US Regulator Clears Way For Crypto ETFs

Lisa Smith, BA (Hons), CeFA
By

Cryptocurrency exchange traded funds could be on the way as hard line financial watchdogs warm to a more mainstream approach to digital currencies.

Exchange traded funds (ETFs) tend to track an underlying index, like the value of Bitcoin or other cryptocurrencies.

Investors buy and sell shares in ETF funds listed on stock exchanges rather than taking a stake in a cryptocurrency.

The news of the change of attitude by regulators at the US Securities and Exchange Commission (SEC) comes as Bitcoin and other cryptocurrencies soar in value in the wake of Joe Biden’s presidential election outcome and disclosure of a possible COVID-19 vaccine.

How ETFs Work

An ETF is a traded security that has a bid/offer spread on a stock exchange, just like a share.

The price can fluctuate all day as traders buy and sell their holdings.

Thousands of ETFs are on world stock markets. The security can include stocks, commodities or bonds linked to a single market or as international securities.

A popular ETF is the SPDR S&P500 ETF which tracks the US Standard & Poor’s 500 Index of large public companies. ETF investors own shares in the fund rather than shares in the companies that make up the S&P500.

The ETF tracks the performance of the index and the price rises and falls in line with how the index moves.

Because ETFs are continually traded, investors find stakes in the fund are easy to buy and sell.

ETFs in the States are regulated by the SEC

An ETF also tends to be a cheap way to invest as fund costs and management fees are low. 

Investment Watchdog Talks Up Cryptocurrency

SEC chairman Jay Clayton says his team is working on regulations that will allow cryptocurrency ETFs to market in the US – a big move towards legitimising Bitcoin and other digital currencies.

His worry is the Wild West frontier approach some cryptocurrency stakeholders take to the market.

Clayton also revealed the SEC is in talks with other US regulators like the Office of the Comptroller of the Currency and the Commodity Futures Trading Commission to decide who has authority over the cryptocurrency sector.

The news has sparked several financial firms to look closely at establishing cryptocurrency ETFS.

A handful of firms have begun exploring the idea.

One innovator, Wisdom Tree has praised the new approach towards cryptocurrencies by the SEC.

CEO Jonathan Steinberg agrees regulation is needed to turn cryptocurrencies mainstream.

“The SEC seems happy to engage, particularly if you are embracing those foundational first principles” of investor protection and maintaining fair and efficient markets,” he said.

Clayton claim cryptocurrency pioneers failed to protect investors in a rush for profits.

“One of the problems we’ve had was we got off on the wrong foot in this innovation,” he said.

“We could toss aside some of those principles of responsibility or transparency. In the past, the agency has had to take some companies to task for raising money to set up a cryptocurrency — known as an initial coin offering — without following the regulatory protocols of other securities offerings. 

“What we don’t like is when someone says the function of their cryptocurrency is payments, so you really ought to look past the securities law stuff’. I can’t do that.”

“Don’t tell us it’s a payment system when it’s actually a financing vehicle.”

Crypto ETFs – The Story So Far

The SEC and cryptocurrency stakeholders have wrestled over regulating Bitcoin ETFs for more than two years.

In March 2017, the SEC refused an application for the first Bitcoin ETF, arguing the market was open to manipulation by rogue investors, too volatile and not transparent.

Since then, others have tried to launch crypto ETFS without success, while a public consultation by the SEC shouted down the prospect.

Attitudes appear to be softening, with the latest announcement from the chairman and other board members seemingly heralding a new dawn for cryptocurrency to take a place alongside other commodities in a regulated and legitimate marketplace.

The obstacle is identified as Section 6b (5) of The Exchange Act that demands regulators prevent fraud and market manipulation to protect investors.

The SEC hard nosed reaction to proposed crypto ETFs was a direct refusal for nine applications submitted in 2018.

Bitcoin Price Surge Excites Investors

Bitcoin has gained more than 10% in value in a week and is currently hovering around the $16,000 mark – a level that the cryptocurrency has held for just two weeks in total since hitting the market more than a decade ago.

In December 2017, Bitcoin hit a high of $19,800 but slumped to a three-year low of $3,176.44 a year later.

Bitcoin’s market capitalisation is now $296 billion – just over two-thirds of the total market cap of all cryptocurrencies.

Someone buying Bitcoin a year ago would have paid $8,640.42, giving a gain of $7,360 in 12 months.

Other cryptocurrencies, like Ethereum, Litecoin and XRP Ripple have also made less spectacular but solid gains in the past week.

Why Not Just Invest In Bitcoin?

ETFs are better for cryptocurrency investors for several reasons.

Although investors can buy shares in a single Bitcoin rather than an entire token to reduce the cost of entering the market, ETFs are still cheaper for retail investors.

Other advantages include:

  • Investors do not have to own Bitcoin
  • Cryptocurrency paraphernalia like wallets and other storage methods are not needed, reducing the risk of theft and fraud that has plagued the sector in the past
  • ETFs can be bought or sold more easily – especially if the Bitcoin price drops
  • ETFs are passive investments requiring no effort by an investor as the security tracks the market price automatically

Cryptocurrency ETF FAQ

As regulators considering bringing cryptocurrency out of the shadows into mainstream investing, this guide looks at what this means for investors.

For investors unfamiliar with cryptocurrency and ETFs, here are some responses to the most asked questions our experts receive.

What’s the risk of investing in a Bitcoin ETF?

Besides the normal concerns about the rise and fall of the price of Bitcoin, a dedicated Bitcoin ETF lacks diversification.
 
Experts warn about investing in one sector or share, and while a Bitcoin ETF could play a part in portfolio diversification, it’s best not to get carried away and investing all your money in a single security.

Are ETFs for speculators or investors?

The timescale of an ETF investment should be medium to long term – at least five or 10 years. This gives you time to ride out any severe volatility in pricing.

What’s the SEC main worry over cryptocurrencies?

Bluntly, the SEC was concerned ordinary investors were sucked into to initial coin offerings, which are like buying shares to fund a start-up company but instead finance a new cryptocurrency.
 
Some were thinly-veiled frauds offering no protection to investors. The SEC response was telling cryptocurrency bosses to clean up their act and follow regulations in place that are designed to safeguard investors.

Are ETFs good investments?

ETFs come in all flavours – good, bad and indifferent. It’s up to individual investors to make their own decisions about specific ETFs, but regulation means they can do so in the knowledge someone in authority has got their back if the deal turns sour.
 
Many ETFs return a performance that reflects the underlying shares, commodities or currencies. If they perform badly, then so does the ETF – and the reverse applies if they perform well.

When is a Bitcoin ETF likely to be launched?

There’s no set date and the first Bitcoin or other cryptocurrency ETF is a long way off in America.
 
Regulators are talking about who takes control of the market and polices the ETFs.
 
Similar discussions to enable ETFs took years to establish the ground rules before a product was launched for the public.

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