Bitcoin and broader cryptocurrency ETFs are considered to be one of the major hurdles that once overcome will open the patch towards mainstreaming. To date, 9 cryptocurrency ETFs put in front of the SEC have been summarily rejected. The uniform approach by the SEC has been to deny the application of cryptocurrency ETFs and push the deadline back to the maximum. At that point the ETFs have been forced to withdraw. Resubmission has to be from square one. The last time a cryptocurrency ETF proposal was reviewed was August 2018.
It’s fair to say the approach has been one of minimal encouragement to re-application or new cryptocurrency ETFs to apply for approval. But why are cryptocurrency ETFs becoming available so important to the development of the sector and why have the SEC, at least so far, been rejecting applicants one after the other? Finally, is there any hope that a future cryptocurrency ETF application might be successful, when is it realistic to expect that might happen and under which conditions?
The logical starting point to exploring this topic is a brief explanation of what an ETF actually is. The term is an acronym for ‘exchange traded funds’, which is exactly what ETFs are. An ETF is an investment vehicle designed to combine both the flexibility of investing in or trading individual stocks but with the diversification of a fund. There are also ETFs that offer exposure to the underlying market price of individual commodities such as gold or oil.
Mutual funds and investment trusts can also offer the diversification of an ETF by representing a portfolio of investments. They are also traded on stock exchanges in units. The difference is that the value of ETFs changes in real time like that of exchange-listed stocks or commodities whereas other kinds of funds are only adjusted, and can be bought or sold, once markets have closed for the day. Also, while not exclusively the case, ETFs tend to passively track an index like the FTSE 100, S&P 500 or an equities sector or commodities index. Because they usually don’t have active management, ETFs charge much lower fees to investors compared to those of actively managed funds.
ETFs have risen in popularity to become one of the most popular ways to invest. Their convenience and cost efficiency means both institutional and private investors put trillions into ETFs every year.
A cryptocurrency ETF would either track the price of a single cryptocurrency, such as Bitcoin, or an index of the major cryptocurrencies. Such an index would be weighted by the market capitalisation of the cryptocurrencies included in a way designed to track the wider cryptocurrency market. Much like a FTSE 100 ETF tracks the weighted performance of the 100 largest companies listed on the London Stock Exchange.
Cryptocurrency ETFs are considered so important to the future evolution of the market because they are regulated financial instruments. Most institutional investors have a policy to only invest in regulated instruments, which precludes them from taking any exposure to the cryptocurrency market, even if they would be theoretically interested in doing so.
Cryptocurrency ETFs would also make the market more accessible to private investors. They wouldn’t have to worry about opening up an account on a cryptocurrency exchange, setting up a wallet, risk being hacked and their cryptocurrencies stolen and many of the other bottlenecks which put people off an investment in the sector. A couple of clicks of a mouse and a private investor would have, through their existing online stockbroker, have direct exposure to the price direction of a single major cryptocurrency or the wider market.
Even if institutional investors allocated relatively tiny amounts of capital to cryptocurrency ETFs, and more traditional private investors took small positions, the result would be a huge injection of liquidity into the market. That would be expected to even out a large portion of the volatility in cryptocurrency prices, which is something that is a major bottleneck to them being viable as fiat alternatives. It would also show which cryptocurrencies have the scalability to be practically usable in everyday commercial transactions and, arguable most important of all, lend greater authority to the sector, building trust with the wider public.
In late 2018 SEC Chairman Jay Clayton offered some insight into what the regulator wants to see before considering approving a cryptocurrency ETF. His two main demands were for “better market surveillance” and improved “custody” options. That can be interpreted as a cryptocurrency market that is better at setting and policing uniform standards and safer ways to hold the digital assets without such as high risk of hacker attacks leading to theft.
Clayton is concerned the less sophisticated monitoring tools used by cryptocurrency exchanges in comparison to stock exchanges means that fair market prices are not guaranteed. It is a fact that the exchange value of the same cryptocurrency can vary significantly between exchanges. A lack of infrastructure able to share data on supply and demand across exchanges means prices are set based on supply and demand levels on a particular exchange.
There are also concerns that the cryptocurrency market is still at risk of manipulation by certain actors and that monitoring systems are not in place that would be able to identify and prevent that from happening.
On security, Clayton commented:
“We’ve seen some thefts around digital assets that make you scratch your head. We care that the assets underlying that ETF have good custody, and that they’re not going to disappear.”
Is There Hope A Cryptocurrency ETF Might Be Approved In the Short to Medium Term?
That’s the million-dollar question. Particularly for anyone who currently holds cryptocurrencies or is thinking of investing in them. As of March 2019, the SEC has two new cryptocurrency ETF proposals to consider. Both are pure Bitcoin ETF proposals. Both have also proposed rule changes that would make their acceptance possible.
From the date of the submissions, the SEC has 45 days to consider than and can ask for a 90-day extension. Further extensions can then be requested but by the 240th day from submission of the applications, the SEC has to finally accept or reject the ETF proposals.
The companies behind both new ETFs believe their products are better constructed than those of previous attempts and do offer investors greater protection. Will the SEC agree? It’s hard to tell but at this stage the odds would probably be long. However, every rejection does bring the market another step closer to a cryptocurrency ETF finally being approved. And that is something that does have the potential to be the biggest single catalyst to the cryptocurrency sector since Bitcoin’s original whitepaper was published back in 2008.