Jack Solowey and Jennifer J. Schulp
After a decade of intransigence, the Securities and Exchange Commission (SEC) on Wednesday finally approved the first Bitcoin ETFs, exchange traded funds that allow shareholders to gain exposure to Bitcoin without directly holding it. While welcome news, these approvals follow years of chronic obstinacy by the SEC, capped this week by some acute bumbling, all of which undermined the agency’s reputation.
The SEC’s repeated rejections of Bitcoin spot‐market ETFs illogically continued despite the agency approving related Bitcoin futures ETFs—an inconsistency that the DC Circuit last summer found to be “arbitrary and capricious.” The court’s condemnation paved the way for the January 10 approval. And in a fitting end to the saga, the SEC botched the big reveal this week, having left itself vulnerable to an unauthorized user hijacking the agency’s official X (f.k.a. Twitter) account to issue a fake approval announcement Tuesday, which SEC Chair Gary Gensler had to claw back.
While there’s reason to celebrate the SEC finally approving a financial product, which as SEC Commissioner Hester Peirce wrote of Wednesday’s approval, affirms “the right of American investors to express their thoughts on bitcoin,” there are also three important lessons to be drawn from the SEC’s Bitcoin ETF drama.
1. Don’t throw stones if you live in a glass house. Following Tuesday’s cybersecurity incident, many took the opportunity to hoist the SEC on its own petard, lambasting the agency for its own cyber deficiencies. In response to Chair Gensler’s damage control, Senator Bill Hagerty (R‑TN), for instance, directed Gensler to his own remarks regarding account security:
The SEC promulgates cybersecurity standards for the securities industry and is not shy about enforcing them. The agency also exercises authority over the cybersecurity practices of public companies. This has included bringing charges of securities fraud for the use of “password” as a password, as well as recently enacting cybersecurity rules for public companies requiring quick turnaround disclosure of cybersecurity incidents.
It’s not surprising, then, that Republicans on the House Financial Services Committee expressed their expectation that the SEC will hold itself to the same disclosure standards. Notably, this is not the first time the SEC has faced criticism for lax cybersecurity measures.
Underlying the (frankly, appropriate) schadenfreude and dunking on the SEC is an important substantive point. Public and private sector organizations face an evolving cyberthreat landscape, and effective cybersecurity is not merely a matter of having the right policies in place, but also of executing them.
Too often, regulators assume that implementation is effectively costless and conflate prescribing enlightened policies with effecting desired outcomes. In this case, the SEC clearly must get its own house in order—according to X Safety, the SEC’s account lacked the very multi‐factor authentication Chair Gensler counseled investors to employ.
But at least as importantly, the commission must develop a deeper respect for the challenge and art of operations, particularly on the part of the market participants it regulates. This means the agency must consider the hard realities of implementing regulatory dictates at going concerns before it issues unworkable rules on an all manner of subjects.
2. Standing athwart market demand is often an unsustainable long‐term strategy. While crypto critics accuse the technology of having no use case, or only being useful for speculation, others apparently see things differently. In fact, there’s evidently enough of a demand for exposure to cryptocurrencies like Bitcoin that asset managers—from the crypto‐oriented Grayscale to the traditional BlackRock and Fidelity—are looking to provide Bitcoin ETFs to their customers.
While investment philosophies and individual risk tolerances differ—and this is emphatically not investment advice—one relatively well‐established approach is to diversify into a mix of lower and higher risk assets in an attempt to efficiently manage overall risk. For some, risk‐on alternative assets may include Bitcoin, and an ETF is a relatively straightforward way to gain exposure.
There’s a word for standing between both willing buyers and willing sellers—prohibition—and in the face of persistent demand, this tactic tends to lead to black or gray markets, or the prohibition’s eventual demise. Notwithstanding the wishes of regulators—including Chair Gensler who used his statement of approval of the Bitcoin ETFs to share his dim view of the cryptocurrency—demand tends to find a way. And stifling that demand in a manner that is, well, arbitrary and capricious, is not only unlawful, but also counterproductive, breeding long‐term disrespect for the law.
3. The rule of law, as opposed to administrative diktat, is a cornerstone of efficient markets. “It is a fundamental principle of administrative law that agencies must treat like cases alike,” wrote DC Circuit Judge Neomi Rao in August when vacating the SEC’s rejection of Grayscale’s Bitcoin ETF application.
The court found that by rejecting Bitcoin spot‐market ETFs (funds holding Bitcoin) while approving Bitcoin futures ETFs (funds holding Bitcoin derivatives), the SEC violated this fundamental principle of treating like cases alike. Specifically, the SEC “failed to reasonably explain” its inconsistent treatment of the two financial products notwithstanding their similar economic risks, congruent fraud prevention approaches, and tightly correlated underlying assets (Bitcoin and Bitcoin futures).
Inconsistent treatment without a reasonable explanation is a textbook case of unlawful arbitrary and capricious administrative action. This behavior is the antithesis of the rule of law: government action limited by fixed rules announced in advance and applied equally. The failure to adhere to a rule‐of‐law approach in financial regulation is not only unjust, but also distortionary. It substitutes the preferences of a regulator for the choices of market participants as the signal informing what financial tools get supplied.
Notwithstanding SEC Chair Gensler’s protestations to the contrary, a financial regulator in practice is not “merit neutral” where it arbitrarily suppresses financial products.
Conclusion
As investors piled into Bitcoin ETF products on the first day of trading, with volumes topping $4.6 billion worth of shares, it’s important to note that the approval “does not undo the many harms created by the disparate treatment of spot bitcoin products,” as Commissioner Peirce noted.
American investors may finally have the long‐denied ability to make their own choices about investing in a Bitcoin ETF, but the SEC has work to do to ensure that the mistakes it made here are not repeated. Going forward, the agency must gain a new respect for the hard work of innovation and implementation, not substitute its preferences for consumer demand, and treat market participants equally.
