Beware of So-Called OTC ETFs Investing in Virtual Currencies

The U.S. Securities and Exchange Commission has announced the prevention of sale of two “funds” that promise to track the price of “cryptocurrencies”.

Crypto Pile

Both funds, which trade in the U.S. only “over the counter” and “off exchange”, are nevertheless listed on a Nasdaq, Inc. (NDAQ.O) exchange in Stockholm, Sweden.  In the U.S., “over-the-counter” (OTC) and “off exchange” transactions occur between buyers and sellers directly without the use or supervision of an organized market, and may occur between broker-dealer firms on behalf of clients.  The risks, hence, are much higher and the buyer needs to beware.

In May 2018, the world’s first bitcoin-based security available on a regulated exchange launched on Sweden’s Nasdaq.  Bitcoin Tracker One, one of the funds blocked in the U.S. by the recent announcement of the SEC, developed by Stockholm-based firm XBT Provider, is an Exchange Traded Note (ETN) that allows traders to invest in bitcoin and access the returns of the underlying asset in U.S. dollar per bitcoin.  See story here.

bitcoin-sweden-nasdaq-xbt-exchange

OTC and off-exchange in the U.S. is to be contrasted with exchange trading, which occurs via exchanges, such as the NYSE.  A stock exchange has the benefit of facilitating liquidity, providing transparency, and maintaining the current market price.  When you buy or sell OTC and off exchange, it is difficult to tell whether you are trading with the other party for a reasonable price.

BitKan-App-300x225

The SEC said in a statement that trading in the two funds—Bitcoin Tracker One and Ether Tracker One—would be halted in the United States until at least Sept. 20, 2018.  The SEC stated in a notice, “It appears . . . there is a lack of current, consistent, and accurate information” and that “application materials submitted to enable the offer and sale of these financial products in the United States, as well as certain trading websites, characterize them as ‘Exchange Traded Funds’” despite the launch announcement which said it was an “Exchange Traded Note” or “ETN”.   An “Exchange Traded Fund”—or “ETF”—is a special kind of mutual fund in the U.S. that is issued and then traded, i.e., bought and sold, on an exchange, as opposed to an open-end mutual fund, whose shares are sold and redeemed directly with the fund company.   The U.S. does not use the term ETN.

Bitcoin ETF

A mutual fund is a professionally-managed trust that pools the outlay of many investors and buys other valuable (hard) assets such as stocks, bonds, other funds, short-term money market instruments, and commodities.  Commodities is a long list, but can include such things as corn, precious metals, and currencies.  Currencies can be either real (U.S. Dollars, Japanese Yen) or virtual.  Virtual currencies are also called “cryptocurrencies”.  Such virtual currency is a type of unregulated digital money which is issued and usually controlled, not by a country and its central bank, but by its electronic developers and is used and accepted among the members of a specific virtual community.  Virtual currency, including Bitcoin, can be used to move money around the world quickly and with relative anonymity, without the need for a central authority, such as a bank or government.

Mutual Funds

ETFs are strictly regulated products in the U.S.  The SEC has so far taken a strict stance against letting actual ETFs tracking Bitcoin and other cryptocurrencies come to market.

SEC Approves Systemic-Risk Reporting Rule For Hedge Fund Firms

Reuters published an article on this here.

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