The Cryptocurrency ETF Boom: Institutional Interest is High, but Regulation Remains the Biggest Hurdle

The Cryptocurrency ETF Boom: Institutional Interest is High, but Regulation Remains the Biggest HurdleAs the cryptocurrency market continues to grow, investors are constantly seeking new investment tools to participate. On October 17th, the total net inflow of spot Bitcoin ETFs surpassed $20 billion for the first time, a pace that far exceeded the five years it took for gold ETFs to reach the same level

The Cryptocurrency ETF Boom: Institutional Interest is High, but Regulation Remains the Biggest Hurdle

As the cryptocurrency market continues to grow, investors are constantly seeking new investment tools to participate. On October 17th, the total net inflow of spot Bitcoin ETFs surpassed $20 billion for the first time, a pace that far exceeded the five years it took for gold ETFs to reach the same level. The "gold-attracting" ability of Bitcoin ETFs has attracted institutional investors' attention to other cryptocurrency ETFs.

On October 17th, asset management company Bitwise submitted registration documents for the XRPETF to the U.S. Securities and Exchange Commission (SEC). The previous day, Canary Capital also submitted a registration statement to the SEC, planning to launch the first spot Litecoin (LTC) ETF. Previously, VanEck and 21Shares had submitted applications for Solana ETFs to the SEC.

"Institutions are submitting more applications for ETFs covering various crypto assets, aiming to capture growth opportunities in these emerging assets and meet market demand for innovative financial products," said Yu Jianing, Principal of Uweb and co-chair of the Blockchain Special Committee of the China Communications Industry Association. "Investors are no longer limited to mainstream crypto assets like Bitcoin and Ethereum. They hope to obtain more diversified asset allocation opportunities through compliant crypto asset ETFs."

Institutions Collectively Target ETFs

The emergence of spot Bitcoin ETFs was met with great market enthusiasm. Data from blockchain data analysis platform CryptoQuant shows that the asset management scale (AUM) of spot Bitcoin ETFs in the United States has reached $60 billion, driven by continuous capital inflows. Data from independent research and advisory firm ETFGI shows that the global ETF market grew rapidly by the end of August 2024, with newly listed ETFs accumulating significant assets this year. Among them, the top three in size are all spot Bitcoin ETFs, and five out of the top ten are spot Bitcoin ETFs, demonstrating their strong capital attraction and growth momentum.

Against this backdrop, institutions have begun to deploy other cryptocurrency ETFs, with the question of who will be the next ETF product after Bitcoin and Ethereum becoming a hot topic in the industry.

Canary Capital, which applied for the Litecoin ETF, believes that Litecoin has a strong track record, having operated 100% normally since its launch, which will be beneficial to the management of its Litecoin ETF. Litecoin, created in 2011, was designed to be a lightweight alternative to Bitcoin. It improved on Bitcoin's open-source code to achieve faster transaction speeds and lower costs. Previously, the U.S. Commodity Futures Trading Commission (CFTC) defined Litecoin as a commodity, not a security, in its complaint against KuCoin, which could have a positive impact on the review of the Litecoin ETF.

In addition to the Litecoin ETF application, Canary Capital recently also submitted an application for the XRPETF. However, there is still debate about whether XRP should be defined as a commodity or a security.

"The cryptocurrency market is constantly evolving and diversifying, and investors are showing greater interest and demand for different types of cryptocurrencies," said Jiang Han, senior researcher at Pangu Think Tank. "The applications from institutions reflect their bullish view on the cryptocurrency ETF market. On the other hand, it will also help to further standardize and legitimize the cryptocurrency market, increasing market transparency and fairness."

Recently, crypto asset management company Grayscale also submitted an application to the SEC, planning to convert its $5.2 billion fund that tracks multiple cryptocurrencies into an exchange-traded fund (ETF). 76% of the fund's assets are allocated to Bitcoin, 18% to Ethereum, and the rest to Solana, XRP, and Avalanche.

Previously, the SEC approved Grayscale's request to convert its Bitcoin Trust (GBTC) and Ethereum Trust (ETHE) into ETFs. Since its conversion to an ETF in January, the company's Bitcoin fund has seen $21 billion in outflows, while the Ethereum ETF has also seen $3 billion in outflows since its conversion in July.

