What Did the SEC Say?

On January 18, the US Securities and Exchange Commission (SEC) sent a clear message to two Wall Street trade groups about their plans for Bitcoin-based exchange-traded funds (ETFs) and mutual funds. The SEC isn’t ready to hop on the crypto train just yet. Hinting at the skepticism surrounding cryptocurrencies, Dalia Blass, the SEC’s director of investment management, expressed substantial doubts about companies’ abilities to meet regulatory standards.

Crypto Benefits vs. Concerns

In the staff letter, Blass acknowledged the potential upsides of cryptocurrencies while airing a laundry list of concerns: transparency, valuation, trading, and liquidity. Sounds like an awkward cocktail party where everyone’s talking over each other without reaching a consensus.

Regulatory Hoops: The 1940 Act

The Investment Company Act of 1940 is the regulatory framework that governs mutual funds, hedge funds, and a whole buffet of investment options. According to the SEC, any funds heavily invested in cryptocurrencies need to satisfy the requirements of this legislation, which is easier said than done when the market is as unpredictable as a cat on a hot tin roof.

The Fork in the Road: Valuation Dilemmas

Blass highlighted a specific concern regarding how funds would value crypto portfolios, especially during chaotic events like a “fork” in the cryptocurrency universe. For the uninitiated, a fork occurs when a blockchain splits into two separate chains, possibly creating new cryptocurrencies — and with them, wildly varying prices. This complexity makes daily evaluations a tricky business. How do you calculate the worth of an investment that could flip faster than a pancake?

Liquidity: Where’s the Exit?

Liquidity is another nail in the coffin of cryptocurrency investment products, according to the SEC. The 1940 Act mandates that all funds must enable investors to liquidate their holdings at the end of each trading day. With crypto’s volatility, achieving this stability can seem about as likely as finding a unicorn sipping a latte at a hip coffee shop.

Fraud and Market Manipulation: A Familiar Tale

Issues of fraud and market manipulation have haunted the crypto world for years, as the SEC pointed out in previous advisories, such as their 2017 bulletin about Initial Coin Offerings (ICOs). In this recent letter, the SEC drew parallels to ETFs, raising alarms over whether fraud could impact these investments in similar ways.

The Bottom Line: Crypto Funds in Limbo

As of now, the SEC’s stance on Bitcoin-focused funds is decidedly uninviting. Blass made it clear that until sponsors can adequately address the SEC’s many questions, the commission does not consider it appropriate to register funds focusing on cryptocurrencies. So, it looks like the crypto party will have to wait a little longer — unless someone can come up with a magical solution to all these regulatory riddles.