Countdown to Decision The SEC’s Final Call on VanEck’s Spot Ether ETF

The SEC has received many proposals for spot cryptocurrency exchange-traded funds (ETFs) in recent years, with the goal of providing investors with access to digital assets via a regulated investment instrument. However, the SEC has routinely denied or postponed judgements on these proposals, citing concerns about fraud and manipulation, investor protection, price transparency, custody solutions, and market maturity.

The most recent high-profile application is VanEck's proposal for a spot Ether ETF, submitted in March 2022. This follows the rejection of prior Bitcoin spot ETF proposals from asset managers such as Fidelity and SkyBridge. The SEC remains concerned about volatility, inadequate oversight in cryptocurrency spot markets, and the possibility of manipulation.

VanEck's new proposal tries to address the SEC's primary concerns by proposing solutions for pricing, custody, monitoring, and liquidity. The proposal claims that the spot Ether market has evolved greatly, with regulated institutions such as CME introducing Ether futures and options. It says that a spot ETF offers superior protection than investing directly in cryptocurrency or via Grayscale's Ether Trust.

This article examines VanEck's suggested solutions for meeting remaining SEC criteria and perhaps approving the first crypto ETF in the US.

Price and Valuation Solutions

The plan recommends hiring an expert benchmark index supplier to assist alleviate worries about price manipulation. The index provider would compute pricing using executable spot prices from licenced digital asset exchanges. This technique seeks to represent genuine market circumstances for the assets, hence lowering the danger of manipulation.

Rather than self-reported prices, the index would be based on observed transactions from regulated exchanges. The pricing mechanism would also be subject to frequent auditing processes. Furthermore, the idea recommends hiring third-party valuation agents to verify correct pricing and nett asset value computations. The fund's NAV would be audited on a regular basis as an extra safeguard. The plan, which includes input from regulated exchanges, experienced index providers, third-party agents, and auditors, seeks to develop effective ETF pricing systems. This multi-layered methodology adheres to best practices for classic ETFs while taking into account the special needs of digital asset markets.

Custody and Asset Security

The plan includes numerous steps to guarantee adequate custody and verification of the ETF's digital asset holdings. First, it intends to utilise a licenced and insured custodian with extensive expertise managing billions of dollars in digital assets. To prevent theft or loss, the custodian would put in place strong cybersecurity safeguards as well as insurance coverage.

To verify holdings, an independent auditor would conduct monthly proof of control audits on the ETF. These audits would validate that the fund's holdings correspond to its declared balances. Auditors would check wallet addresses and blockchain transactions to give this verification.

Furthermore, the ETF intends to use blockchain analytical tools to track and reconcile inflows and outflows of digital assets into the fund. By monitoring transactions on the blockchain, the ETF can ensure that fund share creations and redemptions correspond to the movement of the underlying assets.

Together, these suggested custody solutions seek to instill trust in the verification and security of the ETF's digital asset holdings. The combination of a licenced custodian, periodic audits, and blockchain monitoring would be consistent with current asset safety regulations in ETFs holding conventional assets. Proper custody procedures are crucial for obtaining regulatory clearance.

Mitigating Risks from Liquidity and Manipulation

The proposed ETF seeks to reduce liquidity and manipulation concerns in numerous ways.

First, the fund would only invest in spot digital assets, avoiding derivatives and leveraged instruments that might distort markets and lead to manipulation. Holding simply the underlying spot assets offers a clear picture of the fund's holdings.

Second, the proposal details strategies for continuously monitoring key liquidity and efficiency parameters. This involves monitoring bid-ask spreads, premiums and discounts between the ETF's share price and NAV, and trading volumes. Widening spreads, decoupling from NAV, and thin trading may signal liquidity difficulties or manipulation efforts.

By monitoring these measures and researching any anomalous behaviour, the fund hopes to identify and prevent periods of illiquidity or possible manipulation in the early stages. This protects shareholders from misleading pricing.

Overall, the only use of spot assets and active liquidity monitoring attempts to reduce the manipulation risks inherent with less transparent derivatives while increasing pricing efficiency and tradability for shareholders.

Market surveillance

The idea seeks to reduce manipulation risks by collaboration with regulated digital asset exchanges that have adopted market monitoring procedures. These exchanges use sophisticated technologies to monitor trade activity across their platforms, detecting deceptive behaviours such as spoofing or wash trading. They look at real-time data from order books, performed transactions, and market participants. Many regulated exchanges monitor social media and chat rooms for coordinated market manipulation operations.

If any suspect activity are discovered, the exchanges may conduct further investigations, seek further information from implicated parties, and even impose penalties. They may issue warnings, impose trading limitations, or even delist any digital assets found to have been overly manipulated. By exclusively engaging with licenced exchanges with effective monitoring mechanisms in place, the proposed ETF would benefit from the precautions against manipulation that are currently incorporated into trading venues. Relying on exchange surveillance rather than developing its own monitoring systems also reduces expenses for the fund. Overall, the proposal illustrates how compliance with regulated exchanges corresponds with the SEC's aims for preventing manipulation inside ETFs.

