Over the past year, demand for regulated crypto investment products has soared.
The increasing variety of exchange-traded products (ETPs) listed on traditional exchanges, and the rapid development of indices, have enabled more investors to gain exposure to crypto assets without the complexities of ownership and custody.
Clara Medalie heads research and market analysis at Kaiko, a provider of institutional-grade crypto market data.
Crypto ETPs are now traded in Germany, Switzerland, Canada, Austria, Sweden, Gibraltar and have been green-lighted in Hong Kong, with new applications awaiting approval in a handful of other countries. Further, the launch or planned development of crypto indexes by CME Group, CBOE, Nasdaq, Bloomberg, S&P Dow Jones, and IHS Markit lays the groundwork for a variety of tradable funds and derivatives products.
Traditional exchanges serve as the infrastructural interface between market participants ranging from licensed issuers to calculation agents to data providers to custodians, which is why the growth and diversity of crypto investment products will depend heavily on their lead. Collaboration with the crypto industry for the infrastructural requirements of these products will be crucial for ensuring success, which has the potential to drive a virtuous cycle of market efficiency.
Let’s take a look at the role that exchanges play.
The flurry of crypto ETP activity has been led by Germany’s Deutsche Boerse and Switzerland’s SIX exchange.
SIX exchange now lists 22 crypto ETPs from seven issuers and recently reported record numbers of trades and order book turnover. In early January, a Bitcoin ETP on Deutsche Boerse reported average daily volumes at €57 million, up from €15.5 million the previous month, and nearly equal to that of the highest volume ETF on the exchange.
The willingness of these exchanges to collaborate with crypto industry participants and invest in the infrastructure required to list these products has encouraged a group of innovative ETP issuers seeking to capitalize on surging demand for regulated offerings. Companies like CoinShares, VanEck, 21Shares, FiCAS AG, and WisdomTree have thus far all successfully listed crypto ETPs in Europe.
In the U.S., exchange-traded crypto products have faced a series of regulatory hurdles that have prevented any approvals. Yet, a powerful alternative has emerged, highlighting the ever-growing demand for regulated investment vehicles.
A crypto trust is a type of fund typically run by a professional management team. Accredited investors are able to invest in these trusts by purchasing shares over-the-counter, and there are fewer regulatory requirements compared with publicly traded ETPs.
The best example is the Grayscale Trust, which offers several funds tied to the value of crypto-assets whose shares can be purchased over-the-counter. Grayscale (which is owned by CoinDesk parent company Digital Currency Group) has become an indomitable force in crypto markets, with billions in AUM and yearly returns of +200%. Grayscale leads institutional investing in the U.S. through its regulated crypto offering and is the best evidence yet of demand for these types of products, which are not yet available on traditional exchanges.
Yet, OTC-traded trusts have several disadvantages compared with traditional exchange-traded products: ETP markets are more liquid which makes price discovery more efficient, investors can easily enter or exit markets without having to lock up funds for a given time period, and the structure and rules of an ETP are fixed which provides an additional layer of security for an investor.
Ultimately, the approval of an ETP in the U.S. would pose a significant challenge to the business model of funds like Grayscale. Investors typically prefer the increased flexibility and efficiency that comes with ETPs, which positions traditional exchanges to take the lead pending regulatory approval.
Indexes drive ETPs
The crypto indices developed by exchanges and data providers over the past few years have driven the growth and diversification of crypto investment products. Indices provide information about the price performance of an asset or basket of assets, and can be leveraged to build ETPs, funds and derivatives.
CME’s cryptocurrency indices have enabled the launch of a variety of bitcoin and ethereum futures and options contracts. Open interest for CME’s derivatives contracts soared in 2020, at one point surpassing that of all other crypto derivatives exchanges. The huge success of CME’s crypto derivatives offering is the best example yet of how traditional exchanges are driving adoption. CME’s derivatives markets have improved overall market efficiency, which drives more investors to participate, which drives further efficiency – a virtuous cycle.
Other exchanges and data providers are taking note: CBOE, Nasdaq, IHS Markits, and S&P Dow Jones have all either already launched or announced plans for crypto indices in 2021, which could eventually be used in tradeable crypto products.
Europe vs. the U.S.
We can see a clear divergence in regulated products on either side of the Atlantic. Europe is much more ETP-friendly, while the U.S. has become a force in regulated crypto derivatives and indexes.
The U.S. Securities and Exchange Commission has staunchly rejected any crypto ETP proposals thus far, turning down exchange-traded fund (a type of ETP) applications filed by Bitwise, Wilshire Phoenix and VanEck. Europe has taken a much friendlier approach towards ETPs, but has been notably stricter with derivatives, with a recent ban in the U.K. on crypto derivatives.
In both regions, innovation has thrived when regulation allows it.
In a recent report published by Bitwise and ETF Trends on financial advisors, 47% of respondents noted that the approval of a bitcoin ETF in the U.S. would make them more comfortable allocating crypto to client portfolios, a sign that regulation is currently one of the biggest roadblocks to adoption.
We are still in the very early stages of cryptocurrency financial products and there remain many regulatory hurdles to pass.
Yet, what we do know is that adoption is accelerating and regulators and exchanges, at least in some countries, are open to innovation. The pace of ETP applications has picked up considerably over the past year, indicating that demand is surging and companies are racing to fill this gap.
As regulatory frameworks become clearer, the willingness of traditional exchanges to build the infrastructure to support tradable crypto products will drive further market efficiency. However, collaboration with crypto actors will be crucial to the success of these initiatives.