Japan Explores Crypto ETFs After Snubbing Futures

(Bloomberg) -- Japan’s financial watchdog has abandoned plans to allow listed derivatives based on cryptocurrencies but may yet approve exchange-traded funds that track the asset class, according to a person familiar with the matter.

The decision to bar instruments like Bitcoin futures or Ethereum options in one of the largest markets for cryptocurrencies marks another setback for investors betting on institutional demand to help end a brutal year-long selloff. But the possibility of ETFs tracking digital assets in Japan could revive appetite from retail investors after $500 million was stolen from Tokyo-based Coincheck Inc. a year ago.

The Financial Services Agency is currently gauging industry interest in ETFs tracking digital currencies, according to a person familiar with the agency’s thinking who requested anonymity discussing private plans. The regulator last month decided against pursuing revisions to the nation’s securities law which would have allowed crypto futures and options to be listed on major financial exchanges after concluding that such products would achieve little besides stoke speculation.

The FSA’s stance comes after a months-long internal investigation of why it failed to prevent the Coincheck heist. In addition to dropping support for crypto derivatives, the agency has also decided to give more oversight power to self-regulatory bodies, put most initial coin offerings under the scope of its securities law and cap leverage that can be offered by crypto brokers, the FSA announced late last month.

The conclusions will likely serve as a backbone for a bill the Liberal Democratic Party will probably submit during the current Diet session that ends in March, with the eventual goal of becoming law as early as 2020, the person said. Besides aiming to amend securities legislation through the Financial Instruments and Exchange Act, some of the FSA’s recommendations will likely result in changes to the Payment Services Act, the person said.

Japan’s decision to shelve plans for crypto derivatives comes a year after Cboe Global Markets Inc. and CME Group Inc. listed futures tracking Bitcoin. The instruments have attracted growing but still limited demand from institutional investors, with combined open interest across both currently at about $81 million, according to exchange data.

ETFs remain the holy grail for many in the crypto industry who hope that exchange-traded funds could give crypto products more legitimacy in the eyes of some investors, while making them more accessible to those who already have a brokerage account. But U.S. and European regulators have so far shot down dozens of such proposals, citing worries about price manipulation or the security of the underlying crypto assets.

Investors expect trading in commodities underpinning ETFs to make sense and be free from the risk of manipulation, Securities and Exchange Commission Chairman Jay Clayton said at an event in late November. “Those kinds of safeguards don’t exist in many of the markets where digital currencies trade,” he said.

Switzerland became home to the first such product when it listed the Amun Crypto Basket Index ETP in November, which trades under the ticker ‘HODL’ -- crypto industry slang for holding rather than selling the assets. So far, the exchange-traded product has attracted $6 million and averages less than $1 million in daily turnover.

An ETF listed in the much larger and more-liquid Japanese stock market could attract more interest. Still, even ETFs for more traditional asset classes such as stocks and bonds haven’t caught on with Japanese retail investors who continue to prefer mutual funds. Japan’s ETF market is worth $335 billion (with about 75 percent owned by the central bank). That’s a fraction of the $3.7 trillion worth of ETFs outstanding in the U.S.

--With assistance from Yuki Hagiwara.

To contact the reporter on this story: Yuji Nakamura in Tokyo at ynakamura56@bloomberg.net

To contact the editors responsible for this story: Robert Fenner at rfenner@bloomberg.net, Tracy Alloway, Russell Ward

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