1/31/2024

Do Bitcoin ETFs have risks for the economy?

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Key points:

  • In January 2024, the US Securities and Exchange Commission (SEC) approved 11 spot Bitcoin ETFs.
  • Bitcoin ETFs pose potential risks to other parts of the financial system, exacerbating Bitcoin price volatility and creating systemic risks.
  • However, the extent of these risks will depend on how widely these ETFs ultimately become available.

The recent approval of bitcoin exchange-traded funds (ETFs) in the United States has opened up a new channel for traditional investors to gain exposure to the cryptocurrency market. While this development is seen as a positive step by some, others warn of potential risks associated with this increased integration of cryptocurrencies into the traditional financial system.

The Securities and Exchange Commission (SEC) had previously rejected numerous attempts to launch bitcoin ETFs, citing concerns about investor protection. However, in a landmark decision this month, the SEC approved 11 spot bitcoin ETFs from issuers such as BlackRock and Invesco/Galaxy Digital.

The SEC had previously resisted approving these products, citing concerns about investor protection. However, the agency was compelled to revisit its stance after losing a lawsuit filed by Grayscale Investments, a leading digital asset management firm.

Crypto enthusiasts believe that ETFs will make it easier and more secure for investors to access Bitcoin. However, SEC Chairman Gary Gensler, in granting approval, cautioned that Bitcoin remains a highly volatile asset and that investors and traders should exercise caution.

Fund launch results

Analysts estimate that Bitcoin ETFs could accumulate up to $100 billion in assets from retail and institutional investors this year alone. The launch of these products has been accompanied by a decline of over 6% in Bitcoin’s price.

Some experts warn that widespread adoption of Bitcoin ETFs could pose systemic risks to the traditional financial system during periods of market stress. They argue that these products could amplify Bitcoin’s price volatility, potentially destabilizing other asset classes.

Other experts highlight the interconnectedness of the financial and cryptocurrency markets, citing last year’s banking crisis in the United States as an example. The collapse of cryptocurrency exchange FTX led to a liquidity crisis at the crypto lender Silvergate Bank, which in turn triggered a panic that contributed to the bankruptcy of Signature Bank.

Are concerns about Bitcoin ETFs justified?

Conceived in 2009 as an alternative payment mechanism, Bitcoin is often 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.

However, it is worth remembering that the risks will largely depend on how widespread ETFs ultimately become. Crypto industry executives also note that cryptocurrency crises, especially when they lost about two-thirds of their $3 trillion value in 2022, have been largely limited to the crypto sector. The connection between cryptocurrencies and the financial system still remains very limited.

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