The U.S. Securities and Exchange Commission’s (SEC) approval for a group of spot bitcoin-based ETFs will likely broaden the adoption of these vehicles by mainstream financial firms, but may raise risks too.
Last week, the SEC delivered its long-awaited approval for the listing and trading of 11 spot Bitcoin ETFs, which Moody’s Investors Service said “will likely lead to a broader inclusion of digital assets in mainstream portfolios and encourage institutional and retail investors to participate in crypto markets.”
In a new report, the rating agency said the SEC’s approval included safeguards, such as disclosure requirements, and the obligation to list these ETFs on regulated exchanges, which should provide added comfort to investors who have previously been reluctant to wade into the crypto sector.
“Introducing Bitcoin ETFs will simplify portfolio diversification for traditional institutional investors by mitigating concerns related to custody, potentially eliminating the need for more indirect tracking of Bitcoin prices via futures Bitcoin ETFs,” it said.
Yet, in a separate report, Morningstar DBRS cautioned that the growth opportunities for spot bitcoin ETFs may increase risks for banks.
In particular, the ETFs’ growth may lead to increased market risk, liquidity risk, counterparty risk and reputation risk, the report suggested.
“Despite the potential benefits of the spot bitcoin ETFs, including growing assets under management and their associated management fees, there remain risks related to the underlying asset. Specifically, bitcoin has a high degree of price volatility and lacks regulatory structure,” DBRS said.
Given that the ETFs will closely track the underlying cryptocurrency, the funds are expected to face elevated price volatility too, it said.
“As a result of the potential price swings, banks investing in bitcoin ETFs could experience increased market risk, resulting in mark-to-market losses,” it said.
Additionally, as spot bitcoin ETFs are new, “they could expose banks to liquidity risk,” it suggested.
“Unlike traditional securities, market liquidity may not be deep enough for quick and efficient trade execution, particularly during volatile periods. Insufficient liquidity could lead to unusually wide bid/ask spreads, amplifying price volatilities,” DBRS noted.
Banks could also be exposed to counterparty credit risk, DBRS said, with crypto exchange Coinbase Global, Inc. serving as the custodian and trading venue for these ETFs.
“Therefore, Coinbase’s operational safety is critical, and any potential issues could disrupt operations of all market participants, including banks,” it said.
Finally, there’s the prospect of reputation risk that could arise if retail investors embrace spot bitcoin ETFs in a way that’s not suitable to their circumstances, and then suffer damaging losses.
“Unlike sophisticated institutional investors, retail investors may not be able to appropriately assess their risk tolerance and, hence, these ETFs may not align with their long-term financial goals,” it said.
“Therefore, banks that promote and enable investments in bitcoin spot ETFs could face reputation risk in the event of material financial losses incurred by the holders of these vehicles, or broader vulnerabilities that could emerge in the cryptocurrency ecosystem,” it noted.