Unveiling the Hidden Risks and Challenges for Markets and Investors

Cryptocurrency exchange-traded funds (ETFs) have recently been trending as many companies seek approval to trade, stirring up a wave of enthusiasm and anticipation throughout the crypto community.

As financial vehicles that track the price of cryptocurrencies, these ETFs offer a novel and seemingly more accessible way for investors to enter the crypto market. However, amidst the euphoria and bullish outlooks, it is crucial to cast a discerning eye on the potential dark side of this development.

This article aims to shed light on the hidden risks and challenges that crypto ETFs present to both individual investors and the broader crypto market.

Centralization of Crypto Assets

Cryptocurrency exchanges come in various forms, with centralized exchanges, exemplified by platforms like FTX, being the most prevalent. Centralized exchanges retain control of their client’s private keys and typically mandate a Know Your Customer (KYC) process to deter unlawful activities.

In contrast, decentralized cryptocurrency exchanges operate on a decentralized, non-custodial blockchain system, facilitating direct peer-to-peer transactions. That eliminates the need for intermediaries, allowing users to bypass the KYC process. It is particularly significant for individuals living under repressive governments, offering them an opportunity to participate. Users also maintain full control over their private keys and assume sole responsibility for securing their funds, which can be staked to generate interest.

The cryptocurrency industry’s primary purpose is to provide these advantages, especially to unbanked individuals who lack access to traditional banking services. Conversely, ETFs are inherently centralized products, conflicting with the decentralized essence of Bitcoin and other cryptocurrencies. They do not incorporate the foundational benefits of cryptocurrencies, nor do they encourage new users to engage in the space.

Moreover, ETFs introduce the concept of “paper” Bitcoin, which represents BTC only on a theoretical level. Without the ability to withdraw the purportedly owned Bitcoin, the potential for crises similar to those witnessed with FTX becomes more plausible in the future. That poses a threat to the core principles of decentralization and trustless transactions that underpin Bitcoin.

Regulatory Risks

The regulatory landscape surrounding crypto ETFs presents a significant array of challenges and risks. The approval process for these financial products is complex, creating an air of uncertainty for investors. Government bodies like the U.S. Securities and Exchange Commission (SEC) have been cautious in approving ETFs linked to Bitcoin and other cryptocurrencies. Their hesitance stems from concerns about potential fraud and manipulation within the underlying market.

Todd Rosenbluth, head of research at VettaFi, pointed out that the earlier expected government shutdown might further complicate matters for ETF applications seeking approval. He noted that with the SEC being potentially unable to review new ETFs, there could be room for launches to proceed.

The SEC has postponed its decision on whether to approve applications for spot Bitcoin ETFs to mid-October, highlights Reuters. Todd Sohn, ETF and technical strategist at Strategas Securities, noted that this delay only extends the ongoing deliberation surrounding spot Bitcoin ETFs. He suggested that both investors and issuers may already be growing impatient with the process, so a shutdown only adds to the frustration. Analysts also cautioned that listed funds could face heightened volatility.

However, with the shutdown now avoided, a crypto enthusiast, Mike Dudas, wrote on X that he is looking forward to 6 Bitcoin ETF decisions by the SEC as they have no reason to postpone the decision anymore.

An earlier post on X by Eric Balchunas, a Bloomberg ETF analyst, noted that Valkyrie has recently communicated that they will refrain from purchasing Ether futures until they become operational. Additionally, they have decided to sell the Ether futures they had previously acquired, possibly in an attempt to expedite the process. This move might be in response to pressure or warnings from the SEC.

Hector McNeil, co-CEO and founder of HANetf, emphasized that ETFs essentially act as pass-through vehicles. Therefore, any impact on the underlying markets will naturally have repercussions on the ETFs themselves.

Limited Profit Potential

The high price of a single Bitcoin has often made it a challenging investment for many individuals worldwide. That has led to a growing interest in finding alternative ways to invest in Bitcoin and mitigate the risks associated with directly purchasing the cryptocurrency.

