The 4 Biggest Challenges Crypto ETFs Must Overcome to Succeed
Exchange-traded funds (ETFs) have been anticipated ever since crypto trading was a thing.
The rise of institutional platforms like Bakkt and the popularity of crypto funds — with over 150 active funds today — has seemingly paved the way for crypto ETFs to break into the industry. However, unclear and ever-changing regulations on digital assets have cast doubts on the possibility of crypto ETFs anytime soon.
What are the challenges blocking crypto ETFs from becoming a reality today and what must be done for these obstacles to be overcome?
What Are Crypto ETFs?
Before exploring the above questions, let’s take a look at what crypto ETFs are. Crypto ETFs work just like real-world ETFs. Investors put money into funds that manage a particular digital asset or a basket of assets. The investors don’t actually own the assets, but their investments are managed by dedicated fund managers, making investing passive and effortless.
Why Are Crypto ETFs High in Demand?
Many investors don’t want to go through the hassle of understanding Bitcoin or any other digital assets. With ETFs, they don’t have to learn technicalities like how digital wallets work, how to trade on exchanges, and so forth. Buying and selling is a matter of telling fund managers what to do.
ETFs are also in demand because they allow investors to diversify their holdings easily. This ties back to the previous point, as every digital asset has its own intricacies, which can make diversification complicated. ETFs make this a non-issue.
Since ETFs are an investment vehicle, investors can short ETF shares if they feel crypto values are on a decline. This strategy is often employed in traditional markets and can be utilized to the same effect for cryptoassets.
The 4 Biggest Challenges Crypto ETFs Face Today
1. Increasingly Strict Regulations
The biggest challenge for crypto ETFs so far is in adhering to financial product regulations. A notable case is the Winklevoss twins’ application for their Winklevoss Bitcoin Trust ETF. The application was turned down in 2017, with regulators citing the potential manipulation of bitcoin prices and the lack of security measures to curb the problem as serious concerns.
It was rejected a second time in July 2018, which effectively ended the twins’ pursuit of launching their bitcoin ETF. However, crypto ETFs are still possible thanks to increased institutional involvement in the industry. A significant number of leading firms such as Fidelity and E&Y have invested in crypto markets and expressed their confidence in the blockchain technology, which could sway the decisions of regulators.
It’s important for crypto ETFs to find a solution that protects investors from the fluctuating values of cryptoassets while providing insurance for extreme price changes. Some funds have tweaked their operating model (ETPs) to meet these goals, which seem to be the right step forward in complying with regulations.
2. The Potential for Manipulation Still Exists
Numerous financial bodies, including the SEC, have questioned the vulnerability of cryptoassets to manipulation. Due to the relatively small size of crypto markets, investors with huge holdings can affect prices by performing coordinated purchases and sales for their own gain, also known as a pump and dump.
Thankfully, the liquidity of crypto markets has increased by a considerable amount even in the face of crashing prices in 2018 and 2019. The growing involvement of institutional bodies like Goldman Sachs will further boost the flow of money into crypto markets, which will hopefully ease regulatory concerns.
There is still work to do in combating price manipulation, but a bigger pool of funds is a massive help as it’ll require a lot more funds for parties to artificially influence the value of cryptoassets, particularly the higher market cap ones.
3. Serious Security Concerns
Security in the crypto space has improved immensely, but regulators are not convinced. In 2019, seven crypto exchanges fell victim to security breaches, totaling to a stunning loss of over $150 million. Losses this huge are a kicker not only to regulatory compliance but also to the public perception of cryptoassets.
That said, the availability of innovative market solutions in addition to stricter KYC/AML requirements among blockchain companies has bolstered crypto security by a considerable amount, all of which is only going to increase the chances of ETF approval in the future.
4. Valuing Cryptocurrencies Is Tough
Another major obstacle is the difficulty in valuing cryptocurrencies. There is still a lack of clarity over the factors that influence cryptoasset prices — a no go in the eyes of regulators. Accurate asset valuation is what determines fund performance, how much investors pay for fees, and how managers earn their commissions.
Fortunately, experts believe that the value of cryptoassets will stabilize in the next five to ten years as institutional money continues to enter the market and blockchain adoption increases — a technology that is already being utilized in real-world use cases.
Some notable examples include stablecoins being used as national currencies and conglomerates like Alibaba and Baidu launching their own blockchain-as-a-service (BaaS) products.
The security measures mentioned earlier to prevent price manipulation also contribute to stabilizing cryptoasset prices, hence reducing the risks born by the average crypto investor.
How Blue Swan Grading Helps Crypto Investors Keep Up With The Latest ETF News
Crypto ETFs have several regulatory and security obstacles to overcome before they can be considered legitimate financial vehicles. Yet, it’s not far-fetched to be optimistic about ETFs becoming a reality in the coming years thanks to increased adoption and institutional money inflows.
Investors need to be aware of the crypto ETF space, as it’s a potential game-changer for the blockchain industry. However, we understand that keeping up with the latest updates can be tedious and time-consuming.
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