In a significant move, the U.S. Securities and Exchange Commission (SEC) has given the green light to 11 spot bitcoin exchange-traded funds (ETFs), marking a watershed moment that intertwines the volatile realm of cryptocurrencies with the established financial system. However, as excitement surrounds this development, experts caution that the newfound alliance could introduce unforeseen risks into the financial ecosystem.
The approved ETFs, including those from financial giants BlackRock and Invesco/Galaxy Digital, signal a departure from the SEC’s historical reluctance to endorse such products, citing concerns over investor protection. The regulatory shift follows the SEC’s loss in a court challenge against Grayscale Investments, forcing a reevaluation of its stance.
While crypto enthusiasts celebrate the potential for increased and safer exposure to bitcoin, SEC Chair Gary Gensler issued a warning acknowledging bitcoin’s inherent volatility, urging investors to exercise caution. The combined assets of these ETFs currently stand at around $21 billion, with projections suggesting an influx of up to $100 billion from retail and institutional investors this year.
Despite the optimistic outlook, some analysts express concerns that the widespread adoption of these products could pose risks during market stress. Critics argue that the ETFs might intensify bitcoin price volatility, creating disconnections between the ETF price and actual bitcoin values. Dennis Kelleher, CEO of Better Markets, emphasizes the potential for increased interconnection between the core financial system and the crypto ecosystem as investors pour money into these products.
The aftermath of last year’s U.S. banking upheaval serves as a cautionary tale, demonstrating how financial and crypto markets can transmit risks to each other. Instances such as the collapse of crypto lender Silvergate Bank following withdrawals triggered by FTX’s downfall contributed to the failure of Signature Bank. The ripple effect extended to the collapse of Silicon Valley Bank, sparking a run on stablecoin USD Coin.
Bitcoin, conceived in 2009 as an alternative payment mechanism, has primarily evolved into a speculative investment. Its daily volatility, approximately three and a half times that of equities, according to the Wells Fargo Investment Institute, raises concerns about the potential impact of bitcoin ETFs during market stress.
Antonio Sánchez Serrano, principal economist at the European Systemic Risk Board, warns that bitcoin ETFs could exacerbate volatility during market stress, citing the complexities and risks associated with these products. He highlights the potential for decoupling between ETF prices and underlying assets, causing stress for institutions heavily exposed to these products.
Historical incidents, such as the 2018 collapse of a volatility-tracking exchange-traded note and the 2020 sell-off of some corporate bond ETFs during COVID-19 shutdowns, serve as reminders of the risks associated with complex, less liquid, and highly leveraged exchange-traded products.
While the ETF industry generally disputes claims of systemic risks, critics argue that the immaturity of Bitcoin introduces unforeseeable hazards. The risks will depend on the widespread adoption of these ETFs, and experts emphasize the need to monitor the proportions and identities of purchasers.
In contrast to industry assurances, SEC Commissioner Caroline Crenshaw, who voted against approving the ETFs, expressed concerns about potential spillover effects from largely non-compliant crypto markets to traditional markets. Her apprehension extends to fears that the approved ETFs may pave the way for riskier financial products, setting the stage for what she calls “tomorrow’s failure.”
As the crypto and traditional financial worlds continue to converge, only time will reveal the true impact of these bitcoin ETFs on the broader financial system, leaving regulators, investors, and enthusiasts on the edge of anticipation and concern.