ICOs Have Made It Harder for Crypto ETFs to Pass SEC Muster

Exchange-traded funds (ETFs) and related products are running into significant hurdles. In recent years, the area has been characterized by unbridled growth, but now regulators and securities industry players have begun to push back on exotic ETFs.

One potential reason for the shift? The cryptocurrency space and questions of regulation relating to initial coin offerings (ICOs).

SEC Issued Letter in January

On January 18, Dalia Blass, the head of investment management at the U.S. Securities and Exchange Commission (SEC), issued a letter regarding bitcoin-linked ETFs. Blass revealed a number of questions that regulators have concerning cryptocurrencies, the Wall Street Journal reported.

These are commonly seen as major barriers to cryptocurrencies being classified as fund products. Blass's letter reportedly prompted the withdrawal of a number of applications for bitcoin ETFs, according to the Wall Street Journal. (See also: Issuing an ICO? Don't Skip This Step, Says the SEC.)

Questions Facing Exotic ETFs

Exotic ETFs, including those related to bitcoin and other digital currencies, are now expected to be able to answer a variety of questions posed by the SEC. These questions include the valuation methods those ETFs would use to set daily net asset values, the types of steps that those funds might take to meet daily redemptions, and the holding methods for those cryptocurrencies.

Blass wrote that until those questions "can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products, and we have asked sponsors that have registration statements filed for such products to withdraw them." (See also: ICO Security Playbook: 5 Steps to Ensure Best Practice.)

An Easier Time For Traditional ETFs

At the same time that exotic ETFs are facing new barriers, the SEC may make the pathway to listing easier for traditional ETFs. SEC Chairman Jay Clayton has reportedly considered streamlining the offering and listing of these funds; the financial crisis of 2008 reversed this pathway a decade ago.

Nonetheless, even ETFs linked with sectors that may benefit from blockchain technology have seen snags. The SEC stopped four applicants' use of "blockchain" in their names in January 2018. (See more: SEC Cracks Down on Firms Misusing 'Blockchain' Name.)

At the same time, the market appetite for new products has dried up, too. As a result of compressed trading margins, new ETFs now tend to draw most of their funding from institutional investors rather than traditional trading and brokerage firms which once assumed that liquidity would not be an issue. (See also: SEC Blocks Bitcoin ETFs Again; Rejected Winklevoss Bid In 2017.)

Investing in cryptocurrencies and Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns bitcoin and ripple.

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