Regulators continue to tread carefully on the contentious bitcoin ETF debate.
On the heels of the Securities and Exchange Commission's decision to deny the Winklevoss twins their application for a digital asset-related exchange-traded-fund, bitcoin pundits are wondering what's thwarting the first ETF underpinned by bitcoin.
Here are some of the main issues that have recently given regulators pause:
One pressing concern lawmakers have is security. Hacks have undermined the crypto market in the past, the most famous being the Mt. Gox heist in April 2014, where $450 million of bitcoin BTCUSD, +0.43% were stolen. In addressing these concerns, companies such as Coinbase are beginning to offer up custodial offerings—the holding and protection of the underlying asset.
In its ruling, the SEC stated the proposal from the Winklevoss twins didn't meet standards "to protect investors and the public interest."
With this being said, two firms believe they have a product that satisfies security concerns.
VanEck Associates and SolidX filed a request on June 5, for a bitcoin-related ETF that would be physically backed and fully insured. "A properly constructed physically backed bitcoin ETF will be designed to provide exposure to the price of bitcoin, and an insurance component will help protect shareholders against the operational risks of sourcing and holding bitcoin," the two companies said in a press release.
Lack of liquidity, vulnerability to manipulation
The SEC has raised concerns over the vulnerability of cryptocurrency markets to sharp price moves, saying they are a feeding ground for nefarious characters looking to take advantage of the nascent market. In a Feb. 6 hearing, SEC Chairman John Clayton said: "When you have an unregulated exchange the ability to manipulate prices goes up significantly."
Clayton said that due to the lack of liquidity, a few coordinated sales can cause the price to swing sharply, which could put average investors in harm's way.
Matt Hougan, whose firm Bitwise Asset Management applied for a crypto index-related ETF on July 24, said liquidity has vastly improved over the last 12 months, which will help dissipate some regulatory concerns. "The entry of folks like Jane Street, Goldman Sachs and Flow Traders will continue to improve liquidity," said Hougan, who is global head of research at the San Francisco-based cryptocurrency fund. "These are big established flow trading names and as they become more significant the liquidity and price discovery will only improve."
Erik Syvertsen, general counsel to AngelList, an internet-based venture capital firm that helps startups raise funds and find talent, and part-time attorney to the Olshan law firm, agrees that the SEC would like to see a "more deep market" but said the major hurdle is that the SEC lacks the tools to adequately govern the market. "There is no robust monitoring for manipulation," said Syvertsen. "You are relying on the crypto economics to reduce this and the majority [of regulators] are not comfortable with this."
In a January 18 staff letter, Dalia Blass, director of the Division of Investment Management at the SEC raised concerns around the ability of a digital asset-backed ETF to be valued at the end of each business day, a requirement of an ETF. "Appropriate valuation is important because, among other things, it determines fund performance, what investors pay for mutual funds and what authorized participants pay for ETFs (and what they receive when they redeem or sell)," wrote Blass.
In response Jan F. van Eck, president and CEO of VanEck Associates said the information provided by two futures contracts (run by Cboe Global Markets Inc. and CME Group Inc.) would satisfy a daily price point for adequate performance, adding that the futures prices have traded at prices "close to the price of the bitcoin spot price."
Blass said she would like information on how a fund would value the ETF in the event of a fork—when a cryptocurrency splits into two due to a significant upgrade of a currencies blockchain, or the digital infrastructure that underpins most virtual assets.
All this being said, those hoping for a bitcoin-related ETF may soon have their wish granted, if one SEC commissioner has her way.
Hester M. Peirce's decision to dissent, saying lawmakers are stifling creativity, arguing that the market would self-regulate itself, was viewed as a net-positive for crypto enthusiasts.
To be sure, there is no guarantee that a bitcoin ETF sees the light of day—at least in 2018.
Brian Kelly, founder and CEO of BKCM LLC, an investment firm focused on digital currencies is also upbeat on the chances an ETF product is approved, but doesn't see it in the near future. "I think the likelihood [of approval] in 2018 is low. In fact, I'd be shocked if it was approved this year," said Kelly.
"They [those pushing for the ETF product] have addressed a couple of issues but some still remain. I think the custody issue and the lack of regulated exchanges that trade the underlying asset are the main concerns for the regulators."
Kelly added that 2019 seems more likely for a regulatory-backed launch.