The launch of 11 bitcoin exchange-traded funds (ETFs) in January signaled a new era for digital assets. The approval of these vehicles by the Securities and Exchange Commission was a significant milestone for crypto investors, but new questions now arise around the institutions offering these vehicles and the future of bitcoin as an asset class.
A report from Javelin Strategy & Research, Bitcoin ETFs: Bringing the Investment Discussion Back, lays out the possibilities and hurdles for digital assets as mainstream investment vehicles. Although the success of the ETFs’ introduction is a positive indicator for digital assets in the long term, many questions remain about the infrastructure supporting these assets.
The Demand Was There
It’s important to remember that the bitcoin ETF developed not because of a push from the cryptocurrency industry but because investors demanded it.
“There was no bitcoin community saying, ‘Let’s have an ETF,’” said Joel Hugentobler, Cryptocurrency Analyst for Javelin and a co-author of the paper. “The traditional markets implemented that. They’re almost like an API, plugging into the bitcoin network. That’s a positive consideration in terms of what it means for digital assets other than bitcoin.”
Following in the wake of the bitcoin ETFs is the question of whether they would take some of the steam out of other types of digital assets. But that has not been the case. After an initial hiccup, the price of the bitcoin ETFs has moved steadily upward since their introduction. The price of ethereum has been correlated to a great extent, moving on its own upward path.
“As institutional investors and capital markets are seeing the bitcoin ETFs and the inflows into it, it’s not pushing them away from crypto in general or digital assets,” said James Wester, Director of Cryptocurrency and Co-Head of Payments for Javelin and a co-author of the paper. “If anything, it’s shining a light on this entire asset class now.”
Custody Issues
Many people may not realize that most of the asset managers offering bitcoin ETFs do not actually maintain custody of the assets. To a great extent, they have left that to crypto concerns like Coinbase.
The initial plan for the ETFs was for “in-kind transfers,” in which the purchases of ETF shares involved the actual purchase of bitcoin. That idea was questioned by regulators, as it meant asset managers would be dealing directly with crypto. “Cash-only” transactions—where third parties handle the buying, trading, and holding of crypto in exchange for fiat currency—was approved instead.
But Wester and Hugentobler point out that in-kind transfers are likely to be where the overlap of crypto and traditional financial services is headed, as such transfers are a more efficient model. Approval—based on regulatory comfort with participants handling crypto directly—will need to be obtained first.
For the moment, though, many experienced digital asset custodians are in the industry. Obscure accounting rules from the SEC have prevented banks, brokers, and participants from investing in or holding digital assets. That presents a great need and opportunity for additional custodians. Financial institutions will have to do their their due diligence to find custody partners with the appropriate size, scale, access, licensing, and trust capabilities. Safe custody of bitcoins will be crucial for each ETF issuer, and the expected growth of ETFs will lead to an increased demand for custodial solutions.
“More tech-savvy retail investors would probably prefer to invest in digital assets by using their own wallets and with direct exposure to the asset,” Hugentobler said. “But with many of the older generations who aren’t tech-savvy, their financial advisors are bringing up crypto.”
Indeed, asset manager Fidelity, which markets one of the bitcoin ETFs, has begun suggesting that clients may wish to have 3% to 5% in cryptocurrencies.
Here to Stay
The success of these ETFs may finally quiet the voices that have described cryptocurrency as a fad. Those voices got louder when the ETFs’ value stumbled a bit out of the gate.
“The thing that is surprised me the most has been just how short term a lot of skeptics’ thinking has been,” Wester said. “There was an assessment by people in the crypto and digital asset community that the approval of a bitcoin ETF would be a good thing and would drive institutional demand. Steady supply means prices go up, and shortly after that happened on Jan. 10, prices actually went down. Some of the news sites on Jan. 11 were basically saying, ‘Ha, ha, this didn’t work.’
“I think there is no point where the critics are ever going to say, ‘We’ve now reached a point where bitcoin or cryptocurrency or digital assets in general have proven their value.’ But the long-term interest is there. This is an asset class that’s going to stay around.”
