This is why the US SEC has been rejecting the Bitcoin spot ETF application

This isn’t the first time the U.S. Securities and Exchange Commission (SEC) has rejected a proposal for a bitcoin spot exchange-traded product (ETP), but efforts by different financial institutions continue. Cboe BZX exchange recently attempted to list Fidelity Wise Origin Bitcoin Trust as a Bitcoin ETP on Jan. 25, but also failed.

The SEC letter, published on Feb. 8, said the exchange had failed in its duty to certify that funds were "intended to prevent fraudulent and manipulative practices" and "protect investors and the public interest."

Although the proposal for a bitcoin spot ETP has never been approved by the SEC, and such products are not available in the US market, they do exist in the European market. By investigating the prices of ETPs traded in European markets, one can get a good idea of the potential for fraud and manipulation.

To investigate whether the SEC’s concerns about fraud and manipulation are justified, this article will compare the historical prices of three European-listed ETPs with the historical Bitcoin spot price across 18 exchanges to see if there are any significant price differences that could lead to market manipulation.

The SEC's main concerns

The SEC raised two main concerns about the BZX exchange proposal from a technical standpoint:

(1) No data or analysis is provided to support the contention that arbitrage across bitcoin platforms helps keep global bitcoin prices consistent with each other, thereby discouraging manipulation and eliminating any cross-market pricing discrepancies. There is no indication of how close bitcoin prices are between different bitcoin trading venues, or how quickly price differences are being arbitraged.

(2) The Exchange has not demonstrated that the proposed index calculation method would make the proposed ETP resistant to fraud or manipulation. Specifically, the exchange has not yet assessed the impact that spot platforms that are not included in the index constituent bitcoin platforms may have on the price of bitcoin used to calculate the index.

In order to understand whether the above problems exist, and whether the ETPs listed in the European market may be manipulated, the historical data of the following three ETPs listed on the SIX Swiss Exchange (from Google Finance) are compared with the bitcoin spot price on the exchange (data from Cryptowatch ) were compared.

·WisdomTree Bitcoin ETP（BTCW-USD）

21Shares Bitcoin ETP (SWX:ABTC-USD)

·Coinbase Physical BTC ETP (SWX:BITC-USD)

Correlation between Bitcoin ETP and spot prices suggests price divergence

As stated in the BZX exchange’s proposal, the calculation of the index will be based on the volume-weighted median price (VWMP) of five exchanges — Bitstamp, Coinbase, Gemini, itBit, and Kraken — over the previous five minutes.

In a very simple and basic attempt, daily spot prices from four of the five aforementioned exchanges — Bitstamp, Coinbase, Gemini, and Kraken — were used.

Since Bitcoin ETP prices often differ from Bitcoin spot prices, all charts use daily percentage changes (or daily returns) to allow for easier comparison of price differences.

The chart below shows the daily return comparison between each of the three ETPs and the Bitcoin spot price, which was calculated using the volume-weighted median for the four exchanges.

The scatterplot on the left shows how close the ETP price is to the spot price. If the two line up perfectly, all points should fall on the dotted blue line. The graph on the right compares the daily percentage returns and plots the difference between the two.

Comparing WisdomTree ETP and Spot, while most of the points in the scatterplot clusters are within the +/-5% radius, there are definitely some significant price differences outside of this radius. On one day during the three-month period, the daily yield spread (dashed blue line) between the ETP and the spot price reached more than 10%.

It is worth noting that ETP price percentage changes tend to be more volatile than spot. The chart below comparing Coinbase physical bitcoin (blue line) and bitcoin spot (pink line) shows that the percentage change in the former can reach nearly 15%, while the latter is just over 10%.

Likewise, the 21Shares Bitcoin ETP price is also more volatile than spot, with a lower correlation to spot (62%) than WisdomTree (67%) and Coinbase Physical Bitcoin (66%).

The price comparison shown above shows that there is a cross-market pricing discrepancy between the ETP price and the bitcoin spot price on exchanges. Price differences are not arbitraged fast enough to prevent manipulation.

However, it needs to be emphasized that this is only a very rough comparison using daily data. The price difference may be due to the different cut-off time each ETP uses to calculate the closing price, i.e. exchange-traded products do not trade 24 hours like cryptocurrency spot prices; 00 to trade.

In addition, in practice, a higher frequency will be used to calculate the index price, that is, the BZX exchange proposal proposes to use the first five minutes of data from five exchanges to calculate the index price, and update the intraday indication value every 15 seconds every other day (IIV). The analysis done here uses aggregated daily data only to represent index prices, and the use of high-frequency data may not reflect actual index prices.

It’s worth pointing out that while price differences between ETP and spot prices can be observed using daily data, the price differences between ETPs themselves are much smaller, as shown in the chart below.

It is likely that these ETPs listed on the same exchange all use the same frequency and cut-off time to calculate their price; therefore, there is less price difference between them. This reinforces the point that price differences between the Bitcoin ETP and Bitcoin spot prices may arise from the frequency and cut-off times used in the ETP index calculation methodology, which cannot be replicated identically in this analysis.

Spot price differences between exchanges are minimal

In the first question mentioned at the beginning of the article, the SEC also asked about the degree of correlation between the price of Bitcoin between different Bitcoin trading venues.

According to cross-platform BTC/USD data collected by Cryptowatch from 18 exchanges, there is very little variance in exchange prices. To illustrate the correlation between prices as an example, comparing Coinbase, Gemini and Bitstamp with Kraken, the correlation between each pair is very close to 100%.

The SEC is also concerned about price influence and the potential for manipulation by spot platforms that are not included in the index composition. If the price of bitcoin on other platforms diverges significantly from the four constituent platforms, Bitstamp, Coinbase Gemini, and Kraken market manipulators may seek to exploit this discrepancy to profit.

To see if there are price differences between the four platforms and the rest, the bottom right of the chart below compares the four platforms’ total volume-weighted median price to the aggregate price of all 18 exchanges. Almost perfectly aligned lines show little difference between the two. Spot platforms do not have huge price differences, and the prices of different bitcoin trading venues are closely related.

With daily prices so similar, manipulation across exchanges would be very difficult. However, price manipulation can still occur intraday, but due to the lack of high-frequency intraday data, this is beyond the scope of this analysis.

Based on an analysis of ETP prices on three SIX Swiss exchanges and Bitcoin spot prices on 18 exchanges, there does appear to be a price difference between ETP and spot. This could lead to manipulation of the price of the ETP index, even though applicants often claim that complex index calculation methods prevent such actions.

Based on the price difference between these European-listed ETPs and the spot price, the SEC’s concerns about fraud and manipulation appear to be warranted. That said, the discrepancy may be caused by the frequency of daily data used in this analysis, which is different from the high-frequency data actually used.

In contrast, there are no significant price differences between different bitcoin trading venues. Although the spot markets on these exchanges are more decentralized and less regulated than traditional stock exchanges, it can still be very difficult to maliciously manipulate prices through these platforms.

Given the large number of centralized and decentralized, regulated and unregulated cryptocurrency exchanges, it is difficult to demonstrate the price efficiency and similarity of all exchanges. US ETP applicants still have a long way to go to convince the SEC.