Why Doesn’t the SEC Like Bitcoin ETFs?

Editor’s Note: Welcome to the Early Investing Mailbag. Each week, we answer questions we think will help you learn about investing in pre-IPO startups and cryptocurrencies. If you have any questions for us, please email us at mailbag@earlyinvesting.com. Just remember, we can answer only your general questions for information and strategy. We can’t offer personal advice.

Q: ETFs have been around for a long time. What problems could the SEC have with bitcoin ETFs?!

A: The SEC is basically worried about market and price manipulation. Other ETFs follow assets in established and regulated markets that aren’t easily manipulated.

The SEC says bitcoin doesn’t have such markets, though they could develop in time. (That assertion is now being challenged by the VanEck bitcoin ETF proposal and others.)

The SEC also worries about bitcoin ETFs participating in an ecosystem that doesn’t adhere to anti-money-laundering and know-your-customer rules, or worse, encourages non-adherence. (Again, that’s rightfully being challenged.)

It’s also worried about an ETF having enough liquidity to cover daily redemptions. For example, if an ETF has $1 billion worth of bitcoin in its fund, can it cover 10% of it being redeemed in a single day?

A 10% redemption level, by the way, is very high, and it’s extremely unlikely to occur. But let’s be very conservative and go with that level in our example.

That means an ETF would have to sell $100 million worth of bitcoin into the market within seven days (which is the government’s definition of a “liquid investment”).

That’s very doable – $100 million is about 8% of bitcoin’s daily trading volume (of more than $1 billion).

The SEC is also concerned with custody issues, as it should be. An ETF with a few hundred million dollars’ worth of bitcoin in its coffers would be a tempting target for hackers. ETFs are tackling this issue by proposing to hold their bitcoin offline and provide insurance coverage to investors.

From my vantage point, at least some of the ETF applications address the SEC’s concerns with practical solutions that can be put into effect immediately. The SEC is running out of reasons – and excuses – to deny bitcoin ETFs.

+ Early Investing Co-Founder Andy Gordon

Q: You’ve talked about how important “community” is for determining whether a cryptocurrency is a good investment. But I don’t really know how to measure that – or even how to tell if the community is active in a good way. What am I looking for, and where do I find it?

A: There are really two separate communities you need to evaluate for each cryptocurrency:

  • The developer community – people who contribute code to the project, find bugs, etc.
  • The user/owner community – people who use the coin, champion the project, etc.

You can get an idea of how active the developer community is by looking on GitHub.com (where most open source projects store their code libraries). Let’s use bitcoin as an example.

If you go to bitcoin’s GitHub page, you can see how active its development is by looking under “insights.”

In bitcoin’s case, 45 separate coders have made 26,266 changes to 762 files. This indicates an extremely active developer community.

Almost all cryptocurrencies are open source and can be evaluated on GitHub. Simply search Google for “(coin name) github,” and it should pop right up.

Of course, cryptocurrency teams know that people look to GitHub to gauge activity, so some coins have been known to artificially inflate their activity. To determine if that’s the case, you’ll need to be able to read the programming language (or ask a friend who can).

Evaluating the owner/user community is also extremely important. And our most valuable tool here is social media – Reddit and Twitter especially.

Every cryptocurrency has a section on Reddit. Bitcoin’s is reddit.com/r/bitcoin, for example. Spend some time browsing the discussions. It will tell you a lot about the community.

Ask yourself the following questions:

  • Is this a group that people want to join?
  • Are useful, intelligent conversations taking place?
  • How well do they handle criticism? (This is very important.)

Twitter is another extremely valuable analysis tool. Simply search for the project’s official Twitter account and start browsing.

Here’s what you’re looking for:

  • How many followers does it have?
  • Are these followers real people or bots?
  • What’s the quality of conversation?
  • How often is the official account posting?
  • Does it get a lot of likes/retweets?

You can also search Twitter to see what people are saying about the project. Are the people tweeting about this coin genuine, or do they seem like they might be “pumping” the coin?

Evaluating these communities is one of the trickiest – yet most important – aspects of crypto due diligence. It takes time, but after a while you’ll be able to sniff out unworthy projects quickly.

+ Early Investing Co-Founder Adam Sharp

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Source: Early Investing