According to experts, the recent introduction of U.S. exchange-traded funds (ETFs) tracking bitcoin strengthens the connection between cryptocurrency's turbulent domain and established financial markets, which could result in unexpected hazards.
Eleven spot bitcoin ETFs were approved by the Securities and Exchange Commission (SEC) this month, marking a significant milestone for the crypto industry which has been plagued with bankruptcies and criminal activities. Issuers such as BlackRock and Invesco/Galaxy Digital are among those given approval. Grayscale Investments challenged the SEC's rejection of its products due to investor protection concerns, leading the regulatory agency to reconsider their stance following a court ruling against them. According to crypto enthusiasts, the aforementioned products will enable investors to conveniently and securely access bitcoin. Nevertheless, SEC Chair Gary Gensler cautioned that since bitcoin is still a highly unstable asset, potential investors should exercise caution before investing in it.
Analysts predict that the ETFs collectively possess around $21 billion in assets and have the potential to attract as much as $100 billion from both retail and institutional investors this year. Bitcoin's value has decreased by over 6% since these products were introduced. Some ETF experts have claimed that if these products become widely adopted, they could increase the volatility of bitcoin prices and cause disruptions between the price of Bitcoin and the corresponding ETF. This poses risks to other areas of the financial system during market distress as seen in previous instances where there were high levels of turbulence associated with ETFs.
Last year's banking crisis in the United States demonstrated that financial and cryptocurrency markets are interconnected, with one posing potential risks to the other. According to regulators, Silvergate Bank - a crypto lender - was forced into liquidation after withdrawals triggered by FTX exchange's downfall; this panic then contributed towards Signature Bank's failure. Similarly, Silicon Valley Bank collapsing led to widespread fear which caused people to withdraw from stablecoin USD Coin en masse.
Dennis Kelleher, CEO of Better Markets - an advocacy group that strongly recommended against the SEC's approval of bitcoin ETFs due to potential jeopardy for investors and financial system - stated that pouring funds into these products could significantly elevate the risk associated with interdependence between crypto ecosystem and financial core. Bitcoin was created in 2009 as a substitute payment system, but it is now predominantly utilized for speculative investing. The Wells Fargo Investment Institute reports that its daily average instability exceeds equities by approximately three and a half times. According to Antonio Sánchez Serrano, the principal economist at the European Systemic Risk Board - who is responsible for overseeing financial risk within the EU - Bitcoin ETFs may worsen existing volatility during times of market turmoil. He also highlighted other means through which these funds could contribute to systemic risks. The other channels comprise of the ETF price and the underlying asset decoupling, which may lead to anxiety for institutions that have substantial exposure to these products or depend on them for managing liquidity. Referring to bitcoin ETFs as complex, Serrano stated in an email to Reuters that the embedded risks are considerably greater than those of a basic stock ETF.
In the past, Exchange-traded products that were highly leveraged, less liquid and complex faced challenges. A surge in volatility led to a downfall of a exchange-traded note that tracks the volatility, resulting in investors suffering losses worth $2 billion during February 2018. The CFA Institute, a professional investment organization which has also examined the risks of ETFs, contends that if it weren't for emergency support from the Federal Reserve in form of purchasing shares of bond ETFs, some corporate bond ETFs would have experienced sell-offs due to COVID-19 shutdowns. This stress might have extended to other fixed income markets as well. The general consensus among the ETF industry is that their products do not present any systemic risks. Bitcoin ETF issuers enumerate various market, policy and operational risks in their risk disclosures while admitting that due to the immaturity of bitcoin, unforeseeable hazards could also be present.
There was no comment from the SEC in response to a request. "FAILURE OF THE TOMORROW." According to Serrano and other experts, the extent of risks associated with ETFs will primarily hinge on their level of adoption. According to Olivier Fines, the head of advocacy and policy research for EMEA at CFA Institute, systemic risk predominantly concerns magnitude. He further stated in an email that it is currently unclear who exactly are buying these assets or how much they are investing. According to industry executives in the crypto space, crises within the world of cryptocurrency - such as when digital currencies lost approximately two-thirds of their $3 trillion worth in 2022 - have been largely confined to said sector. According to Senior Analyst at S&P Global Ratings, Lapo Guadagnuolo, there continues to be a severely limited level of connectivity between cryptocurrencies and the financial system. ETF providers claim to have established protective measures whereby the items will be repaid in cash instead of Bitcoin, resulting in a decrease in intermediary involvement that handles the digital currency. Galaxy Digital's global head of asset management, Steve Kurz, who collaborated with Invesco on its ETF stated that he did not notice any drastic or disastrous fluctuations in these products. However, at least one high-ranking SEC official has raised concerns. In January, SEC Commissioner Caroline Crenshaw opposed the approval of ETFs and stated that the agency hadn't evaluated if these funds would result in a connection with conventional markets. She raised concerns about how crises from non-compliant crypto markets could subsequently impact other areas. Despite not responding to a comment request, Crenshaw expressed concern that the ETFs may potentially open doors for more high-risk products. Adding, she expressed her apprehension that today's decisions might lead us towards failure in the future.
