Watchdogs are divided over opening up the retail risk of cryptocurrencies

Judging by the speed of their response to the use of cryptocurrencies, global financial centers believe in the biblical principle: “The last will be first and the first will be last.”

Industry regulators in the world's leading financial centers - once home to all sorts of adventurous innovations - are proving reluctant to approve offbeat crypto funds. But at the same time, more laissez-faire secondary financial centers have seized the opportunity to leap forward. And these latter crypto ETF trading venues are carving a niche for themselves in an emerging monetary space.

This has resulted in a patchwork of crypto ETFs available to investors in various locations.

Brazil has probably gone the furthest. Not content with approving the first Bitcoin and Ether ETFs in Latin America, the Brazilian Securities Commission has also opened the door to the world's first two decentralized finance ETFs. These invest in a basket of tokens issued by decentralized applications (Dapps) such as the crypto exchange Uniswap, and Polygon, a service to accelerate blockchain transactions.

Meanwhile, a number of other jurisdictions outside the US, UK and Asia – such as Canada, Sweden, Germany, Switzerland, Jersey and Liechtenstein – have approved products that invest in individual cryptocurrencies or baskets of such securities. In Europe, for regulatory reasons, these products are referred to as exchange-traded products or bonds and not as funds.

Australia and India are likely to be the next countries to follow suit.

However, the US Securities and Exchange Commission has rejected more than a dozen applications for similar funds in the US. So far, it has only approved ETFs that invest in Bitcoin futures, rather than the underlying cryptocurrency itself - although private trusts can hold Bitcoin directly.

Several other leading financial centers such as the UK, Singapore and Hong Kong (in addition to mainland China) have not even gone that far. Instead, they do their best to maintain a strict separation between the $10 trillion ETF industry and the virtual investment universe, which now has an estimated market cap of about $2 trillion.

The closest ETF investors in these jurisdictions that can get to the forefront of innovation are funds that invest in the stocks of publicly traded companies involved in digital assets.

The SEC's opposition to "spot" ETFs - that is, those tied directly to the live trading price of the underlying cryptocurrency - stems from concerns about "fraudulent and manipulative acts and practices" in the markets where Bitcoin is traded.

These concerns include the potential for “wash trading” – when the same institution stands on both sides of the trade, generating additional fees for minimal risk; Price manipulation by “whales” that dominate Bitcoin trading; and “manipulative activity” involving Tether, a so-called “stablecoin” designed to always be worth $1.

The SEC says it must “protect investors and the public interest” because crypto markets are the “Wild West.” . . full of deceit, fraud and abuse” – in the words of the regulator’s chairman, Gary Gensler.

However, the regulator appears to believe that these issues will be largely resolved with ETFs focused on Bitcoin futures contracts traded on the Chicago Mercantile Exchange, a regulated trading venue.

Not everyone agrees. “Adding another level of disintermediation doesn’t really change anything,” says Jason Guthrie, head of digital assets, Europe, at WisdomTree, an ETF provider. WisdomTree has five European crypto funds with total assets of $334 million.

He describes the SEC's approach to crypto as "disjointed . . . slow and potentially inefficient" because retail investors can buy cryptocurrencies directly through regulated exchanges and brokers like Coinbase and Robinhood.

Singapore is striving to become a hub for blockchain and crypto companies. But the Monetary Authority of Singapore, the country's regulator, has decided that firms should not market or promote crypto services to the local population to protect retail investors from the potential risks of this volatile asset class.

“Singapore is bullish on crypto as a sector, but the government has said we don’t want our people involved,” explains an industry figure who prefers to speak anonymously.

Hong Kong - Singapore's regional rival - has developed a reputation as a hotbed for digital businesses, but in line with Beijing - which banned all cryptocurrency transactions in September, citing concerns about fraud, money laundering and environmental impacts - it has also shifted to shield its own population from crypto trading. Licensed exchanges are only allowed to offer $1 million in liquid assets to professional investors.

While all UK retail investors can trade cryptocurrencies directly, the Financial Conduct Authority has banned the sale of cryptocurrency-related “derivatives” – including exchange-traded products. The UK regulator has also warned that anyone investing in cryptoassets “should be prepared to lose all their money.”

According to the investment firm's anonymous boss: "Different countries are incredibly different in their thinking. The FCA was very negative. Originally we wanted to set up the company in London, but now we are in Europe."

WisdomTree's Guthrie says the FCA's policy was "mainly focused on CFDs [contracts for difference], leveraged products and so on. There have been people offering 100x leverage on Bitcoin before. Nobody needs that. It's absolutely something the FCA should look at."

Still, he believes the definition of a derivative was “a little too broad” as it also included unleveraged products like plain vanilla ETPs and futures.

Chris Mellor, Head of Emea ETF Equity and Commodity Product Management at Invesco, suggests that since cryptocurrency is a new asset class, it is inevitable that regulators will “have to ask new questions.”

“Cryptocurrency investing is not for everyone, and given the newness and volatility of the asset class, you can understand why some regulators have taken a cautious approach,” he notes.

Crypto is undoubtedly volatile, [but it is] similar to small-cap stocks or individual stock investing. It is a high-risk investment

“A robust, institutional product should be more attractive to regulators and anyone who can invest in the future,” he adds.

Guthrie accepts that anyone investing in cryptocurrencies should be aware of the risks. “There is variable liquidity,” he argues. “That comes with risks, concentration risks and potentially large players.”

However, he adds that such concerns don't just apply to digital assets: "Crypto is certainly volatile, [but it is] similar to small-cap stocks or individual stock investing. It's a high-risk investment. It shouldn't make up 100 percent of people's portfolios, but it can very easily fit into a portfolio as part of the risk basket."

“We typically see 1-3 percent [portfolio allocation], up to 10 percent at the risky end,” he says. "At these types of levels we think it's pretty normal. Tesla has long been more volatile than Bitcoin and so [now] an S&P500 security."