Financial Market

Bitcoin ETF decision opens can of worms to invest in new form of money

Meanwhile, local brokers, including CommSec, are looking to make the US ETFs available to domestic investors, as the quality issuer names provides comfort to compliance teams.

Digital gold

While Gensler, like many financial regulators, tend to focus on bitcoin’s facilitation of crime – something not unique to cryptocurrencies, given cash is a favourite method for evading tax or paying for drugs – others see a range of more positive uses.

For some, bitcoin is a store of value, an asset akin to a form of digital gold. (Like the commodity, bitcoin has been designed with a limited supply.) Others focus on its potential as an alternative means of payment, a digital token that can be used to buy goods and services directly through apps, like a global borderless currency.

Bitcoin also allows funds to be stored away from the prying eyes of governments; to send money out of currency-controlled regimes; to protect wealth from inflationary effects of policies such as central bank money printing; and to allow anonymous spending on the internet.

David Tuckwell, from Global X Australia, says public market listings will bring bitcoin onto the radar of financial advisers. 

The market has ascribed some value to all of these functions: bitcoin’s capitalisation was hovering around $US900 billion on Friday. Now, it will be much easier for global investors to buy.

New investors will take comfort from layers of regulation applying to the product issuers, brokers, trustees and custodians. This will be overseen by US market operators and securities regulators, helping to keep investors’ money safe.

“A big challenge for crypto has been the simple fact that exchange quality has been low, and we saw that, in dramatic fashion, with FTX,” says David Tuckwell, senior strategist at Global X, which operates the only two spot bitcoin EFTs listed in Australia, on the Cboe market.

“Bringing crypto into a relegated environment, with established, very well capitalised exchanges, with more transparency, is a very good step. And, frankly, it raises the quality of the offering as well by bringing them into an ETF wrapper.”

Standard Chartered estimated this week between $US50 billion and $US100 billion will flow into bitcoin via the new ETFs this year. This is still a drop in the ocean compared with total global ETF assets, which BlackRock expects will hit $US14 trillion by the end of this year. The inflows could see the bitcoin price quadruple to $US200,000 by the end of 2025, after reaching $US100,000 by the end of this year, Standard Chartered forecasts.

It was trading at $US46,300 on Friday morning.

The projections are based on the impact of gold ETFs, which pushed the spot gold price up by four times over seven years as the products matured. But Standard Chartered suggests bitcoin ETFs will take just two years to become mainstream.

Until now, bitcoin buyers have been forced to navigate unfriendly decentralised exchanges such as Uniswap, which involve downloading wallets and holding coins on USB sticks.

Meanwhile, centralised exchanges such as FTX and Binance also create risks. FTX founder Sam Bankman-Fried has been jailed for fraud after customers lost billions of dollars; the US courts will sentence the founder of Binance, Changpeng Zhao, next month for money-laundering violations.

Venture capitalist Martin Rogers. “I say ‘chill out’ to the original crypto gangsters.”  

ETFs eradicate risks of self-storage and, without the complexities of managing private keys, other local product developers say the structures will birth crypto into the mass market. They are also being offered with low fees.

“ChatGPT allowed people to understand the power of generative AI, but we have not seen that yet in crypto,” says Martin Rogers, who has spent six years in the sector and listed one of the first Australian ETFs on Cboe (since delisted, due to low trading volumes).

“These EFTs will provide a similar catalyst to create retail interest in the technology.”

For bitcoin purists, ETFs remain on the nose as they still believe the cryptocurrency was designed to bypass traditional finance. The pseudonymous creator Satoshi Nakamoto had railed against central bank money printing. However, for unsophisticated investors, un-intermediated access is a source of risk.

“The original crypto gangsters don’t like ETFs,” says Martin. “They say self-custody is the only way to hold crypto, so it can’t be seized by governments. But, to them, I say, ‘chill out’. Very few people can manage self-custody, and now they have a better option.”

Caveat emptor

Some local developers agree with Gensler’s warning that EFT approval provides no reassurance about crypto valuations.

