The time for cryptocurrency exchange traded funds (ETF) is right now, with the U.S. financial market dipping its toes in crypto. Currently, large institutional players can gain exposure to crypto product under Reg D. However, with increasing customer demands, D2C Robos, like Wealth-front (which primarily offers ETFs), are introducing crypto in their offerings – signaling a shift toward creative crypto product packaging also known as crypto ETFs. 

Who has filed for an ETF?

In 2014, Gemini was the first firm to file for a cryptocurrency ETF.  Early adopters and filers of crypto ETFs were similar – small, with a high-risk tolerance. Those companies, such as GraniteShares, VanEck, and Volt Equity, pioneered the space, even with little SEC movement.  Since then, powerhouse institutions, such as Goldman Sachs to newer players such as Grayscale, have all filed. Now, as the SEC changes leadership and business leaders anticipate movement, they are drilling into preparing their institutions for cryptocurrency. 

For example, Ark Investment purchased a total of $1B in cryptocurrency.  Grayscale announced in July a new partnership with BNY Mellon as its asset servicing provider for a crypto ETF and Fidelity announced they are going to hire upwards of 100 crypto experts.  

Even institutions that have typically posed themselves as cautious of cryptocurrency are starting to indicate their willingness to present crypto as a viable investing option to their clients. Case in point: JP Morgan. Throughout the past few years, in public comments and even Congressional testimony, CEO of JP Morgan Jamie Dimon has advised customers to ‘stay away’ from investing in cryptocurrency.  Dimon promoted this caution until late July when JP Morgan became the first major U.S. bank to offer crypto trading to its clients.  As the excitement and viability of a cryptocurrency ETF ramps up, the SEC is still grappling with the complexity emerging from a new asset class applying to a legacy regulatory framework.

What challenges are the SEC facing?

Investors rely on registered funds to plan for their future, and the SEC is trying to honor these safeguards in the form of securities laws put in place, especially the rule around the Investment Company Act of 1940 . The SEC continues seeing an uptick in interest by sponsors who want to engage in digital asset-focused activities and strategies. With that being said, the SEC maintains that there are a significant number of market protections needed related to this new emerging asset class. Dalia Blass, former IM director, raised concerns in a letter to SIFMA and ICI   around funds seeking to engage in cryptocurrency holdings. 

There are several issues attached to the question of volatility as mutual funds and ETFs must value their assets each business day to strike their daily Net Asset Value (NAV). This NAV will determine the fund performance and pricing. If the asset is extremely volatile, the question related to adequate information around how the funds are reaching this value arises. There is a significant level of discussion around development of policies and procedures related to daily NAV being discussed. Liquidity is also an issue as the key feature of an ETF is the daily redeemability. Wherein, the funds must maintain sufficient liquidity thresholds to provide for daily redemption requests. Fund liquidity rules and volatility also ties into how the assets are classified and what bucket they fall into based on the pre-determined liquidity thresholds. 

We would be remiss if we did not bring up the issue of the custody of assets highlighting the concerns around digital asset focused funds falling under 40 Act. There are questions as to whether the specific custody requirements of the 40 Act are being adhered to by the custodians.
Cryptocurrencies were designed to be anonymous and freely transferable on a peer-to-peer basis without the involvement and oversight of trusted market intermediaries. In view of this, there is significant dialog around recent developments in verification of ownership and approaches to operational security. There is immense focus placed on private cryptographic keys and how institutional investors are holding cryptocurrency investments. 

So, why is the SEC skeptical of approving the ETF? SEC chairman Gary Gensler, who is fluent in crypto, is purposefully playing a waiting game to ensure there is clarity, safeguards, and the right foundation required for mainstream investors to be protected. His background with CFTC, Wall Street, blockchain, and cryptocurrency points to good news as the industry struggles to find solid ground in the disjointed U.S. crypto market. Given that the U.S. is lagging behind a few counterparts, such as Canada and Brazil, this explanation seems to hold up as George King, CEO of Osprey Funds, stated the U.S. is “decidedly behind” but “that is obviously by choice.”  

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1. Winklevoss twins on crypto’s allure for the ETF world | Financial Times
2. History of BTCUSD | Trading View
3. Cathie Wood’s ARK Invest is reading the first bitcoin ETF with 21Shares | MarketWatch
4. BNY Mellon to Assist Grayscale with Bitcoin ETF Plans | Crypto Briefing, Fidelity to Hire Crypto Experts as Institutional Interest Grows | Coin Republic
5. JPMorgan's Jamie Dimon: 'Buyer beware' on cryptocurrencies
6. JP Morgan Becomes First Major U.S. Bank to Offer Crypto Trading to Clients | Be In Crypto
7. SEC.gov | Laws and Rules
8. SEC Seeks Response from Industry on Cryptocurrency Funds | FrontLine Compliance
9. ‘2022 is the earliest’ we could see a bitcoin ETF: Greg King (yahoo.com)