SEC Should Fulfill its Mission by Embracing Cryptocurrencies
By: Ockham'S Notebook
Tags: Blockchain, Regulation, Bitcoin, Cryptocurrency

Bitcoin and other cryptocurrencies started out as fringe assets, but are now gaining wider institutional acceptance. High net worth investors can already access a wide variety of cryptocurrency hedge fund strategies. Bitcoin ETFs are available to retail investors in Sweden, Switzerland and Bermuda. Meanwhile, the U.S. Securities and Exchange Commission (SEC) has blocked multiple attempts by multiple asset managers to launch ETFs and closed end funds that invest in cryptocurrencies. The SEC has applied far stricter standards to cryptocurrency funds than it has to other risky and novel assets offered to retail investors such as commodities and complex derivatives. The conspicuous absence of a retail friendly investment fund offering bitcoin exposure in the U.S. market leaves a major gap for American investors. The time has come for U.S. regulators to embrace cryptocurrencies.

A more open regulatory approach to cryptocurrency investment funds is advisable for three reasons.

First, cryptocurrencies function as an important hedge against future inflation and systemic risk. The ability to properly diversify across asset classes is essential in the current environment of heightened uncertainty and high valuations. History shows that currency regimes and technological paradigms can shift rapidly. For many investors, a small portfolio position in bitcoin or other cryptocurrencies is the equivalent to a call option on a future that looks very different than the present.

If a bitcoin ETF were available, registered investment advisers could include appropriately sized allocations in their client’s portfolios. In the absence of friendlier regulation Americans seeking cryptocurrency exposure must invest online via unregulated exchanges without guidance from financial advisers, or forgo any potential long term benefits from the asset class. By embracing cryptocurrencies within the existing regulatory framework, the SEC can better fulfill its mission to protect investors.

Second, allowing cryptocurrency into the existing retail fund management industry will improve the fairness and efficiency of U.S. capital markets. Like it or not, cryptocurrencies are here to stay, but the development of institutional and compliance infrastructure is slower than it could be without regulatory acceptance. Many asset managers, feeling discouraged by regulatory response, have developed products for other jurisdictions rather than serving the U.S. The bitcoin spot and derivative markets are active around the globe but they create operational and compliance challenges that keep too many U.S. based investors away.

By not embracing cryptocurrencies, the SEC is encouraging capital to flow everywhere but regulated markets in the U.S. In the short run this will lead to more fragmented, disorderly, and inefficient markets. In the long run this could make U.S. capital markets less relevant globally, with dire consequences for our national competitiveness.

Finally, embracing this new asset class will support innovation, job creation and capital formation. Bitcoin is important as a financial asset in its own right, but it is miniscule compared to the industries it will disrupt. Permissionless open protocols that underlie cryptocurrency ecosystems will provide access to financial services to a wider range of people than possible today. Moreover, the ancillary industries that undergird cryptocurrencies and blockchain will be a major source of job creation in coming years. This industry needs a supportive institutional architecture to reach its full potential.

When regulators embrace new products and technologies, they encourage innovation while attracting entrepreneurs and investors. Facilitating capital formation is also an essential component of the SEC’s mission, and it is best served by approving cryptocurrency funds with appropriate investor protections.

Although controversial, cryptocurrencies have demonstrated their use as a long term store of value in a diversified portfolio. By welcoming cryptocurrencies into the realm of retail fund management, the SEC can ensure that it protects investors, while maintaining an efficient market structure and promoting capital formation for innovative sectors in the 21st century.