Letter from SEC Reveals Outlook Not Good for US-based Bitcoin ETFs

The US Securities and Exchange Commission (SEC) has issued a letter to two Washington DC firms seeking guidance on bitcoin exchange-traded funds (ETF) applications, of which a dozen are pending. In it, the regulator openly worries about cryptocurrency volatility and whether future potential listings have done enough to protect investors. The letter is widely believed to be a major blow in the quest for Wall Street’s mainstreaming of bitcoin.

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Bitcoin ETF Major Setback

In a Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings of 18 January, signed by newly appointed Director Dalia Blass from the Division of Investment Management, the SEC wrote to the Investment Company Institute and Asset Management Group Securities Industry & Financial Markets Association (SIFMA) about the prospects of bitcoin ETFs.

The outlook is not good, especially if the letter’s import carries weight within the agency.

The letter is clearly written for an audience beyond its two addresses (how many letters have footnotes?). It begins with SEC history and mission statements, outlining its jurisdiction. It also offers up saccharine lines before dealing a deadly sentence. The SEC “stands ready to engage in dialogue with sponsors regarding the potential development of these funds.” And then the phrasing heard around the world: “We believe, however, that there are a number of significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors.”

The agency does “appreciate that proponents of cryptocurrencies and related products have identified a range of potential benefits.” However, “concerns regarding transparency of information, trading, valuation and other matters related to the nature of the underlying assets” seem to be dominating the SEC’s current position. Revealingly, the letter admits “the innovative nature of cryptocurrencies and related products, as well as their expected use and utility in our financial markets, means that they are, in many ways, unlike the types of investments that registered funds currently hold in substantial amounts.”

The climate surrounding bitcoin ETFs has gone from frustration to excitement in recent months with the entrance of heavy mainstream exchanges such as Cboe and CME trading futures contracts (and even the appointment, ironically, of Ms. Blass, who was seen as a pro-ETF attorney). It was believed if things went smoothly at these venerable institutions, bitcoin ETFs were a sure thing. Something like a dozen proposals for listings on the New York Stock Exchange Arca have been filed, and not one is approved.

The letter continues, “we have, at this time, significant outstanding questions concerning how funds holding substantial amounts of cryptocurrencies and related products would satisfy the requirements of the 1940 Act and its rules.” The rather lengthy missive goes on to ask a laundry list of questions, to “facilitate the start of our dialogue,” and it’s not entirely made understood the agency is really waiting for a response.

Dalia Blass

Questions Demanding Answer

Given their volatility, “Would funds have the information necessary to adequately value cryptocurrencies or cryptocurrency-related products[?]” the agency asks. “How would funds develop and implement policies and procedures to value, and in many cases ‘fair value,’ cryptocurrency-related products?”

They even get into nitty-gritty crypto inside baseball: How “would they address when the blockchain for a cryptocurrency diverges into different paths (i.e., a ‘fork’), which could result in different cryptocurrencies with potentially different prices?” And the questions deepen and go on like this for a few pages.

They ask intriguingly, “What policies would a fund implement to identify, and determine eligibility and acceptability for, newly created cryptocurrencies offered by promoters (e.g., an ‘air drop’)? How might a fund account for those holdings if the fund chooses to claim such cryptocurrencies?”

Issues of liquidity, custody, arbitrage, manipulation and “other risks,” and more, seem designed to place the ball squarely in the financial community’s court and away from press criticism the agency is dragging its feet or is in some way stifling innovation. “Until the questions identified above 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, and we have asked sponsors that have registration statements filed for such products to withdraw them,” the letter concludes, suggesting contact persons for future reference.

What do you think about the prospects of a bitcoin ETF? Let us know in the comments section below.

Images courtesy of Pixabay, SEC.

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