The launch of a bitcoin futures ETF in the US has raised further questions over the direction the Financial Conduct Authority plans to take on cryptocurrency products as other jurisdictions steal a march on the UK regulator.
On 19 October, The Proshares Bitcoin Strategy ETF became the first cryptocurrency exchange-traded product listed in the US. In its first day, around $1bn traded hands in BITO on the NYSE Arca exchange, albeit with very few block trades suggesting smaller investors had accounted for the bulk of interest.
The US ETF launch leaves the FCA looking increasingly isolated on its cryptocurrency derivatives ban, which results in retail investors being unable to buy ETFs that hold the cryptocurrency. In Europe, a number of cryptocurrency exchange-traded products are available from the likes of VanEck, Wisdomtree, ETC Group and 21Shares.
The FCA ban came into effect from January and shortly after the regulator warned investors in cryptoassets “should be prepared to lose all of their money”. Its statement prompted the price of bitcoin to tumble 20%.
Why the FCA has banned crypto ETFs
“Certainly, the optics with the FCA registration scheme aren’t great,” says Lawrence Wintermeyer, co-chairman of global trade body Global Digital Finance Executive.
“The UK is very bullish on digital financial market infrastructure. There’s a lot going on with digital assets in private or public markets securities. There’s a lot going on with the CBDC. The congestion area when it comes to regulatory certainty seems to be around native digital assets like ETCs and the derivatives market.”
The FCA attributed its ban to four factors: a lack of basis for valuation of cryptocurrencies; prevalence of market abuse and financial crime; volatility and a lack of clear investment need.
The FCA and the Treasury are anticipated to reveal details of a consultation into UK regulation of cryptocurrencies within the coming weeks. The consultation document made little reference to ETFs, except to say the regulator would not authorise a listing unless it had “confidence in the integrity of the underlying market”.
Portfolio Adviser made multiple requests to the FCA for details on its approach to bitcoin regulation but did not receive a response.
In Europe, the regulation on markets in crypto assets (Mica) is currently being hammered out by the European Commission and would subject crypto exchanges to consumer protection rules when it comes to issues of fraud, cyber attacks or negligence.
See also: Is the FCA’s Binance ban a blow to cryptocurrency becoming mainstream?
UK retail investors miss out on European products
ETC Group chief executive Bradley Duke says it is “crazy” the cryptocurrency specialist’s exchange-traded products (ETPs) are available to retail investors in every country across Europe, except in the UK.
“Retail investors can go out and buy unregulated crypto on a crypto exchange no problem and maybe get scammed or lose their private key. You hear these stories all the time.”
Widsomtree head of digital assets Jason Guthrie (pictured) says the FCA has so far been focused on brokers rather than investment products.
“However, we believe that investment products will be approved in due course – it is in their interest if they want to bring things under their regulatory umbrella,” Guthrie says. “It’s important to remember this is still a young asset class.”
ETC Group launched the BTCetc ETC Group Physical Bitcoin ETC in June 2020. It now has $1.5bn assets under management, while the Wisdomtree Bitcoin ETF launched in December 2019 and has seen inflows of $350m.
Both have UK reporting status and can be accessed by professional investors via international exchanges.
US futures products versus spot bitcoin ETFs in Europe
Divergent approaches to regulation in the US and Europe have resulted in different sets of products. In the US, the Proshares Bitcoin Strategy ETF invests in futures, with the Securities and Exchange Commission previously rejecting proposals for physically-backed products, whereas European products invest in spot bitcoin.
“Accessing physically-backed bitcoin, rather than bitcoin futures, means investors do not need to be concerned with roll costs, backwardation or contango as the ETP they buy tracks the spot price of the underlying cryptocurrency, which is held in custody,” says Guthrie.
Duke describes futures-based ETFs as a “clunky” structure for accessing bitcoin, noting the tracking error on ETC Group’s products is as low as 20 basis points.
“This isn’t any slur on Proshares because they were basically forced to have a futures-based bitcoin ETF,” says Duke. “But I firmly believe the products in Europe are better.”
The BTCetc ETC Group Physical Bitcoin ETC has been modelled on gold funds, given it invests in one asset, which is prohibited under Ucits rules, and is 100% physically backed meaning investors can do a redemption and take possession of the bitcoin.
What do UK professional investors make of bitcoin?
In the professional investment space, GDIM investment manager Tom Sparke reckons significant exposure to cryptocurrency is probably not appropriate at the moment, but that could change.
“There will be a finite number of units of bitcoin within the next decade or so and this will provide a platform from which it is possible to see it becoming a useful asset,” he says. “At the current level of volatility it is not an obvious store of value but it could well become ‘the new gold’ that investors flock to in times of concern.”
Devere chief executive Nigel Green says the Proshares Bitcoin Strategy ETF launch validates the market and is an important milestone towards the mass adoption of cryptocurrencies.
“However, I believe that whilst the future-based ETF adds credibility for the sector and are potentially good for institutional investors, most individuals should buy bitcoin themselves directly if they wish to hold it as part of their portfolios.”
A Wisdomtree survey found 48% of UK professional investors believe cryptocurrencies can play a role in portfolio diversification. Around a third described a modest allocation of 1-2% as suitable.
See also: New research reveals crypto curiosity in financial advice sector is here to stay
How retail fund investors can still gain some exposure to crypto
Additionally, three quarters of UK advisers have fielded clients query about cryptocurrencies.
For UK retail investors there are still opportunities to access crypto currencies and the infrastructure surrounding them via traditional financial assets, albeit as part of a diversified portfolio.
The largest holding in the BNY GF Blockchain Innovation fund is Grayscale Bitcoin Trust, a $40bn bitcoin fund that has returned approximately 40,000% since its inception in 2013, while the Grayscale Ethereum Trust also sits in the top-10 holdings. Grayscale is currently looking to transform the closed-ended funds into ETFs.
The BNY fund also holds Coinbase, the US crypto exchange, which went public on the Nasdaq in April this year. The GAM Star Disruptive Growth and Star Alpha Technology funds both also hold the stock in their top-10 holdings.
Additionally, Ruffer made headlines over the last year as it added a position in bitcoin via One River in November 2020 and netting $1bn when it sold out of its position in April this year over fears the asset class was displaying speculative characteristics.
See also: Ruffer defends bitcoin holding amid FCA warnings on cryptocurrency
