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US Bitcoin ETFs raise questions about broader risks to the financial system
- ETFs strengthen ties between bitcoin and traditional finance
- Volatility and price dislocations pose broader risks, experts say
- Experts say 2023 bank failures show potential for contagion
- Risks depend on the extent of product adoption.
LONDON/WASHINGTON, Jan 31 (Reuters) – The launch of U.S. exchange-traded funds (ETFs) tracking bitcoin is deepening the ties between the volatile world of cryptocurrencies and the traditional financial system, potentially creating new and unforeseen risks, experts say.
The Securities and Exchange Commission (SEC) this month approved 11 Spot Bitcoin ETFs from Issuers Including BlackRock (BLK.N)New tab, opens a new tab and Invesco/Galaxy Digital, in a watershed moment for a crypto industry plagued by bankruptcies and crimeThe SEC had long rejected the products citing investor protection concerns, but was forced to reconsider after losing a legal challenge. provided by Grayscale Investments.
Cryptocurrency enthusiasts say the products will make it easier and safer for investors to gain exposure to bitcoin. But when approving the products, SEC Chairman Gary Gensler warned that bitcoin remains a “volatile asset” and investors should be wary.
The ETFs together represent about $21 billion in assets and could attract as much as $100 billion this year alone from retail and institutional investors, some analysts predict. Bitcoin has fallen more than 6% since the products launched.
If widely adopted, such products could pose risks to other parts of the financial system during times of market stress, by exacerbating bitcoin price volatility or creating dislocations between the ETF’s price and bitcoin’s, some ETF experts said, citing evidence from previous ETF volatility events.
Others have said last year’s U.S. banking turmoil showed that financial and crypto markets can transmit risks to each other. Crypto lender Silvergate Bank, for example, liquid following withdrawals triggered by the collapse of crypto exchange FTX, which in turn fueled panic that contributed to the failure of Signature Bank, regulators said. The collapse of Silicon Valley Bank, meanwhile, triggered a rush for the stablecoin USD Coin.
“As investors put money into these products, you dramatically increase the risk of a much greater interconnectedness between the core of the financial system and the crypto ecosystem,” said Dennis Kelleher, CEO of Better Markets, an advocacy group that had urged the SEC to reject Bitcoin ETFs, citing risks to investors and the financial system.
Designed in 2009 as an alternative means of payment, bitcoin is primarily used as a speculative investment. Its average daily volatility is about three and a half times that of stocks, according to the Wells Fargo Investment Institute.
Bitcoin ETFs could “particularly exacerbate” this volatility during times of market stress and other channels through which ETFs can create systemic risks, said Antonio Sánchez Serrano, senior economist at the European Systemic Risk Board, the European Union’s financial risk watchdog.
These other channels include decoupling the ETF price from the underlying asset, which can cause stress for institutions with significant exposure to the product or that rely on it for liquidity management.
“The differences with a traditional stock ETF are simply too great in terms of embedded risks,” Serrano wrote in an email to Reuters, referring to Bitcoin ETFs, which he categorized as complex.
Exchange-traded products that are complex, less liquid and highly leveraged have struggled in the past.
In February 2018, a stock traded on the stock exchange that tracks volatility went bankrupt In 2020, COVID-19-related shutdowns triggered a selloff in some corporate bond ETFs. This stress would have spread to the broader fixed income market had the Federal Reserve not provided emergency support, including purchase of bond ETF sharesargued the CFA Institute, a professional investment organization that has also studied the risks associated with ETFs.
The ETF industry generally denies that its products pose systemic risks.
In their risk disclosures, Bitcoin ETF issuers list a host of market, political, and operational risks, but acknowledge that Bitcoin’s immaturity means some dangers may be unpredictable.
The SEC did not respond to a request for comment.
“TOMORROW’S FAILURE”
To be sure, the risks will depend largely on the extent of ETF adoption, Serrano and other experts said.
“Systemic risk is a size issue… We don’t yet know enough about who is actually buying these products and in what proportions,” Olivier Fines, head of advocacy and policy research for EMEA at CFA Institute, said in an email.
Crypto industry executives also point out that crypto-related crises, including when cryptocurrencies lost about two-thirds of their $3 trillion value in 2022, have been mostly limited to the crypto sector.
Connectivity between cryptocurrencies and the financial system remains “very limited,” said Lapo Guadagnuolo, senior analyst at S&P Global Ratings.
ETF issuers also say they have safeguards in place. For example, the products will be redeemed in cash rather than bitcoin, minimizing the number of intermediaries that physically hold the cryptocurrency.
“I don’t see cataclysmic dynamics in any of these products,” said Steve Kurz, global head of asset management at Galaxy Digital, which partnered with Invesco on its ETF.
However, at least one senior SEC official has expressed concerns.
When voting against ETF approval in January, SEC Commissioner Caroline Crenshaw said in a statement that the agency had not considered whether ETFs would create a link to traditional markets that “would allow crises in largely non-compliant crypto markets to propagate.”
Crenshaw, who did not respond to a request for comment, also said she was concerned that ETFs could pave the way for riskier products.
“I fear that we are preparing today for failure tomorrow,” she added.
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Written by Tommy Reggiori Wilkes; reporting by Hannah Lang and Elizabeth Howcroft; additional reporting by Saqib Ahmed, Chris Prentice and Douglas Gillison. Editing by Michelle Price and Anna Driver.
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