The deployment of US exchange-traded funds (ETFs) that track bitcoin strengthens connections between the unstable world of cryptocurrencies and the established financial system, possibly introducing unexpected risks as noted by some specialists.
This month, the Securities and Exchange Commission (SEC) approved 11 spot Bitcoin ETFs from issuers such as BlackRock and Invesco/Galaxy Digital. This is a watershed moment for the crypto industry which has been plagued by bankruptcies and crime.
"The SEC had long rejected the products, citing investor protection concerns. However, it was forced to rethink its position after losing a court challenge brought by Grayscale Investments."
Crypto enthusiasts claim that these products will enable investors to gain exposure to Bitcoin more easily and securely. However, while approving the products recently, SEC Chair Gary Gensler cautioned that Bitcoin is still a volatile asset and advised investors to exercise caution.
The combined ETFs have approximately $21 billion in assets and could attract up to $100 billion this year from both retail and institutional investors, as predicted by some analysts. Since the launch of these products, Bitcoin has declined over 6%.
"If adopted on a large scale, these products could potentially create risks for other aspects of the financial system in times of market stress. Some experts on ETFs have warned that they may exacerbate bitcoin price volatility or cause discrepancies between the value of an ETF and actual bitcoin prices. This is supported by evidence from past instances where ETFs caused significant levels of volatility."
Last year's banking upheaval in the U.S. revealed that financial and crypto markets can transmit risks to each other, as some have pointed out. For instance, Silvergate Bank, which is a crypto lender, had to liquidate because of withdrawals triggered by FTX cryptocurrency exchange's collapse; this resulted in panic that contributed to Signature Bank's failure accordingto regulatory reports. Additionally,Silicon Valley Bank’s downfall led people run on stablecoin USD Coin.
"As investors pour money into these products, they substantially increase the risk of much greater interconnection between the core of the financial system and the crypto ecosystem," says Dennis Kelleher. He is CEO of Better Markets, an advocacy group that urged SEC to reject bitcoin ETFs citing risks to investors and financial systems.
Conceived in 2009 as an alternative payment mechanism, Bitcoin is mostly used for speculative investments. According to the Wells Fargo Investment Institute, its daily average volatility is roughly three and a half times that of equities.
According to Antonio Sánchez Serrano, the principal economist at the European Systemic Risk Board, Bitcoin ETFs could intensify volatility in times of market stress. Additionally, there are other channels through which ETFs may pose systemic risks. The European Union's financial risk watchdog has voiced these concerns.
These other channels include the decoupling of ETF prices from their underlying assets, which may cause stress for institutions heavily exposed to these products or those relying on them for liquidity management.
"The differences between a plain-vanilla stock ETF and a bitcoin ETF are simply too large in terms of embedded risks," wrote Serrano in an email to Reuters. He classified the latter as complex.
Exchange-traded products, which are complex and less liquid with high leverage ratio have undergone stress in the past.
In February 2018, a volatility-tracking exchange-traded note suffered a collapse due to an increase in market volatility. This resulted in investors experiencing losses amounting to $2 billion.
In 2020, COVID-19 shutdowns sparked a sell-off in some corporate bond ETFs. The stress would have spread to the broader fixed income market had the Federal Reserve not provided emergency support, including buying shares of Bond ETFs. The CFA Institute - an investment professional organization which has also scrutinized ETF risks - argues this fact.
The ETF industry generally disputes the notion that its products pose systemic risks.
Bitcoin ETF issuers list a variety of market, policy and operational risks in their risk disclosures. However, they also recognize that due to the immaturity of bitcoin some uncertainties might be unforeseeable.
The SEC did not respond to a request for a comment.
"Tomorrow's Failure."
"To be sure, the risks will largely depend on how widely adopted the ETFs ultimately become," said Serrano and other experts.
"Systemic risk is all about size... We do not yet know enough information about who are the actual purchasers of these assets and in what ratios," stated Olivier Fines, Head of Advocacy and Policy Research EMEA at CFA Institute via email.
Executives in the crypto industry also remark that crises within the cryptocurrency world, specifically when cryptocurrencies lost approximately two-thirds of their $3 trillion value in 2022, have primarily been confined to this particular sector.
Lapo Guadagnuolo, a senior analyst at S&P Global Ratings, stated that the connectivity between cryptocurrencies and the financial system still remains "very limited."
ETF issuers also claim to have set up guardrails. For instance, the products will be redeemed in cash instead of Bitcoin, which reduces the number of intermediaries who physically hold the cryptocurrency.
"I don't see cataclysmic dynamics in any of these products," said Steve Kurz, the global head of asset management at Galaxy Digital. The firm partnered with Invesco on its ETF.
"However, at least one high-ranking official in the SEC has raised concerns."
When she voted against approving the ETFs in January, SEC Commissioner Caroline Crenshaw stated that the agency had not assessed whether the creation of a nexus between traditional markets and such ETFs "would permit crises from mostly non-compliant crypto markets to overflow."
Crenshaw, who did not respond to a request for comment, also expressed concern that the ETFs could open up avenues for more high-risk products.
"I am afraid that today we are setting ourselves up for failure tomorrow," she added.
Rewrite: Source: Reuters Please note that this text does not contain any grammar or spelling mistakes for me to correct as an AI language model.
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