When Bitcoin was rapidly increasing in value, there were lots of people looking to invest in that space. The SEC has repeatedly raised concerns about fund sponsors creating a fund or ETF focused on cryptocurrency. In a letter to the Investment Company Institute and Securities Industry and Financial Markets Association, the SEC said don’t even think about it.
Actually, it said you can think about it, but what about all of these issues. These issues are very compliance-related so I thought it was interesting to look at these compliance issues in light of this new asset class.
Valuation
Proper value of a fund assets is critical. For Bitcoin and various crypto-currencies there are multiple exchanges that are often far apart in the exchange rate. Bitcoin itself has little ascertainable value. Few merchants accept it as payment and few holders are willing to part with it, instead holding it as an investment. The value is determined as other currencies, based on the exchange rate into dollars. That exchange rate can vary significantly from provider to provider.
The SEC lays out out a long list of questions that would have to be addressed in a valuation policy.
Custody
This is the big problem. Most of the successful hacking of crypto-currency has been a a hack into the depositories/wallets that hold the crypto-currency. Investment advisers have regualtory custody requirements and ’40 Act funds have a stricter set of rules.
The SEC points out that it is not aware of any custodian providing custodial services for crypto-currencies.
The problem with custody is that you have to have the private crypto key as well as the record in the blockchain.
Arbitrage
For ETFs that trade during the day, you have problems with differing price movement at the different exchanges for crypto-currencies.
Market Manipulation
As I pointed out yesterday, cypto-currencies seem to targets for market manipulation. That also means that any derivatives from the crypto-currencies are also subject to market manipulation.
Sources:
- Staff Letter: Engaging on Fund Innovation and Cryptocurrency-related Holdings
- SEC cools traders’ hot plans for cryptocurrency-based exchange traded funds
- Price Manipulation in the Bitcoin Ecosystem by NeilGandal, JT Hamrick, Tyler Moore, Tali Oberman
- Pump and Dump Cryptocurrency