SEC Division of Investment Management Publishes Feedback from Cryptocurrency ETP Inquiry

In January, the Securities and Exchange Commission (SEC) Division of Investment Management published a widely cited open letter to the industry in which the Division asked a series of questions about how it should consider risks associated with bitcoin- and other cryptocurrency-backed exchange-traded products (ETPs).  The SEC staff expressed concerns about whether the bitcoin markets were sufficiently mature and liquid for registered funds to invest in that class of asset, and flagged several other issues related to valuation, liquidity, custody, ETP arbitrage and potential manipulation, among other things.

Now the Division is starting to post feedback it received from that inquiry.  To date, the SEC has posted six letters: one from an exchange, one from a trade association, one from an investment manager and several from individual market participants.  Presumably, this is the leading edge of what will be more and more responses over time.

Here’s a quick summary:

Several of the letters maintained that many of the issues regarding cryptocurrency ETPs are either very similar or identical to those encountered for other commodity-linked ETPs.  In respect of valuation, some of the responses pointed to bitcoin futures markets on the Cboe Futures Exchange and CME from which real-time data could be pulled.  However, some market participants also noted that air drops and forks create valuation issues that have yet to be sufficiently addressed.  Many of the letters also argued that cryptocurrency ETPs would be sufficiently liquid, as billions of dollars’ worth of bitcoin trade on exchanges daily.

One comment letter claimed that there should be no disparate treatment in terms of custody between cryptocurrency futures contracts and commodity futures contracts used in other ETPs, while others conceded that there is still work to be done to address the Division’s concerns in respect of holding cryptocurrency directly.  In addition, several letters claimed that the spot and over-the-counter cryptocurrency markets could support the existing arbitrage mechanism for an ETP.

Responses were split on issues related to manipulation and other risks, as one response argued that these risks are no different than those for other commodity-linked ETPs, while another shared the Division’s concerns for the potential for fraud and manipulation in cryptocurrency markets.  Another response also argued that the introduction of a regulated ETP could quell some of these concerns, as it would lend itself to the SEC’s increased enforcement and regulatory authority.

One comment letter also argued that it is not appropriate to apply traditional securities laws to cryptocurrencies due to their unique nature, while another cautioned that if the SEC continues to over-regulate cryptocurrency markets, innovators will look to do business in other jurisdictions.

The SEC has also received thousands of comments in response to applications to list specific cryptocurrency ETPs, and, due to the sheer volume of comments and apparent disagreement among SEC commissioners and market participants, it does not appear likely that any formal decisions will be made to approve these applications in the near future.  We will continue to monitor any responses to this inquiry and any additional guidance the SEC may publish in respect of cryptocurrency ETPs.