One Year After The Crypto Craze, Wall Street Is Still Scratching Its Head At Cryptocurrencies

If 2017 was the year of crypto-mania, then 2018 is the year that Wall Street grappled with how to incorporate the asset class into its markets.

We got a taste of how the two worlds might interact last December, when both the Chicago Mercantile Exchange and Chicago Board of Options Exchange introduced bitcoin futures products. But the CME and CBOE’s relative speed in securitizing bitcoin has yet to be replicated across Wall Street.

The SEC has twice rejected proposals for bitcoin ETFs, citing potential fraud as a continued concern. Other regulators like FINRA have put its members on notice, saying they want to know about any cryptocurrency trading among its firms.

Part of the issue, according to OTC Markets Associate General Counsel Cass Sanford, is that it’s so early in the life of cryptocurrencies that nobody is sure how to go about trading it in a safe, regulated environment.

“Everybody wants to have a securitized crypto asset tomorrow, but nobody really knows how to do it,” she said. “It’s hard to introduce these assets into a regulated environment, because if a crypto asset is a security, and it was issued illegally, then no regulated broker-dealer is going to want to touch it.”

Of course, this conundrum has one well-known exception. The Bitcoin Investment Trust GBTC is the gold standard for how to securitize a cryptocurrency, having traded on OTC Markets Group’s OTCQX market since 2015. So, how exactly was it able to succeed where so many others have failed in bridging the gap between cryptocurrency and the capital markets?

GBTC And The ‘Slow-PO’

GBTC is structured as an open-ended trust sponsored by Grayscale Investments. The trust‘s sole asset is bitcoin, which is stored and protected by custody service Xapo. As of the end of September, GBTC had $1.33 billion assets under management and 201,523,500 shares outstanding. Each of those shares represents 0.00099395 bitcoin, with their value rising and falling in accordance with the price of the cryptocurrency.

In order to become traded on the OTCQX market, Grayscale used the ‘Slow-PO’ method. The Slow-PO is similar to a direct listing—the method used by Spotify Technology SPOT to list on the Nasdaq in April—where a company goes public without raising additional money. During a Slow-PO, a company’s previously restricted shares become available for public trading after a one-year holding period has elapsed and other conditions for resale under SEC Rule 144 are met.

In March 2015, the mandatory one-year holding period expired and GBTC shares became eligible to trade on the secondary markets.  Greyscale worked with a sponsoring broker-dealer file a Form 211 and obtain FINRA approval for trading, completed the OTCQX application and met the initial qualifications under OTCQX Rules. Broker-dealers then were able to quote and trade the security and ultimately provide their customers with exposure to Bitcoin via their traditional brokerage account.

Though GBTC is not registered with the SEC, it posts quarterly reports through OTC Markets’ Alternative Reporting Standard.

Why Aren’t There More Crypto-Backed Securities?

Today, Grayscale has eight other crypto-backed trusts in the pipeline, including those with exposure to cryptocurrencies like Ethereum and Ripple along with one diversified fund.

As with the rest of the crypto market, GBTC has fallen in price through 2018. But that’s not to say it hasn’t done its job as a tradeable asset. In 2017, the average daily trading volume for GBTC—6.28 million shares per day—was greater than the trading volume of the CBOE bitcoin futures. In 2018, it was ranked No. 1 on the OTC Best 50 Companies list, based on an equal weighting of one-year total return and average daily dollar volume growth.

So why hasn’t the structure been replicated by other issuers?

What might help, she said, is more guidance and communication from regulators. In July, FINRA issued a notice to its broker-dealer members, encouraging firms to notify FINRA of crypto-related activities.

“Having a clear understanding of where this new asset class falls within the securities (or commodities) laws allows market participants to go about setting up the proper compliance procedures to trade these products.”

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