The US Securities and Exchange Commission (SEC) released a staff letter on Jan. 18, directed at two Wall Street trade groups that are interested in opening ETFs and mutual funds based on Bitcoin (BTC). The letter makes the case that companies offering cryptocurrency-based investment products are not yet able to comply with SEC regulations.

Dalia Blass, the SEC’s director of investment management, wrote in the letter:

“We appreciate that proponents of cryptocurrencies and related products have identified a range of potential benefits. We are also aware that critics of cryptocurrencies have raised various concerns regarding transparency of information, trading, valuation and other matters related to the nature of the underlying assets.

In light of these considerations, we have, at this time, significant outstanding questions concerning how funds holding substantial amounts of cryptocurrencies and related products would satisfy the requirements of the 1940 Act and its rules.”

The Investment Company Act of 1940 is the source of regulation for all mutual funds, closed-end funds, hedge funds, private equity funds, and holding companies.

The letter contains questions that the SEC believes must be answered in order for them to consider supporting the idea of a cryptocurrency-based fund. Blass writes that the valuation of crypto portfolios at the end of each day will be difficult due to the volatility of the market and the nature of Blockchain protocol:

“For example, how would they address when the blockchain for a cryptocurrency diverges into different paths (i.e., a “fork”), which could result in different cryptocurrencies with potentially different prices?”

The SEC also sees liquidity as a potential problem since, according to the 1940 Act, a fund must be able to allow its investors to easily liquidate their holdings at the end of each day.

The risk of fraud and market manipulation, already brought up in an August 2017 SEC bulletin in relation to Initial Coin Offerings (ICO), is again repeated in this letter in relation to exchange-traded funds (ETF).

In early January 2018, the SEC had asked two Bitcoin-related ETF proposals to be withdrawn, citing the same concerns over liquidity and valuation underlined in the most recent letter.

The SEC’s final position on the possibility of Bitcoin-based funds is currently unfavorable. Until the questions posed in the letter are “addressed satisfactorily”, Blass writes:

“we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products, and we have asked sponsors that have registration statements filed for such products to withdraw them.”