The SEC throws a wet blanket on the cryptocurrency ETF fever dream—for now

The United States Securities and Exchange Commission came out against cryptocurrency-based exchange-traded funds on Thursday. However, there may be a glint of hope for those hoping to see a crypto-related ETF one day in the distant future.

Dalia Blass, the SEC’s Director of the Division of Investment Management, wrote a letter to the heads of two trade groups strongly cautioning against implementing cryptocurrency-based ETFs. The U.S. investment fund market is “one of the most robust, varied, and successful markets for investment products in the world,” she wrote, but at the same time there are “a number of significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors.”

Cryptocurrency is not a plug-and-play solution for integrating with existing investment products. There are questions of how bitcoin’s notorious volatility would square with funds that have to calculate a fair market price for their portfolio every day. Investors might not be able to cash out of a crypto-ETF as easily as they would a conventional ETF—converting cryptocurrency to fiat is a straightforward process, but it is rife with regulatory concerns that vary from country to country. There’s little consensus to be found here, so the concern is over whether or not such a new investment product can meet the same regulations as its longstanding old-school brethren.

“The SEC is justified in its actions as it ultimately tries to protect the end investor,” says Max Chen, writer for ETF Trends. “While this is a slight setback in providing an innovative investment strategy to a greater audience through the ETF investment vehicle, the ETF industry will continue to hum along, with money managers and fund sponsors carrying on with new investment themes ahead.” He says we’ll probably have to wait for the underlying cryptocurrency market to mature before secondary markets come to bear.

These are feverish, speculative times in the world of cryptocurrency, so ETF issuers have been looking for a way to launch a bitcoin fund or similar. Last year the SEC canceled two proposed ETFs that would deal in bitcoin, one of them started by the Winklevoss brothers. It is difficult to use cryptocurrency to innovate in the financial space while still appeasing regulators. Thus Blass’s letter ought not to come as much of a surprise.

This doesn’t mean the SEC has completely turned its nose up at crypto-enabled ETFs—it just has way more questions than answers about how they’re going to work when they do arrive. They may do well to take guidance from a Swedish company called XBT Providers, which has operated a bitcoin ETF for the past two years. (Sweden is more receptive to cryptos and may even issue the world’s first national cryptocurrency.)

The SEC’s tone toward cryptocurrency ETFs is certainly one of skepticism, but the door isn’t shut yet.

Blass’ letter outlines a number of questions that, once satisfactorily answered, might see blockchain-enabled innovation more readily come to American money markets. Just a few of these questions include:

• “How would differences among various types of cryptocurrencies impact funds’ valuation and accounting policies?”
• “How would a fund prepare for the possibility that funds investing in cryptocurrency-related futures could grow to represent a substantial portion of the cryptocurrency-related futures markets?”
• “Under what circumstances would a fund have to hold cryptocurrency directly?”
• “To what extent would cybersecurity threats or the potential for hacks on digital wallets impact the safekeeping of fund assets under the 1940 Act?”

While it doesn’t seem that bitcoin-based ETFs will get the SEC’s blessing in the near future, the message is clear: the regulators are paying close attention to figure out if and how cryptocurrency can become a meaningful part of the American economy.

The U.S. government has changed its mind on contentious topics in the past. Of course it’s going to hold cryptocurrency to a rigorous level before deciding anything or implementing a course of action.After all, financial innovations have sometimes led to messy situations before.