Week In Crypto: SEC Says No To Bitcoin ETF, 3AC Ordered To Liquidate

July 1, 2022
US regulators have rejected an application for a bitcoin exchange-traded fund (ETF), while crypto hedge fund Three Arrows Capital (3AC) has received a court order to liquidate.

US regulators have rejected an application for a bitcoin exchange-traded fund (ETF), while crypto hedge fund Three Arrows Capital (3AC) has received a court order to liquidate.

This week, the hopes of the crypto investment world were dashed once again, as the US Securities and Exchange Commission (SEC) rejected yet another application for a spot bitcoin ETF.

In October last year, Grayscale, owner of the Grayscale Bitcoin Trust (GBTC), teamed up with NYSE Arca to seek approval for the conversion of GBTC into a spot bitcoin ETF.

First launched in 2013, GBTC has traded under various names since then, first privately and exclusively for accredited investors, and later publicly.

It is by far the largest bitcoin fund in the world and currently holds about 3 percent of the total supply of bitcoin, or 643,000 coins in total.

In November last year, when the price of bitcoin briefly touched $69,000, GBTC hit a record high of $43bn in assets under management (AUM).

Since then, GBTC’s AUM has crashed as precipitously as the bitcoin price, and currently stands at about $12.9bn.

But that is not the worst of GBTC’s troubles. As a closed-end fund, bitcoin can be deposited to the fund but cannot be redeemed for cash.

The price of shares in the fund, therefore, does not track the market price of bitcoin on a one-to-one basis.

Instead, GBTC shares trade at either a premium or discount to net asset value (NAV). A premium signifies unusually high demand for shares in the fund, while a discount signifies unusually low demand.

In February 2021, the GBTC discount went negative and by mid-June this year it had hit a record 34 percent.

In other words, although bitcoin can currently be purchased for about $20,000 on any other exchange, shares in GBTC can be purchased for the equivalent of $14,000 (if any current holders are desperate enough to sell at that price).

The enormous discount has become a headache for Grayscale, and it is now one of its main motivations to convert GBTC into a spot bitcoin ETF. However, the SEC remains unconvinced that it meets the required criteria.

Too risky for the SEC

As outlined in its decision statement, the main reasons the SEC rejected Grayscale’s proposal were due to concerns around fraud and potential market manipulation.

The SEC also pointed out the lack of another regulated spot bitcoin market of a similar size that could offer a “surveillance sharing agreement”.

The lack of such a market means that manipulation could take place in some other spot bitcoin market — the largest in the world being the BTC-USDT pair on the Binance exchange — and it could lead to harms for US investors in Grayscale’s ETF.

In its 86-page report, the SEC explained that previous bitcoin-related applications and orders had run into similar problems, and that these issues still remain.

Wash trading, manipulation by dominant market participants, hacking of trading platforms and insider trading were all noted by the SEC as risks that are systemic to the spot bitcoin markets.

The SEC still sees stablecoins, and specifically Tether, issuer of USDT, as one of the major red flags hanging over the spot bitcoin markets.

The SEC referenced previous orders and published research which show that the price of bitcoin has been affected by “manipulative activity” using stablecoins such as USDT.

In 2019, for example, as noted by the SEC, a research paper by two US university professors found that Tether had fuelled the 2017 crypto bubble by printing unbacked USDT and distributing it to major crypto exchanges.

The exchanges then used the USDT to inflate the price of bitcoin and other crypto-assets, or to backstop those same assets when prices were falling.

“Rather than demand from cash investors, these patterns are most consistent with the supply-based hypothesis of unbacked digital money inflating cryptocurrency prices,” the report notes.

Grayscale heads to court

Responding to the SEC’s decision, Grayscale said it is “deeply disappointed” and has initiated proceedings to appeal the decision in court.

“Converting GBTC to a spot Bitcoin ETF would have brought the world’s largest bitcoin fund further into the US regulatory perimeter and provided US investors access to bitcoin through the familiar protections of an ETF wrapper,” Grayscale said in a statement.

“We hold firm in our belief that converting GBTC to a spot Bitcoin ETF remains the best option for investors: it would effectively eliminate the discount and cause the shares to track the price of bitcoin.”

Grayscale alleged that the SEC is failing to apply a consistent standard when it comes to bitcoin investment vehicles, as evidenced by its rejection of GBTC, a would-be spot ETF, but its approval of several bitcoin futures ETFs.

“If regulators are comfortable with ETFs that hold derivatives of a given asset, they should logically be comfortable with ETFs that hold that same asset,” said Grayscale.

In April, for example, the SEC granted approval to NYSE Arca and Teucrium to launch a bitcoin futures ETF. It has also granted similar approvals to ProShares, Valkyrie and VanEck.

“At Grayscale, we have not and will not waver in our commitment to converting GBTC to a spot Bitcoin ETF.

“The decision to pursue litigation is not one we take lightly, but we are confident in our legal team, as well as our compelling, common-sense legal arguments.”

3AC ordered to liquidate

The second major development in the crypto markets this week comes courtesy of Three Arrows Capital (3AC), the once high-flying hedge fund that is now facing insolvency.

According to a report from Sky News, a court in the British Virgin Islands has ordered 3AC to liquidate, while lawyers from the Teneo firm are preparing to handle the firm’s insolvency.

The court order comes only days after Voyager Digital, a crypto-lending platform, served 3AC a default notice on $670m of loans in bitcoin and USDC.

In Singapore, where 3AC is based, the Monetary Authority of Singapore (MAS) has also issued a statement reprimanding the hedge fund for providing false statements and exceeding the AUM threshold for a registered fund management company (RFMC).

In its own statement, the MAS said that in 2013 3AC obtained RMFC status, which allowed it to operate a fund management business with no more than 30 qualified investors and no more than SDG$250m.

In September 2021, 3AC novated the management of the only fund it managed to an offshore entity in the British Virgin Islands, but it resumed management of a portion of the fund’s assets in February 2022.

In April, 3AC notified MAS that it intends to cease fund management activity in Singapore from May 6 onwards. The MAS added that it had been investigating 3AC’s activities since June 2021.

Zhu Su, co-founder and CEO of 3AC, has not spoken publicly since June 15, but he did close 3AC’s position in GBTC on June 16. Previously, 3AC was the largest single holder of GBTC shares.

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