One such alternative is a Bitcoin ETF, which allows investors to gain exposure to cryptocurrencies without the hassle of setting up a wallet or dealing with volatile exchanges. However, industry experts caution that Bitcoin ETFs are not without their risks, Gulf News highlights.

Brian Deshell, a UAE-based cryptocurrency trader and analyst, highlighted that while buying shares of a Bitcoin ETF provides exposure to Bitcoin’s price movements, it may not necessarily fulfill all the desires of investors looking to access cryptocurrencies. He emphasized that investors should be confident that their money will be secure in a regulated product like a Bitcoin ETF. However, it hasn’t been proven to be an effective means to significantly grow one’s wealth in the crypto market, and progress in regulatory approvals has been limited.

Brody Dunn, an investment manager at a UAE-based asset advisory firm, noted that although a Bitcoin ETF isn’t a direct investment in cryptocurrency, it still carries risks due to its exposure to Bitcoin. He cautioned that individuals who assume that investing in Bitcoin ETFs will make it incredibly safe for them without conducting proper due diligence may face concerns.

Dunn acknowledged that the introduction of a Bitcoin ETF is positive for the overall Bitcoin and crypto market. However, he raised a concern that it may not necessarily benefit individual investors as much as it benefits institutional players. While an ETF may attract more institutional money into the market, the average investor may not experience the same level of benefit as intended.

Further SEC Delays on Crypto ETFs

Even though United States Representatives Mike Flood, Wiley Nickel, Tom Emmer, and Ritchie Torres have urged the Securities and Exchange Commission (SEC) to promptly greenlight the listing of spot Bitcoin (BTC) exchange-traded funds (ETFs), the agency has, once more, postponed its decision.

The SEC has extended its decision deadlines for spot Ether ETFs from VanEck and ARK 21Shares to Dec. 25 and Jan. 10, respectively. GlobalX will have to wait until Nov. 21 for the commission’s decision on their application. In addition, the SEC pushed back the decision dates for spot Bitcoin ETF applications from Invesco, Bitwise, and Valkyrie to mid-January.

These recent delays occurred two weeks earlier than the anticipated second deadline for many applicants, who had initially expected to receive feedback from the securities regulator between Oct. 16–19. The timing of the delays may be linked to the narrowly averted U.S. government shutdown, which could have disrupted various federal agencies, including financial regulators.

In response to the delay of its spot Bitcoin ETF, Bitwise Asset Management submitted an amended application, addressing the SEC’s concerns regarding the product. In this revised application, Bitwise engaged with what the SEC called “the ‘mixed’ or ‘inconclusive’ academic record” on the lead-lag relationship between BTC futures and spot markets.

Meanwhile, multiple Ethereum futures exchange-traded funds (ETFs) have commenced trading in the United States. On Monday morning, investment firms, including ProShares, VanEck, Bitwise, Valkyrie, Kelly, and Volshares, collectively introduced nine ETFs on the Chicago Board Options Exchange (CBOE). That marks the first time trading of such ETFs related to Ethereum in the U.S. market.

ProShares introduced three funds in this launch: the Ether Strategy Fund (EETH), the Bitcoin and Ether Strategy ETF (BETH), and the Bitcoin and Ether Equal Strategy ETF (BETE). These funds offer investors different strategies for exposure to both Bitcoin and Ether.

Conclusion

In navigating the promising yet difficult terrain of crypto ETFs, it is essential to recognize the risks and challenges that lie beneath the surface. The centralization of crypto assets within these funds poses a threat to the very ethos of decentralization that underpins cryptocurrencies. Regulatory uncertainties and potential delays further compound the complexities surrounding this innovative financial instrument. Moreover, the limited profit potential due to fund structures and associated fees may not align with the expectations of some investors.

Prospective investors need to approach crypto ETFs with a discerning eye. A thorough understanding of the risks highlighted in this article is crucial in making informed decisions. Regulators need to prioritize transparency and provide clear guidelines for the creation and management of these funds. Likewise, investors should conduct extensive research, seeking diverse perspectives and expert opinions. Before committing capital to crypto ETFs, it is vital to weigh the potential benefits against the inherent risks.