The regulator’s warning was unambiguous. “There are a number of significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors,” wrote Dalia Blass, a director at the Securities and Exchange Commission, which oversees the US investment industry.
In a letter sent last month to two trade groups, Ms Blass outlined more than 30 questions that she said needed to be resolved before the SEC would give the green light to mutual funds and exchange traded funds that invest in bitcoin and its peers.
“Until the questions . . . can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products,” she wrote.
Ms Blass’s letter was sent in response to a swath of applications from ETF providers to launch funds tracking cryptocurrencies. The surging prices of digital currencies such as bitcoin and Ripple last year, along with the launch of derivatives markets by two exchanges, gave hope to ETF executives that the asset class had become sufficiently mainstream that their products would be approved.
Though the price of bitcoin has come crashing down since its December highs, the mania surrounding the cryptocurrency is undiminished. Having risen in value so dramatically in recent years, bitcoin has drawn the attention of speculators hoping to multiply their investments in short order. With close to 17m bitcoins in circulation and with a price per unit just under $10,000, the market capitalisation stood at $161bn last week.
While the SEC’s statement has killed off the chance of US funds launching in the coming months, cryptocurrency enthusiasts believe it is only a matter of time before the market develops. They hope that, as the asset class matures, the hype surrounding bitcoin will transfer to its shadow ETF market.
This is being driven by “the fear of missing out,” says Sylvia Jablonski, a managing director at Direxion, which applied for five bitcoin ETFs, some of which would have used leverage to amplify the price movements. “Investors are enamoured with the price swings in bitcoin . . . but they cannot go out and buy bitcoin for their clients. This would be a way to have exposure to the asset class.”
Ms Jablonski says many of her more sophisticated customers — including hedge funds, investment advisers and institutional investors — would like to invest in cryptocurrencies as a way to make tactical and technical trades. As a wildly volatile asset class, bitcoin appeals to high-risk traders as it allows them to make big bets on its potential to rise or fall.
One of the earliest attempts at launching a cryptocurrency ETF market in the US was made by Cameron and Tyler Winklevoss, the venture capitalist twins who are among the loudest bitcoin cheerleaders. Their initial application was rejected by the SEC last March. But in December, two exchange operators, Cboe Global Markets and CME Group, opened bitcoin futures markets, spurring a handful of ETF providers to submit new applications.
Rather than owning the bitcoins outright, these proposed products — from the likes of VanEck, Rex ETFs and Direxion — were designed to invest in futures contracts. This would have allowed them to avoid one the SEC’s main objections to the original Winkelvoss fund, that the bitcoins it would target were mostly traded on unregulated markets.
Several of the applications were for funds whose values were designed to move in the opposite direction to bitcoin’s price, a technique known as shorting. This tactic would have been possible only by investing in derivatives, such as futures contracts, rather than the cryptocurrency itself.
Several of the SEC’s concerns relate to price volatility. Throughout 2017 the price of bitcoin rose from around $1,000 to just below $20,000 a unit. Since then its price has nearly halved.
“The extreme appreciation in price shows the tremendous amount of speculation, which is definitely a sign to be cautious,” says Karan Sood, chief executive of Cboe Vest, another company hoping to bring cryptocurrency ETFs to the market.
The US regulator also raised concerns over a lack of liquidity and that if investors rushed to take their money out of the ETFs on a given day, the funds would not be able to meet the redemptions due to how hard it would be to sell off their assets.
Ms Jablonski says the more established the futures markets become, the better equipped they will be to support ETFs and ease the SEC’s fears. “Having a developed futures market will bring liquidity, transparency and price discovery,” she adds.
Swedish company XBT Provider has been running a bitcoin exchange-traded product for two years and has attracted more than $1bn from European investors. But rather than an ETF, which holds the assets it tracks, the XBT product is an exchange-traded note, a close cousin of the ETF that invests instead in unsecured debt notes, similar to bonds.
There are other options for those wanting to gain exposure to the market. Last month, providers Amplify ETFs and Reality Shares launched funds tracking the stocks of companies involved in blockchain and other distributed ledger technologies that underpin cryptocurrencies.
Rather than tracking cryptocurrencies or related derivatives, the funds invest in publicly traded companies that develop, research, fund and use the underlying technologies. So far at least, the SEC seems to have accepted this compromise.