Lack of clear regulatory guidelines and the uncertainty it brings has delayed the development of the crypto industry. This is particularly evident when we look at the challenges faced by firms looking to list exchange-traded funds (ETFs) based on the traded price of bitcoin.
In June 2018, the U.S. Securities and Exchange Commission (SEC) did not approve the Winklevoss brothers’ application for the first cryptocurrency ETF on the BATS BXZ Exchange. The regulator highlighted security, market manipulation and investor protection as significant compliance issues.
In January this year, the Chicago Board of Exchange withdrew its application for the SolidX and VanEck bitcoin ETF and then re-submitted the application a few days later. At the same time, NYSE Arca filed a proposal with Bitwise Asset Management for a bitcoin ETF. Although the SEC encourages financial product innovation, in the rejection orders issued in August 2018 the Commission took the view that the bitcoin market lacks sufficient size and structure and does not have sufficient protection against fraud and market manipulation.
The SEC did emphasize, however, that its disapproval “does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment.”
ETFs explained
ETFs are one of the biggest growth areas in financial services. At the end of 2018, U.S. ETF assets alone totaled around $3.4 trillion according to XTF Research in the Wall Street Journal. Ranging from straightforward index trackers to style ETFs that cover growth and momentum to the more complex leveraged ETFs, they are similar to mutual funds. They trade intraday like stocks and are popular because they provide a less expensive way for investors to gain exposure to a wide range of asset classes.
The structure of crypto-based ETFs is similar to index ETFs in that they can track an index or basket of assets. For example, a cryptocurrency ETF could track the price of just bitcoin, or perhaps the top ten cryptocurrencies.
Crypto ETFs are the next step
An approved crypto ETF would give investors access to the crypto markets, via traditional investment structures. They would act as a bridge, connecting large pools of institutional capital to the emerging crypto markets. Institutional capital, which could be a key to increased crypto market volumes, would be more confident investing in a familiar instrument, such an as ETF that had been qualified by the SEC. The resulting increase in market volume would be of importance to the crypto markets, on a national and international basis, and as such, the regulatory approval of an ETF is a critical step in the evolution of the markets.
Two key questions remain. The first is whether or not the SEC believes crypto markets are of sufficient size to merit an ETF. Second, are there sufficient protections in place in the exchange and the underlying crypto markets to prevent fraud and market manipulation?
The general view is that the SEC’s approval of a bitcoin ETF may be getting closer. In July last year SEC Commissioner Hester M. Peirce said in a public statement that the SEC was wrong to disapprove the rule change that would have permitted the listing and trading of shares in the Winkelvoss Bitcoin Trust.
In a recent presentation to the SEC, representatives from VanEck and SolidX made the argument that the key issues that caused the SEC to reject the previous ETF applications have been addressed and that the SEC should approve their ETF.
Taking the long view
U.S. investors have few if any options if they want to invest in crypto ETFs. It is clear from recent events that SEC approval will be a turning point for the industry. A publicly traded bitcoin ETF will open the market to institutional capital, improving market liquidity and enabling investors to use a familiar, regulated investment vehicle to track multiple currencies and tokens.
It is still a case of “wait and see” but investors that take the long view will reap the rewards when, and not if, crypto-based ETFs become part of this rapidly expanding market.
