The recent launch of exchange-traded funds (ETFs) tracking Bitcoin (BTC) has raised concerns among experts about the potential risks that may arise as cryptocurrencies become more intertwined with the traditional financial system.
The Securities and Exchange Commission (SEC) approved 11 bitcoin exchange-traded funds earlier this month, marking a significant moment for the cryptocurrency industry, which has faced challenges such as bankruptcies and criminal activity.
The Securities and Exchange Commission had previously rejected these products, citing investor protection concerns.
However, a court challenge by Grayscale Investments has led the SEC to reconsider its position.
Spot Bitcoin ETFs Could Attract $100 Billion in Investments
The combined assets of these ETFs are about $21 billion, and analysts expect that they could attract up to $100 billion in investments this year from individual and institutional investors.
Some experts have expressed concern that if these products achieve widespread adoption, they could create risks for other parts of the financial system, especially in times of market stress, according to a Reuters report.
They argue that ETFs could exacerbate Bitcoin price volatility or create a disconnect between the price of ETFs and the true value of the cryptocurrency.
These concerns are based on evidence from previous volatility events involving ETFs.
Moreover, experts point to the interaction between financial markets and cryptocurrency markets, and highlight the risks that can be transmitted to each other.
They cite examples such as the liquidation of cryptocurrency lender Silvergate Bank due to the collapse of cryptocurrency exchange FTX, which later contributed to the bankruptcy of Signature Bank.
The collapse of the Silicon Valley bank also sparked a run on the stablecoin USD Coin.
“As investors pour money into these products, the risk of greater interconnectedness between the underlying financial system and the cryptocurrency ecosystem increases dramatically,” said Dennis Kelleher, CEO of Better Markets, an advocacy group that urged the SEC to reject bitcoin ETFs. “. Pointing out the risks to which investors and the financial system are exposed.
Spot ETFs can amplify volatility
The average daily volatility of Bitcoin is about three and a half times that of stocks.
However, some experts have warned that spot Bitcoin ETFs could amplify this volatility, especially during market turmoil.
They also highlighted other potential risks associated with complex ETFs, such as decoupling of ETF prices from the underlying assets, which could put pressure on institutions that are heavily exposed to these products or rely on them to manage liquidity.
There have been instances of stress in complex, less liquid and highly leveraged exchange-traded products in the past.
For example, in 2018, an exchange-traded note tracking volatility collapsed amid a spike in volatility, resulting in investor losses of $2 billion.
In 2020, the COVID-19 pandemic caused a sell-off in some corporate bond ETFs, which could have spread to the broader fixed income market if not for emergency support from the Federal Reserve.
While the ETF industry generally disputes claims that their products pose systemic risks, issuers of Bitcoin ETFs acknowledge various market, political, and operational risks in their disclosures.
However, they also mentioned that Bitcoin’s immaturity can lead to unpredictable risks.
The extent of these risks depends largely on the level of adoption of Bitcoin ETFs.
“Systemic risk is about scale,” said Olivier Vines, head of advocacy and policy research for EMEA at CFA Institute. “We still don’t know enough about who is actually buying it and in what proportions.”
On the other hand, cryptocurrency industry executives say that crypto crises have been largely contained within the cryptocurrency sector, and that the connection between cryptocurrencies and the financial system remains limited.
“I don’t see catastrophic dynamics in any of these products,” said Steve Kurz, global head of asset management at Galaxy Digital, which has partnered with Invesco on its ETF.