Could Spot Bitcoin ETFs Violate the Purpose and Principles of Cryptocurrencies?

• It’s been over a decade since the first application for a spot Bitcoin exchange-traded fund (ETF) was filed, and the Securities and Exchange Commission (SEC) has rejected more than a dozen additional applications since then, continually delaying decisions on others.
• The $7 trillion ETF industry is still eagerly awaiting crypto investors and looking for a product that would provide exposure to Bitcoin without directly buying and setting up wallets.
• ETFs come with a multitude of counterparty risks, including sponsors, custodians, and other partners. Those who witnessed the recent crypto market crash understand how devastating such risks can be.

Spot Bitcoin ETFs: Are They Really Beneficial as Expected? Could the ETF movement violate the fundamental principles and goals of Bitcoin? BlackRock and more!

Spot Bitcoin ETFs: Still Waiting

The first spot Bitcoin ETF application was filed in July 2013, and it was rejected in both 2017 and 2018. Over a decade has passed since the initial application, and the SEC has rejected more than a dozen additional applications, continually delaying decisions on others.

In the latest iteration of the ETF drama, Bitcoin enthusiasts celebrated a court ruling confirming that the SEC didn’t arbitrarily approve Grayscale’s ETF application, and this was celebrated by industry advocates. However, it led to the SEC delaying its decision on the seven pending Bitcoin ETFs, followed by a price drop. Now, we’re waiting for the SEC’s next move and Grayscale’s pleas for approval.

To some extent, embracing a case for a Bitcoin ETF makes sense in terms of acceptance. The $7 trillion ETF industry is still filled with crypto investors waiting for a product that would provide them with Bitcoin exposure without having to buy BTC directly and set up wallets. Also, as a community that wants digital assets to be taken seriously, the crypto world is inclined to welcome the validity that a U.S. spot ETF would bring.

However, crypto, especially Bitcoin, is based on the need for financial sovereignty, transparency, and settlement that traditional finance (TradFi) lacks. The willingness of the crypto industry to seek ETF approval appears to contradict the industry’s purpose, much like the American colonists requesting colonial government intermediation after refusing to allow it once they rebelled against the taxes imposed by the British.

Mainstream adoption is a common goal among crypto advocates, and SEC approval of a Bitcoin vehicle seems like a fast track to that. But seeking approval from an opaque centralized agency for an intermediary investment product contradicts the industry’s purpose and is frankly unnecessary.

The irony is felt when cautious investors wait to buy Bitcoin ETF shares instead of choosing a more secure way to hold BTC directly. ETFs come with multiple layers of counterparty risk, including sponsors, custodians, and other partners. The potential destructiveness of such risks was seen during the recent crash, as customers lost over $10 billion within a few months, trusting third parties they believed to be secure. While the crash may seem diminished, the main takeaway is clear: if you don’t own the private keys to your Bitcoin, your assets are not under your control and may not even exist.

Those who have closely observed this situation understand this, but investors who have been waiting for ETFs may not. It is our duty as builders and experienced individuals in the industry to help them understand the new level of security and risk mitigation brought by Bitcoin’s technology.

Disadvantages of Spot Bitcoin ETFs

The disadvantage of spot Bitcoin ETFs goes beyond the conceptual contradiction and the risk of unknowingly buying into a riskier investment. The potential cost to the crypto movement is significant.

For example, BlackRock’s iShares Bitcoin Trust made an announcement in June that propelled Bitcoin’s price to a one-year high. However, many in the Bitcoin community, perhaps blinded by the idea of massive institutional inflows, quickly jumped on the bandwagon of TradFi 2.0, seemingly forgetting Bitcoin’s ethos of financial sovereignty.

Within BlackRock’s presentation, there’s a section related to hard forks that states:

“The Sponsor will use its discretion to determine which fork is the appropriate network for purposes of the Trust, and in doing so, may adversely affect the value of the Shares. […] The Sponsor does not guarantee what the ultimate determination of the most valuable fork will be. […] The Sponsor and Pay’s Holders, the Bitcoin Custodian, other service providers, the Index Provider, crypto exchanges, or other market participants may also disagree on what is generally accepted as ‘Bitcoin’ for purposes of the Trust, which could adversely affect the value of the Shares.”

This clause introduces uncertainty around the consensus mechanism for a protocol that already has a well-defined and battle-tested consensus mechanism.

On a broader level, BlackRock is likely to accumulate a significant Bitcoin supply, and the iShares ETF may be subject to opacity and potential rehypothecation. This is something to consider in a world where we have the opportunity to own assets directly on a transparent and immutable ledger. It makes one question the shareholders who are exposed to the risk of having only paper demand for Bitcoin.

As decentralized finance and TradFi coexist more prominently, SEC approval of a spot Bitcoin ETF at some point is inevitable. It’s crucial for the Bitcoin community to remain conscious and steadfast in understanding why we’re building a new financial system.

We can and should recognize the advantages of both traditional financial instruments and Bitcoin. However, we should also be vigilant about the consequences of developments like spot ETFs, help newcomers understand the innovations of Bitcoin’s technology, and continue to progress.