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The hopes of Tyler and Cameron Winklevoss to list an exchange-traded fund based on bitcoin were dashed by the Securities and Exchange Commission. That suggests the digital currency's future may not be in the U.S., and probably shouldn't hinge on a fund that invests in nothing else.

One avenue that's still open

Pensions

The U.S. regulator ended an almost four-year debate with the Winklevoss twins Friday, indicating it wasn't comfortable approving an ETF that would be based on a mostly unregulated asset and over which surveillance and enforcement may be difficult. While previous reservations from the SEC seemed surmountable, this one required bitcoin to be something else.

There's talk in bitcoin circles of using other avenues, such as a filing in Europe for an Undertaking in Collective Investments in Transferable Securities (or UCITS) stamp that would allow the creation of ETFs that could be traded across the continent and, by proxy, in Asia and Africa too. That helps explain why the currency bounced back so quickly from its weekend plunge in response to the SEC decision.

Evergreen Hope

Bitcoin plunged almost 20 percent after the SEC denied an ETF registration, then recovered on bets that this will happen elsewhere

Source: Bloomberg

I'm sorry to say that idea is equally unlikely to fly.

While UCITS regulations allow investments in derivatives and even alternative assets, there are very strict requirements on diversification. A fund can't have more than 10 percent of its net assets in securities from a single issuer, so a vehicle based on bitcoin is very unlikely to get UCITS approval. Without that,it's hard to see centers such as Singapore, Hong Kong, London or Frankfurt allowing unit trusts based on a bitcoin fund to trade. That would limit them to small exchanges with little liquidity.

This doesn't mean the digital currency has no future with retail investors.Managers should start thinking of it as a risk-management tool alongside other assets. They may have a better chance of UCITS approval with a fund that invests in, say, two or three digital currencies and maybe European and U.S. government bonds. That would also make that fund safer -- the point of the diversification requirement.

Or they could try an approach that has already worked in the U.S. While the SEC hasn't really recognized bitcoin as an asset class that it can monitor or have any responsibility over, the Internal Revenue Service did so a while ago. That openedthe door for providers of private pension plans to allow users to fund their accounts in bitcoin. So, while average U.S. investors may not be able to bet on bitcoin using an exchange-traded fund, they maylegallyput their retirement money into the digital currency and use that to invest in traditional funds.

For all their cutting-edge ideas, bitcoin enthusiasts need to think outside the box a bit more.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Christopher Langner in Singapore at clangner@bloomberg.net

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net

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Bitcoin Needs to Think Outside ETF Box - Bloomberg