suggests that the market was 1) already partly discounting a smooth approval process, and 2) took this information request as a sign the SEC was planning to reject the proposals. Both assumptions are bewildering: eventual approval is far from a sure thing, and yesterday’s SEC move is not at all a rejection. Let’s unpack that, because the narrative matters.

Crawling towards a yes

First, on the likelihood of approval: The current batch of spot BTC ETF proposals have a higher chance of getting through than previous waves, but the odds are still low. Bloomberg ETF analyst Eric Balchunas, who knows what he’s talking about, puts the probability at 50%, which is encouraging. And the arguments presented in the filings (I confess that I’ve only read the BlackRock one, but I assume the others follow a similar thread) are solid. But the SEC’s approach to crypto has, for some time, not been based on investor protection (the current range of approved listed products carries greater embedded risk and/or cost disadvantages for retail participants) or on squeezing crypto into existing rules (just not possible given the structure of blockchains and tokens). The SEC’s approach is political, and the current winds are complex.

The assumption that approval is assured just because BlackRock is involved is, well, risky. BlackRock has had ETF proposals rejected before, when the SEC felt they were too “out there” – we know that the current SEC chair feels that crypto is in that bucket. We also know that relations between Wall Street and the SEC are at a low point, so it’s unlikely that BlackRock has had “friendly conversations” with SEC leadership on this topic, or has been given an insider wink. And Gensler could choose to reject based on a political wish to avoid being seen as “in the pocket” of large investment firms.

That said, BlackRock has a wealth of experience with ETF proposals, and must have some friends at the SEC. What’s more, if Gensler is worried about losing the Grayscale suit currently under deliberation, he could prefer to have a legacy name such as BlackRock beat it to the ETF listing finish line.

It’s nuts that such a significant decision should come down to politics and personal preference, but here we are.

Excuses to say no

Now let’s move on to what the SEC is actually asking for. The BlackRock proposal filed by Nasdaq spends several pages arguing that Section 6(b)(5) of the Securities Exchange Act of 1934, which requires measures to prevent manipulation, can be satisfied by a surveillance sharing agreement between Nasdaq and the CME, where BTC futures trade. This is based on previous SEC rulings, the size of the CME market, the relationship between futures and spot prices, and the low likelihood (in the eyes of the exchange and the sponsor) that ETF activity would unduly influence the BTC price. But just in case all this isn’t enough (which was the SEC verdict in previous refusals), Nasdaq will also enter into a surveillance sharing agreement with a US-based spot exchange.

The Nasdaq proposal refers to “the” spot exchange, but doesn’t specify which one it is. It’s obviously Coinbase (the only US-based spot exchange the SEC might consider “significant size”), but the exchange is not named perhaps because an agreement had not yet been signed at time of filing, or perhaps (unlikely, though) BlackRock thought it could get away with not mentioning an exchange the SEC is currently suing.

Of course, the SEC will want to know the name of the exchange, to be able to determine if indeed it is of “significant size”. That’s why the reaction to yesterday’s query was overdone – it’s not a refusal, it’s a reasonable request for more information.

But it could point to what the SEC will lean on to yet again justify rejection. This could (and probably would) be contested, since on other occasions the SEC has determined that the “regulated market of significant size” of the underlying asset is not the only way to demonstrate resistance to manipulation. The BTC futures ETF approvals are one example, as are numerous commodity-based funds.

This means that approval will eventually happen, especially as the political nature of the decision becomes increasingly obvious. It could, however, take much longer than the market is hoping for.  

And, there’s the chance that the SEC loses the Grayscale case (in which the crypto industry’s largest asset manager is suing for the right to be able to convert its GBTC fund into a spot BTC ETF) – Bloomberg’s legal analyst puts the odds of a Grayscale win at 70%. Of course, the SEC could find another loophole and still kick this down the road, but the political pressure would ratchet up several significant degrees.

Market expectations

The lesson we can take away from yesterday’s move is that there is considerable risk of embedding high hopes into the BTC price. Approval will eventually happen, but it could be any time between next week (if the SEC wants to pre-empt a Grayscale win) or a couple of years from now (if the SEC draws out these proposal decision periods as long as possible and then rejects, whereupon we start all over again).

It's a tempting but risky gamble: a spot BTC ETF in the world’s largest financial market would most likely bring in a considerable wave of new retail and institutional investors who seek exposure to an “alternative” asset, as well as those who hope for profits from narrative-driven speculation. Given the hard supply cap and the relatively scarce amount available to new entrants (due to longer-term investor accumulation – almost 70% of issued BTC has not moved in over a year), any new inflows could produce sharp moves upwards.

But odds are at best still even on whether this could happen in the short term. And meanwhile, there is no shortage of other headwinds to contend with.

Whoa, ETH

Yesterday also delivered another big surprise that I’m still trying to get my head around. The SEC push-back understandably affected BTC – but ETH also dropped sharply on the news, even though the ETF proposals in question have nothing to do with the asset.

(chart via TradingView)

A lot of this was probably trading bots programmed to execute paired trades. What happened after the initial slump is intriguing, though. BTC recovered some, as it sunk in that the SEC request was not a sign of rejection. ETH recovered even more sharply, however, and is currently 1.6% higher than 24 hours ago while BTC is still around 1.1% below.

Why? In part, it could also be bots programmed to buy ETH if its price falls below a certain amount, or if the BTC/ETH ratio reaches a certain level. This dropped sharply yesterday, as BTC’s fall was understandably more pronounced that that in ETH – but it reached levels last seen just over a week ago. In other words, the drop was notable but not significant for the bigger picture.

(chart via TradingView)

It could be positioning ahead of the upcoming launch on the CME of futures based on the BTC/ETH ratio – but, assuming the CFTC doesn’t object, this is still a month away, it feels too soon for that.  

There’s no fundamental trigger that I’m aware of: progress toward the next Ethereum upgrade is progressing, but the timing of the next catalyst is still uncertain and a ways off.

It could be that some market participants realized that perhaps too much ETF optimism had been baked into BTC’s recent outperformance, and that it was time for ETH to catch up.

Whatever the reason, it serves as a reminder that BTC may still be the main crypto on-ramp for new investors, and it may still be the principal “macro” representative in the asset class, but that ETH is the next logical diversification step. In other words, when investors are comfortable with BTC, they often next turn to ETH.

The market’s second-largest crypto asset in terms of market cap is riskier (younger, less liquid, more regulatory uncertainty) but this goes hand-in-hand with higher upside. In theory, anyway – recently, both ETH’s historical and implied volatilities have been at or even below equivalent measures for BTC.

(chart via glassnode)

Intuitively, this doesn’t make sense. Perhaps what we’re seeing is the beginning of a return to a more normal volatility pricing.

HAVE A GREAT WEEKEND!

Today I want to share with you the video of an all-time classic, one of my favourites, which combines summer heat, politics, a funky beat and kick-ass outfits: Ball of Confusion, by The Temptations. Enjoy.