U.S. government backs Crypto ETFs - What next?

U.S. government backs Crypto ETFs - What next?

After multiple delays, the U.S. Securities and Exchange Commission (SEC) has finally reached a decision regarding cryptocurrency ETFs. Despite the unusual circumstances behind the decision, it now appears that the plan by Bitwise Asset Management and Van Eck to launch an exchange traded fund (ETF) based on the most in-demand cryptocurrencies can move forward.

So, what's next for the crypto community? No one knows. Offering digital currencies in an ETF is uncharted territory. The markets certainly got a bit of boost in the hours immediately after the announcement, but it wasn't enough to say that the SEC's decision could bring an end to the current crypto winter.

We can also say for certainty that cryptocurrency ETFs will not in any way change the practical, day-to-day uses of cryptocurrency. If you are using a bitcoins to play slots online, you'll still be able to do so. The same goes for using your coins to pay for taxi rides, get a cup of coffee, etc. None of that changes as a result of the decision.

A surprising weekend call

Making a decision on crypto ETFs is something the SEC has seemed unwilling to do for quite some time. For six months U.S. regulators have kicked the can down the road on the Bitwise application for an ETF. But something big must have happened. During the weekend before the ratification, the decision-makers at the SEC held a meeting to reconsider the latest postponement they issued just days earlier.

No one quite knows what was said during this meeting, but the SEC responded just after midnight on April 1 (2019) with a statement saying they would move ahead with approval for cryptocurrency ETFs. The news instantly sent positive vibes through the markets. However, there is no way to know - at the time of this writing - if those good vibes will be sustained over the long term.

Perhaps more important is understanding why the SEC made the decision it did, and why that decision came while most of the Western world was sleeping. Are circumstances so desperate that SEC regulators had to make an announcement at midnight? Could it not have waited until the start of business on April 1?

As you might expect, their decision to come to such a quick conclusion and make their announcement in such an unorthodox way has been regarded by some skeptics as recklessness. Some have speculated that regulators did what they did out of fear of being perceived as unable to get anything done except when the U.S. government is in shutdown mode.

Regardless of the regulators' motives and anyone who suspects those motives, the underlying fact of the matter is that cryptocurrency ETFs are now ready to launch. The only question is how many will be up and running before the end of 2019.

More about ETFs

The SEC has long been wary of cryptocurrency ETFs for the simple fact that the basic components of an exchange traded fund rely on tangible securities. Because crypto is not tangible, some people have a challenging time accepting it as a marketable security with any real value behind it. Regulators are rightfully concerned about offering investors a new investment vehicle with no inherent value-generating capacity.

Perhaps a more detailed definition of an ETF is necessary here. For that, we turn to Investopedia. They define an exchange traded fund as follows:

"An ETF is a type of fund that owns underlying assets (shares of stock, bonds, oil futures, gold bullion, foreign currency, etc.) and divides ownership of those assets into shares."

The best way to understand an ETF is to see it as a fund into which investors put their money for the purposes of collective investing. That fund then goes out and uses the money to purchase marketable securities like stocks, shares, precious metals, etc. The fund itself makes or loses money commensurate with the gains and losses of the securities it holds.

Not a mutual fund

Although an ETF does share some similarities with a mutual fund, the two types of funds are expressly different. For example, your typical ETF is passively managed while a mutual fund is actively managed. We should also point out that you can buy into an ETF at any point during the trading day. You cannot do that with a mutual fund.

Mutual funds are much more tightly controlled for the purposes of maintaining stability. You can only buy into a mutual fund at the end of the trading day, based on the value calculated by looking at all the fund's assets. You cannot buy and sell shares in a mutual fund at will either, in the same way you can both stocks and ETFs.

Concerns over Crypto ETFs

The SEC giving its approval to crypto ETFs automatically creates some concern among investors who are already skeptical of cryptocurrencies like Bitcoin, Bitcoin Cash, and Ethereum. Many of those same investors warn people to stay away from crypto altogether. Now they have the added task of trying to steer people away from crypto ETFs.

As stand-alone investments, ETFs are generally considered a good deal. They tend to come with lower fees and charges as well as tax advantages - at least in the US. The big worry with ETFs is the fact that they can artificially influence the price of the individual securities within the funds themselves. That same concern exists with crypto ETFs.

If it is possible for an ETF to artificially influence some of the securities it holds, it stands to reason that a crypto ETF could do the same thing. Just a little bit of action on either side (buy or sell) from large-scale investors could inadvertently tip the price of a given cryptocurrency one way or the other. And as you probably know, all it takes is a little bit of movement to create a large wave.

Another concern with ETFs is that they allow margin trading and shorting. Taking a short or long position doesn't much matter for stability, but margin trading could be problematic. Keep in mind that margin trading was largely responsible for the 1929 stock market crash and the subsequent Great Depression.

The problem with margin trading

Margin trading is the practice of borrowing money to purchase securities. The idea is that profit from those securities will be used to pay back what was borrowed. It is all well and good when markets are strong and borrowed money is repaid quickly. But as we know from history, all it takes is a little bit of panic to wipe out a whole lot of value.

In the years leading up to the Great Depression, the U.S. economy was growing extremely quickly. Wall Street enjoyed unprecedented growth to the extent that investors began borrowing just so they could get their hands on rapidly rising stocks. But in late 1929, the U.S. economy began to slip. That started a significant selloff that ended up wiping out most margin traders, leading to the October 24 stock market crash.

All of those investors losing their shirts wouldn't have been so bad except for the fact that they had used borrowed money to buy their securities. That means the banks that loaned them the money were wiped out as well. Therein lies the problem with margin trading. The institution that lends the funds to allow margin trading is risking its assets just as much as the investor who borrows.

Concerns over crypto volatility

Margin trading is already risky for traditional securities like stocks and shares. Most of the world's exchanges are subject to significant swings. However, they do have one thing going for them that cryptocurrency does not: they have real companies behind them. These are companies that produce tangible goods and valuable services that people want. Cryptocurrency has no such advantage.

The Coinbet.com team continually stresses the fact that the value of cryptocurrency is in its use as a payment or monetary system. If you take that value away, its only worth comes from an agreement among investors who decide it still has worth. Once that agreement begins to slip, you are in for crash.

Crypto's volatility is a real concern even without margin trading and ETFs. But now that ETFs have been given the green light by the SEC, those investors already wary of investing in cryptocurrency have yet another reason to worry.

In summary

So, is the SEC decision a good one? That depends on your perspective. First are questions of why regulators chose to meet on the weekend and then make their announcement just after midnight on Monday morning. If there is anything more to it than just regulators with bad timing, there could be cause for concern.

Second, investing in an ETF is always a practice requiring a bit of extra caution. Investors hoping to put money into a crypto ETF need to be absolutely sure they know what they are doing.

Finally, the SEC decision will not affect the day-to-day use of Bitcoin, Litecoin, etc. Regardless of any ETFs and how well they perform, people using crypto as a payment system is a separate entity that will continue on as it always has.

Byline: This article was published by Henry.
About: I'm a bitcoin advocate and admin of Coinbet.com.