REGISTERED CRYPTO FUNDS – HOPE FOR BITCOIN INDUCED ETF?

The United States Securities and Exchange Commission (“SEC”) on July 6, 2020 granted approval to issue equity shares of Acra U.S. treasury fund (‘Acra Fund’), an SEC-registered closed-ended fund under the Investment Company Act 1940, in its digital form of security tokens named ArCoins on the ethereum blockchain. This is the first time ever that the crypto-skeptical SEC has allowed a registered investment fund to be represented by cryptographic tokens to enter the investment markets.

Previously, several attempts were made by companies specializing in cryptocurrencies to persuade SEC for launching bitcoin induced Exchange Trade Funds (“ETF”) but to no avail as their fillings were quickly dissented and quashed. The main reason for such dissent was the failure to demonstrate proper compliance under the Securities Exchange Act 1934 (“Act”), in particular Section 6(b) which entails the terms and conditions required to be registered as a national securities exchange. Under Section 6(b), sub-clause (5) requires the rules of the national securities exchange be “designed to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest” but according to SEC none of the fillings were consistent with these requirements. In simpler terms the SEC was never convinced that the crypto-market is sufficiently resistant from market manipulations.

Comparing the SEC’s approval of ArCoins from the previously failed attempts of launching bitcoin induced ETF, two points stand out:

1. restricted transfer for enhancing security; and

2. pace setter for a safer digital hybrid asset class.

Restricted Transfer for Enhancing Security

ArCoin represents an equity interest in Acra Fund and are not stable coins but are security tokens on ethereum blockchain. Since, these tokens follow ERC-1404 protocol over the ubiquitous ERC-20 protocol, it has provided user-based permission control to enhance security. This way tokens can only be transferred to whitelisted wallets, meaning, as per the user’s permission, token withdrawals on a public blockchain will be restricted to a list of known addresses only. Accordingly, to be on the whitelist and receive ArCoins certain regulations can be introduced, such as compliance with Anti-Money Laundering and Know Your Customer Protocols. Hence, to the satisfaction of SEC, ArCoin is providing a regulated blockchain where unauthorized transfers will just be rejected by the smart contracts.

Pace Setter for a Safer Digital Hybrid Asset Class

ArCoin combines a regulated and considerably the least risky asset, The United States Treasury and the easily accessible public blockchain, Ethereum. This Hybrid Asset takes the efficiency of a public blockchain as it has removed the need for a financial intermediary, such that investors or institutional investors can directly trade shares from the Acra Fund and combines it with the safety of regulations by holding unauthorized activities accountable, providing security to trading and settlement process.

BlockSuits Comments

The above two points describe the very innovative nature of this ethereum backed ArCoin and are the main reasons why SEC granted an approval but it’s not a watershed moment. This is because ArCoins are traded directly from the Acra Fund creating a peer to peer network of share transfer but they are not registered in any stock exchanges and hence are not ETF. Further, by removing these intermediaries like brokers and dealers a good portion of United States securities laws don’t apply. Although this avoids any regulatory retardation but dodging a whole set of legal responsibilities will never allow blockchain infused investment to flourish at its full potential.

Nevertheless, ArCoin has in a way achieved a digital asset milestone as it has not only created a new hybrid asset class but also highlighted that the regulators cannot meet the pace of ever-growing technological growth. In the present scenario, such failure to keep pace with ethereum backed ArCoin has resulted in extremely limiting the growth of security tokens in their secondary market as it enforces a restricted transfer of ArCoins to known addressees, that also on a peer to peer basis excluding all kinds of intermediaries needed to facilitate a secondary market. Therefore, although ArCoin should be applauded for finally fitting into SEC’s requirements through its innovative approach but the growth of such investment is rather curbed. It is only hoped that better clarification is provided by the regulators so that the legality of various blockchain based investment opportunities can be clearly determined and freely function in the crypto-market.

The article is authored by Rishika Raghuwanshi, Co-head, BlockSuits.