Market Perspectives

Ready for Take-Off?
The Outlook for Crypto Funds in Asia-Pacific

We outline key considerations for asset managers exploring opportunities in this new domain.

November 2021

Following the launch of several bitcoin exchange-traded funds (ETF) in the United States and Canada, and other crypto exchange-traded products (ETP) listings in Europe, we assess developments in the Asia-Pacific market to date and outline key considerations for asset managers exploring opportunities in this new domain.


Ahmad

 


Irfan Ahmad
APAC Product Head
State Street Digital


The market responds to rising demand for crypto assets

With mounting demand for cryptocurrency exposure among institutional and retail investors globally, it was only a matter of time before the markets for crypto ETFs and ETPs ꟷ which are securities that offer investors exposure to cryptocurrencies ꟷ began to take off.

Although regulators, in general, continue to take a cautious approach to cryptocurrency markets, some big strides have been made in parts of North America and Europe over the last couple of years.

Those asset managers looking to launch ETFs, may see initial participation in crypto via alternative funds as a means of not only testing market demand but also reassuring regulators about the issuance of mainstream ETF structures for crypto in their markets.

In Europe, asset management regulation may limit the ability of undertakings for collective investment in transferable securities (UCITS) funds ─ which form the bulk of mutual funds sold across the European Union ꟷ to invest in cryptocurrencies, but the market for cryptocurrency-linked ETPs is seeing strong growth, reaching US$43.9 billion, in February of this year.[1]

The table below provides a summary of crypto ETF and ETP products and their current distribution across regions.

The market in Asia Pacific

Until now, there have been no crypto ETFs or ETPs ꟷ tracking spot of the underlying cryptocurrency and broadly available to retail investors ꟷ launched in Asia Pacific. Asset managers in the region are actively looking to explore opportunities and having an understanding of the regulators attitude towards these products will be an important consideration.

Investor appetite in the region is strong, and not just among retail investors. A report by Chainalysis, a blockchain data platform, found that 40 percent of the bitcoin on-chain activity  conducted of the top 50 exchanges originates in Asia Pacific.[2]

To date, investors in the region seeking exposure to crypto assets ─ such as hedge funds and family offices ꟷ have turned to private funds, that are commonly domiciled in offshore jurisdictions, and make use of alternative fund structures.

Those asset managers looking to launch ETFs, may see initial participation in crypto via alternative funds as a means of not only testing market demand but also reassuring regulators about the issuance of mainstream ETF structures for crypto in their markets.

There is also a general lack of standardisation for how asset managers should determine reference prices for crypto assets. Today, many rely on bespoke models and may use average prices or trading volume-adjusted prices.

When it comes to listed funds, regulators in the region have continued to voice concerns about pricing of crypto assets, which is yet to be standardised. Further, some markets do not yet have clear rules in place to facilitate this. The significant volatility of the underlying assets is another concern that complicates ETF approval.  While crypto ETFs would trade on exchanges and be subject to trading hour restrictions, cryptocurrencies can be traded 24/7, leading to fears of how investors could be negatively impacted with no real-time exit option.

While Asia-Pacific regulators remain undecided about approving ETF issuance, a number of them are granting Recognised Market Operator (RMO) licences to newly established digital asset exchanges. These can operate as private exchanges to begin with and will limit membership to accredited and institutional investors.

These exchanges could play a pivotal role in the development of the ETF and ETP market in the region. As with private fund structures, asset managers may seek to use private exchanges ─ with their institutional membership ꟷ as a testing ground/sandbox for crypto products. Success in this environment may again help to boost confidence among regulators and mainstream exchanges.

Getting ready to launch: Addressing operational complexity

Asset managers considering launching crypto ETFs and ETPs will also need to think about how to meet some of the unique operational demands of these products.

One key consideration relates to the custody environment. There are now hundreds of digital asset wallet providers in the market, among which managers may choose to store crypto assets. However, these wallet providers do not have standardised platforms to connect with other market participants in the way that a normal central securities depository (CSD) custodian would. Each digital wallet provider has  instead a bespoke approach to connectivity. A flexible application programming interface (API) based technology architecture is essential to working with these providers. At State Street, we have implemented connectivity to wallet providers to facilitate digital fund administration services. We are also looking to further streamline the technical infrastructure in this space and enable higher interoperability.

There are many attributes to consider when developing a fund structure that invests into digital assets. In navigating this process with our clients, we ask key questions below:

1. Is the fund investing in a single cryptocurrency or basket of crypto?
2. What is the funds fiat currency / how many share classes will be considered?
3. Which authorised participants/ market makers will you engage to trade your crypto product?
4. For existing asset servicing relationships, what is the impact on current service models like the middle office?
5. Is this a synthetic or physical based product?
6. Which wallet provider will be supporting the issuer/fund with safekeeping?
7. What is the jurisdiction of the issuer and the asset manager?
8. Is there an available price source for the underlying crypto?
9. Is this a regulated or unregulated fund structure?
10. What reporting capabilities are currently available from the vendors involved?

Another consideration is that crypto assets themselves have their own idiosyncrasies that need to be factored into the fund administration process. For instance, quantities of bitcoin are expressed using eight decimals, while Ethereum uses 18. This creates additional complexity for systems in calculating and reporting asset valuations.

There is also a general lack of standardisation for how asset managers should determine reference prices for crypto assets. Today, many rely on bespoke models and may use average prices or trading volume-adjusted prices. What is crucial , whichever approach is used, is that reference prices can be robustly supported as regulators expect a clear explanation of how they have been derived.

Asset managers will need to be prepared to learn as they go as they seek to build a market for exchange-traded crypto products in Asia-Pacific. Engaging with partners that have experience supporting these products in other regions will facilitate speed to market and operational resilience.

State Street – Your partner in crypto

State Street DigitalSM stands ready to fully support asset managers in the emerging digital product space. We have engaged with multiple firms globally to support the launch of cryptocurrency-based ETFs and ETNs. Today, we service a large number of issuers in the cryptocurrency market and are actively working with issuers in Canada, Germany, Luxembourg, Australia and Singapore.

[1] Digital Asset Management Review, Cryptocompare, February 2021
[2] APAC CRYPTOCURRENCY REPORT, Chainalysis, October 2019

 

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