The lawsuit against Gemini is not about an exchange-traded fund, it’s about how a particular Bitcoin futures contract is being represented.
On June 2, 2022, the United States Commodity Futures Trading Commission (CFTC) initiated an action against Gemini, the crypto exchange founded by billionaire twins Tyler and Cameron Winklevoss. Among other things, the complaint alleges that Gemini made a number of false and misleading statements to the CFTC in connection with the potential self-certification of a Bitcoin futures contract, the prices for which were to be settled daily by an auction (the “Gemini Bitcoin Auction”). In the complaint, the CFTC specifically articulated the position that these statements were designed to mislead the commission as to whether the proposed Bitcoin futures contract would be susceptible to manipulation.
While the Winklevoss brothers were not named in the suit, the complaint alleges that “Gemini officers, employees and agents […] knew or reasonably should have known that the statements and information conveyed or omitted […] were false or misleading.” These are serious accusations, considering that CFTC’s third and twelfth core principles require markets involved in derivative trading, including those seeking to offer Bitcoin futures contracts, to have policies and practices ensuring that “contracts [are] not readily subject to manipulation” and that they offer reasonable “protection of market participants.”
Gemini offered a formal statement in response to the CFTC’s action:
“We have an eight-year track record of asking for permission, not forgiveness, and always doing the right thing. We look forward to definitively proving this in court.”
The response from the founding twins, however, was somewhat less professional. Cameron Winklevoss tweeted:
It’s too bad that Gemini’s founders are not taking the suit more seriously. The ramifications of this potentially true fraud may not be limited to any penalties assessed against Gemini by the courts, but also significantly impact the entire industry.
What is the relationship between this action and Bitcoin ETFs?
The lawsuit against Gemini is not about an exchange-traded fund (ETF), it is about representations made in connection with a particular Bitcoin futures contract. It is also not being brought by the U.S. Securities and Exchange Commission, which has been holding out on approving a large and growing number of Bitcoin ETF proposals. It is, however, about potential manipulation in the crypto markets.
The SEC’s record of declining to approve any spot-market Bitcoin ETF has been consistent on two fronts: To date, no Bitcoin ETFs in the spot or physical markets (as opposed to Bitcoin Futures ETFs) have been approved, and so far, the consistently expressed concern of the SEC is that Bitcoin pricing is too subject to manipulation to approve a Bitcoin ETF. Without approval by the SEC, securities exchanges cannot trade the proposed products, which do not fit well under traditional guidelines on what kinds of interests can be sold on a securities exchange.
Admittedly, the SEC recently approved a limited number of Bitcoin Futures ETFs, including two under the same rule that those proposing Bitcoin ETFs in the spot markets are relying on. In part, the SEC relied on the CFTC’s determination that Bitcoin Futures ETFs could be listed on CFTC-regulated exchanges. As part of the CFTC’s process, that agency requires self-certification that the new product complies with CFTC regulations and is “not readily susceptible to manipulation.” In very general terms, the SEC has concluded that these Bitcoin Futures ETFs are protected against manipulation enough to justify allowing their trade on securities exchanges.
The current action against Gemini arises out of conduct that allegedly occurred in 2017 and 2018, when the CFTC was evaluating the Gemini Bitcoin Auction (just after the SEC denied a request from the Winklevoss brothers seeking SEC approval for a Bitcoin ETF). The very fact that a major U.S. crypto exchange that positions itself as having a record of regulatory compliance appears to have been lying in its communication with regulators further bolsters the SEC view that crypto markets are rife with fraud and subject to manipulation, and therefore, that we are not ready for Bitcoin ETFs.
Is crypto really for criminals?
The reality, however, may be quite different, as suggested by both the rising volume of enforcement activity in the crypto space (indicating the existence of substantial oversight), and also technical analysis of criminal activity in the space (conducted by independent firms and showing marked declines in the rate of criminal activity). Consider, for example, the 2022 Chainalysis report on crypto crime. This report documents a clear decrease in fraud and abuse as a percentage of all crypto activity.
Nonetheless, headlines continue to report that the dollar value of crypto fraud has risen significantly. It is perhaps understandable that news sources will frame stories in terms that are likely to gather the widest audience, and it is clear that $14 billion being stolen by scammers is a splashier headline than noting that crypto crime as a percentage of illicit transactions dropped to a remarkable low of 0.15% in 2021.
What is somewhat surprising, however, is the extent to which the “crypto is for criminals” narrative continues to be emphasized by some regulators, particularly in the SEC. SEC chair Gary Gensler has compared the crypto ecosystem to the “Wild West,” complaining that crypto “is rife with fraud, scams and abuse.” In mid-May 2022 Gensler was still sounding the alarm, suggesting that there is “a need to bring greater investor protection to these crypto markets.” This was on the heels of a decision by the SEC to nearly double the size of the Crypto Assets and Cyber Unit within its Department of Enforcement.
Thus, when a sister agency like the CFTC initiates an enforcement action against a major player in the crypto space with very detailed allegations of false and misleading statements suggesting that manipulation has indeed been occurring in the Bitcoin space, this adds fuel to the fire that the SEC continually focuses upon. Moreover, the likely position of the SEC that the markets are not sufficiently mature for approval of a spot-market Bitcoin ETF is only strengthened when founders of a crypto company facing that action publicize their disdain on social media.
So, should there be a spot-market Bitcoin ETF?
In October of 2021 and early in 2022, the SEC approved multiple futures-based Bitcoin ETFs. Although these products were already available on CFTC-regulated exchanges, this was still a change in the SEC’s position that the entire crypto market was too susceptible to manipulation to allow exchange-traded products. The significance of the change in position is that the futures and spot markets are so closely linked now that there is no rational basis for concluding that only one of them is sufficiently free from the risk of fraud or manipulation to allow exchange-traded products.
On April 6, 2022, the SEC approved a futures-based ETF regulated under the same regulation under which spot-based ETFs would be regulated. It approved another such product in May 2022. While the agency explicitly declined to provide any “evaluation of whether Bitcoin […] has utility or value as an innovation or an investment,” it did conclude that both of these ETFs were sufficiently protected against manipulation to be traded on securities exchanges.
Now that the SEC has decided Bitcoin Futures ETFs may be traded on regulated securities exchanges, there would seem to be no reason to conclude that American investors should be denied the opportunity to participate in Bitcoin ETFs as well. Such investment is widely permitted in other nations, including Canada and Australia. As for the CFTC’s enforcement action on Gemini, it would be unfortunate if a cavalier response from the Winklevoss brothers — who have previously been turned down for permission to offer a Bitcoin ETF by the SEC — sets back the progress on this front any further.