"If these applications are approved, it will further solidify the mainstream status of crypto assets and attract more traditional investors to the market," said Yu Jianing. "Institutional investors will be able to invest in crypto assets through compliant and secure channels, which will significantly improve market liquidity and reduce price volatility of crypto assets. At the same time, as ETF products become more widespread, the correlation between traditional financial markets and crypto asset markets will strengthen, and the volatility of crypto assets may become more closely linked to global macroeconomic policies, monetary policies, and other factors."

Yu Jianing pointed out that the widespread launch of crypto asset ETFs may also bring certain risks, especially in terms of market manipulation and systemic risk control. With rapid inflows and outflows of large sums of money, the market may face liquidity shocks under extreme conditions, especially under conditions of greater macroeconomic uncertainty. Therefore, regulators need to maintain strict monitoring of market operations and risk management in the future.

Regulation Becomes the Biggest "Roadblock"

Regulators' attitude towards the cryptocurrency market is a key factor affecting the development of ETFs.

"Although the SEC has been open to spot Bitcoin and Ethereum ETFs, applications for ETFs for other crypto assets still face many challenges," Yu Jianing believes. This is mainly due to the inherent volatility and susceptibility to manipulation of the crypto market. Assets like Litecoin and Solana, compared to Bitcoin and Ethereum, have relatively lower market maturity and liquidity, making them vulnerable to single events or investor sentiment.

"When reviewing these crypto asset ETFs, the SEC will inevitably strengthen its scrutiny of market manipulation, asset custody security, and transparency. Therefore, institutions need to demonstrate that they have sufficient market liquidity and secure trading mechanisms to obtain regulatory approval when applying for such products," Yu Jianing said.

On October 18th, the SEC formally appealed a previous court ruling on XRP, reigniting legal disputes about whether the sale of XRP by cryptocurrency exchanges meets the conditions of securities. The regulator questioned key aspects of the court's decision, including the dismissal of Ripple executives and non-cash XRP distributions.

Recently, the SEC once again delayed its decision on spot Ethereum ETF options, pushing the deadline for a ruling from October 19th to December 3rd. The SEC said it needs more time to consider the application proposal. Compared to Bitcoin ETFs, the performance of Ethereum ETFs after listing has been underwhelming, with continuous net outflows. To date, Ethereum ETFs have experienced net outflows of $5.56 billion.

Yu Jianing believes that the main concerns of regulators not approving include: market manipulation risk, insufficient liquidity, and custody security. Compared to traditional financial markets, the crypto market is still highly volatile, and market transparency and price manipulation issues are more prominent. The high level of attention paid by the SEC and other regulators to market manipulation, especially for crypto assets other than Bitcoin or Ethereum with larger market capitalizations, their lower liquidity and potential for market manipulation will be important reasons hindering ETF application approval.

According to a recent report, U.S. regulators have collected a total of $31.92 billion (approximately 227.26 billion yuan) in fines and settlements from 25 cryptocurrency companies since 2019, reflecting regulators' high level of concern about risks in the crypto market. To date, U.S. regulators have reached eight settlements with cryptocurrency companies in 2024, collecting over $19 billion (approximately 135.272 billion yuan) in fines and settlements, a historical high, up 78% year-on-year and up 8327% compared to 2022.

In response, Yu Jianing said that the SEC's attitude towards the crypto asset market can be seen as a pragmatic measure to balance compliance and regulation. The SEC's frequent enforcement actions are not just directed at individual companies or projects, but reflect its overall regulatory logic, which is to regulate the industry to prevent market abuse and protect investors from harm.

"In the long run, the regulatory trend will be more institutionalized and refined," Yu Jianing believes. In the future, global crypto asset regulation will gradually converge, and major economies, including the United States, may provide a clearer legal framework for crypto assets through legislation or executive orders. For example, issuing more inclusive regulations to allow more compliant businesses to enter the market while setting standards for crypto exchanges, custodial institutions, and DeFi platforms. This means that businesses that can comply with strict compliance operations in advance will have greater room for development, especially those that are willing to cooperate with regulation and improve transparency will be more likely to win over institutional investors.

In Jiang Han's view, the SEC's strict regulation of cryptocurrency institutions reflects its emphasis on protecting investor interests and maintaining market stability. Through methods such as filing lawsuits and collecting fines, the SEC is stepping up its regulation of the cryptocurrency market. Future regulatory trends may be even stricter and more comprehensive, including further regulation of areas like cryptocurrency exchanges, wallets, and ICOs. At the same time, regulatory policies may also continue to adapt and improve as the market changes.