Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Several ETF sponsors have asked the Securities and Exchange Commission for approval to launch cryptocurrency ETFs. Here to talk about whether the SEC will approve and how investors might use crypto ETFs is Ben Johnson. Ben is Morningstar’s director of global ETF research.
Hi, Ben. Thank you for being here today.
Ben Johnson: Thanks for having me, Susan.
Dziubinski: Why would investors want a cryptocurrency ETF, and what role could this type of fund play in a portfolio?
Johnson: I think there are a variety of reasons that investors want a cryptocurrency ETF. I personally would argue that many of them are probably the wrong reasons, and the chief among them being that it’s an asset whose price has gone up a lot over a short period of time. So, as investors when faced with the choice between one marshmallow today or two marshmallows tomorrow, we always want two marshmallows today. And crypto, I think, in the minds of many is the way to get your hands on those two marshmallows as quickly as possible. So, I think the want is really frankly just driven by the price appreciation that we’ve seen for this asset.
Now, let’s separate wants from needs. Why might an investor need a cryptocurrency ETF? Well, cryptocurrency ETFs would, in many cases, present an incremental improvement over different ways that they might otherwise access these different assets today, chiefly with respect to integration into their existing investment portfolios. These are assets that are typically held outside traditional investment accounts, outside investors’ traditional investment portfolios. So, there’s a convenience factor, certainly, which is, I guess, sort of a hybrid want and need. That degree of integration could be helpful. They might also simply need help accessing this asset. They might not be able to navigate all of the myriad ways that you can access it today, many of which, quite frankly, are incredibly easy. But nonetheless, they might have a greater level of familiarity, a greater level of comfort knowing that this asset is overseen in a regulated investment product, it’s a product that they can trade on a traditional stock exchange, it’s a product that they can hold in their traditional brokerage account and it integrates directly with their portfolio, it’s custodied. In many cases, the proposals that are out there include an insurance feature that might just simply be easier for many investors. It might help them sleep better at night. It might help them keep closer tabs on whatever positions they are taking in crypto assets.
Now, whether or not wants and needs net out for one or another is anybody’s guess and is really going to be case specific. But I think it’s important to understand why investors might want a crypto ETF and really the practical realities, the practical benefits of putting crypto assets in a regulated investment product that trades on an exchange.
Dziubinski: The SEC hasn’t yet approved any cryptocurrency ETFs here in the United States. Why do you think that is? And do you think that the SEC will eventually approve these products?
Johnson: It’s been a long dance with the SEC for a lot of these aspiring crypto ETF providers. They were effectively told to go and put things on ice. If you go back a number of years, the SEC spelled out in exhaustive detail what its concerns were with the proposals that were on the docket at that point in time. Now, some of them just had to do with the plumbing of the crypto ecosystem. Things having to do with custody, for example: who is going to hold these assets, how are they going to hold them, how are they going to account for them to move them around and what have you.
The other concerns that the SEC cited at the time that linger to this day, and it’s difficult to discern whether or not they will ultimately resolve, had to do with the potential for manipulation and fraud in the underlying crypto markets. And if you look back at some of these letters, those two words were mentioned in some cases combined a few hundred times in the SEC’s comments on these filings. You fast forward to today, it’s difficult to say whether those have really fundamentally been addressed. Now, what we’ve seen in the intervening period is that there have been different product types that have come into the market in the U.S., specifically certain crypto trusts that aren’t necessarily a good vehicle for many investors. And you’ve seen other regulators outside the U.S. approve crypto exchange-traded products in their local markets.
So, there have long been crypto products available to investors in Europe. Most recently and most notably what we saw is that the Canadian securities regulator approved a number of different crypto products, at first a trio of Bitcoin ETFs for trading in Canada. Whether or not the SEC remains a holdout, remains sort of the uncool regulator on the global scene, frankly, is anybody’s guess. What we are seeing from them in recent weeks is more communication, greater transparency around what they are looking at, what their concerns are, and this has led some to believe that a launch is imminent, others to think that it’s probably further out than previously anticipated. At the end of the day, really, it’s anybody’s guess. And many investors, certainly those who absolutely want crypto, still have any number of different ways that they can access this asset outside of registered investment products.
Dziubinski: Let’s say that the SEC does eventually green-light these products, what are the risks that investors need to be aware of, specifically with a crypto ETF?
Johnson: I think the biggest risks that investors face with crypto is no different than the risks they face in their existing investment portfolios, and it’s the one that stares them in the face when they look in the mirror each and every day. I think the biggest risks are really behavioral. This is an incredibly volatile asset. It’s an asset that really is just driven by narrative. It’s really no different than fiat currency, it’s no different than why we assign value to gold. There are no cash flows here. There are no fundamentals to analyze. It’s an asset that is going to be worth whatever someone is going to be willing to pay you for it either today, tomorrow, or 10 years down the road. It’s purely speculative. And as such, the animal spirits are really going to rule the day here. And your own animal spirits are going to be the biggest risk that you face. You either decide to participate, surely because your neighbor is participating and the next person down the block is participating and they got to buy a nice new set of golf clubs, or a shiny new car because they made a lot of money with these assets, or the risk, I think more fundamentally, that you start to allocate money that was meant for other uses to an asset that is this speculative.
So, what putting crypto in a registered investment product does is it allows investors to potentially allocate to crypto in an IRA, for example. Now, if those are retirement assets, in theory, depending on who you are and how old you are, you might have a lot of time and you might have a willingness to take that level of risk. But again, I think the biggest risk is that you don’t know the risk you are signing up for, or you sign up for it for the wrong reasons, because we’ve seen this asset class appreciate tremendously over a short period of time. And then, when you see market environments like we saw on May 19 of this year where the asset suddenly sells off in very sharp fashion, you don’t know what to do and you run for the exits at the wrong time, you allocate more money than you were originally willing to commit because you are trying to buy the dip. Your behavior ultimately is what’s kind of winning the day and not kind of coolly rational, sort of investment rationale when it came to what informed your decision to make this allocation to begin with.
Dziubinski: Well, Ben, thank you so much for your time today and your perspective on this very high-interest potential new product. We appreciate it.
Johnson: Thanks for having me.
Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
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