Rising Wave of US Bitcoin ETFs Triggers Debate on Potential Threats to Financial Stability

• Experts caution that the approval of bitcoin exchange-traded funds (ETFs) in the US could deepen the ties between the volatile cryptocurrency market and the traditional financial system, introducing unforeseen risks.
• The SEC's recent approval of 11 spot bitcoin ETFs marks a pivotal moment for the crypto industry, challenging prior rejections and aiming to offer investors easier and safer access to bitcoin.
• While these ETFs could attract substantial capital, some experts express concerns about potential increased volatility in bitcoin prices or discrepancies between ETF and bitcoin prices, posing risks to the broader financial system during market stress.

Experts warn that the introduction of exchange-traded funds (ETFs) tracking bitcoin in the United States could strengthen the bonds between the volatile cryptocurrency market and the established financial system, leading to unanticipated risks.

This month, the Securities and Exchange Commission (SEC) approved 11 spot bitcoin ETFs from issuers like Invesco/Galaxy Digital, BlackRock (BLK.N) and others. This is a turning point for the crypto industry, which has been plagued by criminality and bankruptcy.

After losing Grayscale Investments' legal challenge, the SEC was obliged to reconsider its long-standing rejection of the products on the grounds of investor protection.

The goods, according to cryptocurrency aficionados, will make it easier and safer for investors to invest in bitcoin. SEC Chair Gary Gensler cautioned investors to exercise caution as bitcoin is still a "volatile asset" when authorizing the products.

With a total asset value of about $21 billion, the ETFs may attract as much as $100 billion in capital from institutional and retail investors this year alone, according to some experts. Since the items were released, bitcoin has decreased by more than 6%.

According to some ETF experts, who cited data from prior ETF volatility events, if the products are widely adopted, they may increase the volatility of bitcoin prices or cause dislocations between the price of the ETF and bitcoin, which could be dangerous for other components of the financial system during periods of market stress.

Some said that the turmoil in US banks last year demonstrated how dangers might spread across the financial and cryptocurrency systems. Regulators claim that cryptocurrency lender Silvergate Bank, for instance, dissolved as a result of withdrawals triggered by the collapse of cryptocurrency exchange FTX, which in turn fueled panic and contributed to the demise of Signature Bank. Meanwhile, a run on stablecoin USD Coin was triggered by the failure of Silicon Valley Bank.

Bitcoin ETFs and Potential Systemic Risks

Bitcoin was created in 2009 as a substitute for cash, but its primary usage is as a speculative investment. The Wells Fargo Investment Institute estimates that its daily average volatility is around three and a half times that of stocks.

In times of market stress, Bitcoin ETFs may "particularly exacerbate" this volatility, according to Antonio Sánchez Serrano, senior economist of the European Systemic Risk Board, the EU's financial risk watchdog. There are additional ways that ETFs might generate systemic hazards.

The decoupling of the ETF price from the underlying asset is one of those other channels, and it can be stressful for institutions who are substantially exposed to the products or that depend on them for managing their liquidity.

Complex, highly leveraged, and less liquid exchange-traded products have seen stress in the past.

During a spike in volatility in February 2018, an exchange-traded note that tracked volatility collapsed, costing investors $2 billion in losses.

Some corporate bond ETFs had a sell-off in 2020 as a result of COVID-19 shutdowns. The CFA Institute, an investing professional group that has also researched the dangers associated with ETFs, has stated that if the Federal Reserve had not offered emergency support, which included purchasing shares of bond ETFs, then that stress would have extended to the larger fixed income market.

The argument that systemic hazards are present in ETFs is typically refuted by the industry.

The issuers of bitcoin ETFs disclose a wide range of market, policy, and operational risks in their risk disclosures; however, they also note that because bitcoin is still in its infancy, certain risks may be unpredictable.