The race to launch Canada’s first ETF is over, and the Purpose Bitcoin ETF is the winner. In regulatory filings published only a few days ago on SEDAR, the Purpose Bitcoin ETF disclosed that the OSC had issued a receipt for its long-form prospectus. To offer securities to the public, an investment fund must first receive approval from the OSC for a preliminary prospectus, after which a final prospectus can be submitted. If the final prospectus is approved, the securities can be publicly issued. Under the passport model (not adopted by Ontario), an investment fund approved by its principal regulator gains automatic access to capital markets in other provinces and territories, subject to continuous disclosure requirements.
The Purpose Bitcoin ETF is considered an “alternative mutual fund” under National Instrument 81-102, which means it is permitted to invest in asset classes or use investment strategies that are not permitted for traditional mutual funds. It is established as a trust and administered pursuant to a Declaration of Trust, which is the primary governing document for such investment funds. Purpose Investments Inc. serves as the trustee, manager and portfolio manager.
Risks Associated with the Purpose Bitcoin ETF
The Purpose Bitcoin ETF will invest substantially all of its assets in long-term holdings of bitcoin itself, not bitcoin futures. It will acquire bitcoin from regulated cryptocurrency trading platforms such as Gemini, Coinbase Pro and others. Its bitcoins will be held in cold storage, but will be uninsured (except for commercial crime insurance during “brief periods” when the assets are in hot wallets).
The Sub-Custodian responsible for holding the bitcoins is the Gemini Trust Company, a regulated cryptocurrency exchange and custodian headed by Bitcoin billionaires, Cameron and Tyler Winklevoss. As a custodian, its primary role is holding the bitcoin in secure “wallets” safe from unauthorized access. Gemini touts its “institutional-grade” cold storage custody system and claims that to date, it has not experienced a loss due to fraud or hacks from its hot or cold storage wallets.
The Purpose Bitcoin ETF is self-described as high risk and the ETF Facts disclosure for the fund warns “Don’t buy this ETF if you need a steady source of income from your investment.” Given the recent price volatility of bitcoin, investors should consult with a financial professional to see if bitcoin investment funds are suitable for them.
Future Regulatory Trends in Cryptocurrency
The Purpose Bitcoin ETF is the first bitcoin ETF cleared by Canadian securities regulators. That Canada approved a Bitcoin ETF before the U.S. Securities and Exchange Commission did shows a growing recognition among Canadian regulators that Bitcoin is here to stay, and that regulated investments are better than unregulated investments.
No doubt, Canadian securities regulators had on their minds the catastrophic collapses of Bitcoin exchanges Mt. Gox and Quadriga, which were unregulated cryptocurrency exchanges that lost investors billions. While the Purpose Bitcoin ETF is not a cryptocurrency exchange, it relies on such exchanges to acquire its assets, and its sub-custodian faces the same risks of security breaches (by internal or external malevolent actors) that could lead to devastating losses for investors.
A Canadian Bitcoin ETF seemed inevitable since the OSC’s October 29, 2019 decision approving the closed-end The Bitcoin Fund (for more background, please see this previous post). Lawrence Haber, the lead director of the OSC, penned that decision which set aside an earlier refusal of the OSC to issue a receipt for The Bitcoin Fund, stating “it is not the job of securities regulators to ban speculation or risk-taking.” That view may have permeated the OSC’s thinking on bitcoin ETFs and convinced them that their role was taming the cryptocurrency landscape by “professionalizing investing in risky assets” (as Mr. Haber put it).
Interestingly, Mr. Haber’s October 29, 2019 approving The Bitcoin Fund noted that “If the Fund were an ETF, that might have impacted my analysis of the risks identified by Staff [in The Bitcoin Fund], in particular, with regard to price manipulation risk.” (emphasis added). Given the current approval of the Purpose Bitcoin ETF, this suggests that the price manipulation risk that inspired caution before has been adequately addressed.
What’s next for bitcoin in Canada? The approval of closed-end funds and ETFs investing in bitcoin suggests that regulators prefer to leave analysis of the merits of bitcoin to investors, but intend to use the regulatory apparatus to arm investors with adequate disclosures to inform their decisions.
The next challenge for the CSA may be unregulated Crypto-Platforms (also known as “cryptocurrency exchanges”). Last year, the CSA published guidance regarding when a Crypto-Platform is subject to Canadian securities regulations. It warned Crypto-Platform operators (including those operating outside of Canada but with Canadian users) that “CSA members intend to take enforcement action or continue existing enforcement action against Platforms that do not comply with securities legislation.” It appears that the enemy is no longer bitcoin, but unregulated bitcoin entities.