Bitcoin Risks Highlighted By SEC and CFTC

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President Franklin D. Roosevelt once said, “The only thing to fear is fear itself …”[1] Apparently, some in the federal government no longer share this belief. In a recent Investor Bulletin[2] (“Bulletin”), the Office of Investor Education and Advocacy (OIEA) of the Securities and Exchange Commission (SEC) and the Office of Customer Education and Outreach (OCEO) of the Commodity Futures Trading Commission (CFTC) “urge investors to consider a fund with exposure to the Bitcoin futures market to carefully weigh the risks and potential rewards of investing.

What is a Bitcoin (or digital asset) future?

The Bulletin described Bitcoin as a “digital asset or an asset that relies on blockchain technology” and a Bitcoin futures contract as a “standardized agreement to buy or sell a specific amount of Bitcoin at a specified price on a particular date in the future. “Bitcoin is viewed by the SEC and CFTC as a commodity. Trading in commodity futures contracts must take place on futures exchanges regulated and supervised by the CFTC.

What are companies or investment funds?

Section 3 (a) (1) of the Investment Companies Act 1940 defines an “investment company” as an issuer which is or purports to be primarily engaged, or proposes to primarily engage, in investing, reinvesting or trading in securities.[3] The definition also includes an issuer that is engaged or proposes to engage in an activity of investing, reinvesting, holding, holding or trading in securities, and owns or proposes to acquire “investment securities” of a value greater than 40% of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis.[4] Investment companies are then further divided into three types of entities – the most relevant for this discussion are management companies which can be open-ended (mutual funds) or closed-end investment vehicles offered to investors. public.

Some of these regulated funds offer Bitcoin futures trading as a way for investors to gain exposure to Bitcoin. While certain investor protections are required for these funds, it is important for investors to understand that entering and exiting positions in Bitcoin or Bitcoin futures is highly speculative, volatile, and involves a degree of risk that does not exist. is not prevalent in some other investment options. The Bulletin provides a number of points that an investor should consider when it comes to regulated funds and their use of Bitcoin futures:

  • The investor’s risk tolerance. Investors should focus on their risk profile and define the level of risk they are taking versus the level of risk they are willing to take.

  • Disclosure by the fund of its risks. A fund is required to disclose the main risks associated with investing in the fund in its prospectus. Investors should be diligent in reviewing a fund prospectus, in particular the Investment Objective, Strategies and Risks sections.

  • Potential loss of investment. All investments in funds carry a risk of financial loss. This risk may be increased for positions in Bitcoin futures due to the high volatility of Bitcoin and Bitcoin futures (meaning that prices can fluctuate significantly). There is also the potential for fraud and manipulation in the underlying Bitcoin cash or “spot” market.

  • Difference in investment result. A rise in the price of Bitcoin may not result in a similar increase in the value of a fund holding positions in Bitcoin futures. This is in part because funds that trade commodity futures may not have direct exposure to the assets underlying the contracts. Futures prices may vary depending on the month of delivery and differ from the spot price of the underlying commodity. Futures contracts also expire periodically, resulting in fluctuations in portfolio exposure, as expiring futures positions are usually incorporated into new contracts. The value of a particular fund can be affected by this continued exposure to futures contracts.

Conclusion

There are risks to investing in digital assets, digital asset futures, and digital asset funds, including volatility, potential for fraud, and manipulation. Bitcoin futures are highly speculative investments. Investors should thoroughly review their risk profile, the fund’s investment objective, and other offer-related disclosure information before investing in funds that trade Bitcoin futures. Fund managers should be prudent and take adequate steps to ensure that the investing public has full and fair disclosure of all relevant risk factors in order to mitigate gaps in the public’s ability to understand risks and the potential benefits of such an investment. While there are risks associated with investing in digital assets, such investments should not be feared by sophisticated investors who proceed with caution.

[1] Franklin D. Roosevelt, 1933 inaugural address.

[2] Trading Funds on Bitcoin Futures – Investor Bulletin. June 10, 2021.

[3] See Section 3 (a) (1) (A) of the Law on Investment Companies

[4] See Section 3 (a) (1) (C) of the Law on Investment Companies

Copyright © 2021 Nelson Mullins Riley & Scarborough LLPRevue nationale de droit, volume XI, number 175


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