Proof of Reserves

The plan includes many procedures to confirm the fund's digital asset reserves. Most importantly, it intends to conduct monthly proof of control audits by an independent auditor. This would confirm that the fund has ownership and control over the assets it claims to possess.

The audits would give cryptographic confirmation that the fund's digital asset holdings correspond to its claimed reserves. This offers investors trust that the fund's assets are correctly recorded and verified on the blockchain.

The plan does not include specific audit processes. However, standard approaches include the auditor requesting signed messages from wallet addresses, verifying ownership of public keys, and reviewing account balances. The findings may then be publicised to promote transparency about the fund's reserves.

Regular independent audits are consistent with best practices in the bitcoin sector. It deters possible misbehaviour and guarantees investors that money inflows and outflows correspond to the blockchain record. Overall, these proof-of-control procedures seek to alleviate the custody concerns associated with digital asset ownership.

Authorised Participants

The proposal focuses on applying well-established ETF establishment and redemption processes via Authorised Participants (APs). APs are broker-dealers who are permitted to create and redeem ETF shares directly with the fund.

When demand for the ETF rises, APs may issue more ETF shares by sending the necessary basket of assets to the fund custodian. This helps to maintain the ETF's market price consistent with the nett asset value (NAV) of its underlying assets.

Similarly, if demand falls, APs may redeem ETF shares from the fund in exchange for the underlying assets. This creation and redemption process offers significant liquidity and keeps the ETF trading near to fair value.

By using the tried-and-true AP model, the proposed spot crypto ETF seeks to function inside the SEC's well-defined regulatory framework for regular ETFs. The sponsor emphasises his considerable ETF operational expertise in handling the AP processes and systems involved.

Disclosures & Reporting

As an exchange traded fund, the proposed Bitcoin ETF would be subject to all current requirements for disclosure, reporting, governance, and compliance processes that ordinary ETFs follow. This includes complete openness and disclosures about the fund's assets, as well as portfolio holdings and value disclosed on a daily basis on the website.

The fund would also follow all SEC reporting requirements, producing regular filings that disclose the fund's financials, risks, fees, investing activities, and any other relevant information. This guarantees that regulators and investors have complete insight into the fund's activities and assets.

By adhering to the SEC's well-established structure for investment businesses and ETFs, the proposed Bitcoin ETF aspires to offer the compliance, governance, and transparency features required of regulated financial instruments. The decades of experience with ETF disclosures and reporting give a solid foundation for how a Bitcoin ETF may meet disclosure requirements and regulatory standards.

Overall, stringent adherence to current investment firm laws would guarantee that the Bitcoin ETF meets the governance, compliance processes, disclosures, and reporting standards that investors and regulators demand from SEC-approved investments. This is intended to address concerns about transparency and regulatory uncertainty for a Bitcoin ETF.

Governance.

The plan includes detailed compliance processes to guarantee that the fund follows regulatory rules. As an ETF, the fund would form a board of directors to supervise operations, manage service providers, and ensure compliance with all relevant rules.

The board would be made up of independent members that have substantial expertise in investment management and compliance. Their responsibility is to represent shareholders' interests by monitoring the fund for conflicts of interest, supervising costs, and ensuring disclosure compliance.

The fund would also develop compliance rules and processes that are consistent with current ETF laws. This involves adherence to rules on related transactions, leverage, liquidity, and value. The adviser and independent auditors would assess the fund on a regular basis to ensure compliance.

To avoid manipulation, the fund would monitor for excessive trading and adhere to any trade halts and limits. The adviser would keep documents to demonstrate compliance with governance standards that are susceptible to SEC review.

Robust governance and compliance systems assure investors that the fund adheres to regulatory norms. The plan emphasises using decades of ETF structure knowledge to meet SEC governance and compliance requirements.

Conclusion:

To summarise, the current suggestions for a spot digital asset ETF seek to address the SEC's primary concerns about pricing, custody, liquidity, manipulation, and regulatory compliance. The ideas include solutions like certified custodians, proof of control audits, experienced benchmark index suppliers, and strict adherence to current ETF rules and governance requirements.

The suggestions seek to limit risks associated with price manipulation by using regulated spot exchanges with market monitoring, adhering to tight authorised participant restrictions, and adopting third-party valuation agencies. The funds would also go through stringent audits and use blockchain analytical tools to verify asset ownership and track movements.

Overall, the suggestions highlight decades of experience launching ETFs under the SEC framework. They intend to address issues by adhering to current investment firm requirements on disclosures, reporting, governance, and compliance processes. If authorised, these ETFs might provide efficient and liquid access to digital assets via a regulated fund structure. However, it remains to be seen if the SEC will find that the plans adequately address remaining concerns associated with these developing assets.