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Crypto-based funds crawl toward mom and pop

They’ll get there ‘eventually’ says one SEC commissioner

LONDON, ENGLAND - OCTOBER 24: A visual representation of the digital Cryptocurrency, Bitcoin on October 24, 2017 in London, England. (Photo by Dan Kitwood/Getty Images)
LONDON, ENGLAND - OCTOBER 24: A visual representation of the digital Cryptocurrency, Bitcoin on October 24, 2017 in London, England. (Photo by Dan Kitwood/Getty Images)

A fund based on cryptocurrency will eventually pass muster at the Securities and Exchange Commission despite the agency’s denials of all previous efforts, predicts its lone Democratic commissioner.

Robert J. Jackson Jr. expects some applicant to meet the minimum requirements for a cryptocurrency-based fund that could be traded by ordinary investors. A number of cryptocurrency-based applications await the agency’s decision, he said in an interview, though he wouldn’t speculate on whether one of those will get approval, or when.

“Eventually, do I think someone will satisfy the standards that we’ve laid out there? I hope so, yes, and I think so,” Jackson said.

Several proposals to list such shares, most of them based in bitcoin, for trading among the general public have failed to clear the SEC.

Approval would be a milestone for cryptocurrencies, of which regulators have been wary in part because of the volatile prices. Bitcoin, for example, is trading at about $3,400, down from a high of more than $19,000 in December 2017. Any fund based on it would show similar movement.

Because the fund would trade securities — not cryptocurrencies that are largely exchanged for cash without regulatory oversight — it would need to satisfy requirements that apply to more ordinary funds.

Among the more prominent SEC actions on such funds was a 3-1 vote in July to reject a proposal by Bats BZX Exchange Inc. to list and trade shares of the Winklevoss Bitcoin Trust. The agency deemed the fund inconsistent with Securities Exchange Act requirements to prevent fraudulent and manipulative acts.

The Bats exchange that would have hosted trading of the fund argued that bitcoin markets are inherently difficult to manipulate. But the SEC found that the proposal didn’t establish the kind of surveillance common in stock markets. The commissioners were also concerned with the lack of liquidity in certain bitcoin markets, their trading volume and the ability to safeguard proprietary information.

That decision affirmed one made by the agency’s staff a year earlier.

Republican Hester Peirce was the only commissioner to vote in favor of the fund. The SEC was acting like an overprotective “helicopter parent” in denying approval, Peirce said in a speech in September, arguing that it’s not the agency’s job to determine whether bitcoin will ultimately succeed or fail.

The other commissioners said, however, that the decision was not a judgment of whether bitcoin or the blockchain technology that underpins it has utility or value as an investment, but merely one on BZX’s inability to meet standards to prevent fraud and manipulation.

The ETF was filed on behalf of the Winklevoss Bitcoin Trust, owned by Cameron and Tyler Winklevoss, brothers who gained fame after suing Facebook’s Mark Zuckerberg. Jackson said denial was easy because the proposal was riddled with investor protection shortcomings.

‘Serious’ issues

“The case that we had before us last year involving the Winklevoss trust, in my view, was not a difficult case,” Jackson said. “So there you had a situation where the risk for manipulation and for people getting hurt was enormous. The liquidity issues in the market were very serious.

The trust says it’s working to overcome the concerns, having created a market surveillance team.

“We are committed to the ETF process and understand the commission’s concerns and the need for more marketplace surveillance and protection to prevent against manipulative behavior,” said Yusuf Hussain, for a firm affiliated with the Winklevoss Bitcoin Trust, in an email. “We have also helped to form the Virtual Commodity Association to provide a mechanism for exchanges in the crypto industry to share information to help build marketplace integrity.”

The SEC’s denial of the crypto-fund applications encouraged others to come back to the agency with ideas on how to meet its standards, according to Jackson.

“I’m happy to say market participants have begun to come in with ideas,” he said. “Whether or not we’re going to find one that really protects investors I don’t know, but I do know that that case wasn’t especially close.”

In January of last year, the SEC instructed 14 applicants to withdraw their requests to register bitcoin investments because of concerns around regulating the digital assets. Shortly after that action, the regulator sent a letter to the financial industry with a long list of questions it sought answers on before it would clear a path to approval.

While bitcoin-based funds that cater only to wealthy investors are available, the SEC has jurisdiction over funds that would be available to ordinary investors who don’t meet wealth or financial knowledge requirements.

“Getting the stamp of approval from the deepest and most liquid capital markets in the world is hard, and it should be,” Jackson said. “Once we put the stamp of the United States Securities and Exchange Commission on an investment, once we make it available to everyday mom and pop investors, we are taking risks that Americans can get hurt.”

Jackson’s parents held retail jobs and delved into the stock market on their own, which shaped his thoughts on ordinary investors and the Winklevoss proposal.

“I come to this job thinking about my mom and dad,” he said. “Would I have wanted them to be able to buy that ETF? Hell no. Hell no. And I might not be sitting here if my father had, so, yeah, I take really seriously putting the American stamp of approval on any investment product. I’m not going to do it until those questions get answered.”

Correction, 1:15 p.m. | An earlier version of this story misstated details of the ETF filing on behalf of the Winklevoss Bitcoin Trust.

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