Bitcoin
How Bitcoin ETFs Are Changing the Risk-Reward for Institutional Investors
As predicted, the launch of spot bitcoin exchange-traded funds (ETFs) in the US market has had a huge positive impact on the digital asset industry. A trigger is triggered stampede of retail investors and set records for bitcoin investment (BTC) and in ETFs.
Most importantly, being in a product approved by the U.S. Securities and Exchange Commission (SEC) changed bitcoin’s risk-to-reward ratio, bringing crypto back into the institutional investment conversation. This is sparking new interest from some companies and encouraging others to restart projects that had been put on hold. The door to the mainstream financial system has reopened.
Note: The opinions expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.
Institutional investors think about risk in many dimensions, some of them being: products, counterparties and the risks surrounding the underlying asset itself. In traditional finance (TradFi), all of this is well understood.
Products have become commoditized, with many companies offering similar products. Counterparties – market makers, custodians, clearing houses, etc. that help absorb commercial risk are well known. The different asset classes are also well understood and there are established ways of assessing the risks of a given asset.
Over many years, much of the risk and volatility has been eliminated from the system. These are black swan events that create problems. The risk is low, but so are the rewards. Opportunities to beat the market are hard to find.
What we have seen in crypto is a series of events that have had a negative impact but are predictable due to the lack of regulation and controls in the industry. The risk of these events happening has been too high for institutions to seek outsized rewards.
Bitcoin ETFs reduce risk in all three dimensions.
ETFs have been available in the US market for over 30 years. Everyone understands the product. Buying the asset in a securitized product is simpler than buying bitcoin outright. Many investors think it is the best route to pay a management fee to have someone else take care of custody, settlement risk, and other operational aspects of Bitcoin trading. They no longer need to take these risks directly.
The presence of big brands like BlackRock, Fidelity and others reduces counterparty risk. There are many native crypto custodians, liquidity providers, and market makers, but they are relatively unknown in the world of TradFi.
ETFs introduce some of the crypto universe’s dependent counterparties to general investors. Knowing that the big TradFi players have done due diligence on their finances, processes and procedures, and security practices reduces the fear factor. Additionally, it shows who they could ask for help if they wanted to hold bitcoin and other digital assets and do spot trading in the future.
By approving bitcoin as an underlying product within the ETF space, the SEC has reduced the risk at the base level of the asset – namely the fear that crypto could be banned outright in the US, obviously greater regulatory clarity could further reduce the asset risk, but market demand for ETFs led the agency to resolve some important issues. It also pressured ETF issuers to implement many of the simple risk-reducing elements that institutional players hope to see.
All of these elements create confidence in the market, which is crucial to resuming the journey of digital assets into the mainstream. There is a lot of ideology, jargon and technical terms surrounding cryptography. But essentially it’s just another asset class that uses a different technology.
Before FTX, many people left these risks aside and focused on price appreciation and gaining market access. After FTX, people are saying, I want to get involved, but I need to know that I’m protected on a basic level. ETFs do this while exposing institutional investors to crypto-dependent counterparties. They put the industry back on a positive path.
There are two things keeping institutions away from digital assets right now. One is philosophical. They neither believe nor like Bitcoin or cryptography. Then, there is a second group for whom the risk/reward ratio is not yet attractive enough. For these people, the success of ETFs makes it increasingly difficult to stay on the sidelines, especially when clients request crypto products.
The day will come when the main risk with Bitcoin and other digital assets will be in the base level of asset performance – just as with TradFi. It won’t be a decision or a product that magically makes this happen. It will be a long process, but eventually all questions about products, counterparties and regulations will disappear.
The only question will be: do you want to invest in digital assets or not?