Justin Arzadon, head of digital assets at Betashares, says the products “remain highly volatile and, as a result, should only form a very small part of an overall portfolio, [and] investors should not get ahead of themselves when it comes to allocations to the asset class”.

Tuckwell agrees that crypto involves an “existential risk” that one day, the investment will collapse to zero. “[But] in any kind of investing, there is always a trade-off between risk and potential reward,” he adds.

“It is very much a case of buyer beware – but the risk of an investment going to zero is not unique to crypto, you see it happening to stocks on the ASX all the time.”

It remains unclear how many financial advisers, who drive most of the global volume into EFTs, will recommend the products, especially if more are listed in Australia, given strict fiduciary duties. The products will need to be rated and admitted to approved lists, and early indications suggest advisers will give the new offerings a wide berth. Vanguard, for example, said on Thursday its clients would not be getting access.

SEC chairman Gary Gensler: “Investors should remain cautious about the myriad risks associated with bitcoin.”
 AP

But Tuckwell expects once more bitcoin ETFs appear on ASX, local advisers will consider them as access is provided through the HUB24 and Netwealth platforms.

“The kingmakers in the EFT market are financial advisers,” he says. “If you have bitcoin and ethereum on regulated exchanges, where exchange quality is higher, there is clarity and legal contingencies around custody,” he says.

Analysis of the SEC’s reasoning this week shows some of the big risks that saw it reject numerous applications over recent years have now been addressed.

One of its concerns was the underlying bitcoin price being manipulated. But this week, after examining bitcoin futures market pricing, it said it was confident exchanges can “prevent fraudulent and manipulative acts and practices” and, “in general, protect investors and the public interest”.

There have also been improvements in the quality of custodians. This includes using “cold storage”, where the actual bitcoins backing the ETFs are stored “off chain”, making them less susceptible to hacking. For most of the US products, the custodian is Coinbase, which is listed on the New York Stock Exchange; another is Gemini.

Market sources said the Australian Securities and Investments Commission and ASX would also be comfortable with them for products listed on the local sharemarket.

There have also been refinements to EFT structures. Many early offerings were linked to “feeder funds”, essentially derivatives or synthetics, but the SEC has become more comfortable with spot funds, where the actual cryptocurrency is held for the investors in trust.

Regulatory foundations

While the US attracted most of the attention this week, in Australia, ASIC and the ASX have set foundations over the past 2½ years, anticipating plenty of local demand for the products.

It was October 2021 when ASIC released updated regulatory guidance that created a special category of crypto-asset to back “exchange-traded products” in Australia, setting out expectations on custody, pricing methodologies, disclosure and risk management.

ASIC chairman Joe Longo. Despite his criticism of cryptocurrencies, ASIC set a policy in 2021 paving the way for bitcoin EFTs. Alex Ellinghausen

ASX released an admission policy for crypto-asset ETPs in August 2022. “These require issuers to compile documentation on custody, plans for trade execution, benchmarks, and experience of key participants,” it said.

ASX confirmed this week any trading would be subject to special margin requirements on brokers to offer protection from intraday volatility, given bitcoin trades 24/7 while ETFs settle overnight.

All the new regulation has helped to change the perspective of leaders of US finance, who now have dollar signs in their eyes given the fees for broking the new products.

Only last month, JPMorgan CEO Jamie Dimon called for bitcoin to be banned, describing the “only true use case for it is criminals, drug traffickers, money laundering [and] tax avoidance”. This week, BlackRock named JPMorgan as one of two brokers that will be responsible for steering cash into its bitcoin ETF.

Similarly, BlackRock boss Larry Fink described bitcoin in 2017 as “an index of money laundering” and compared hype around it to the Dutch tulip bulb craze of the 1600s. Now, he says BlackRock’s iShares’ offering will “democratise” access to the asset class.

“We are hearing from clients around the world about the need for crypto,” he said in October, attributing a rally to a “flight to quality” amid global tensions.

ASIC chairman Joe Longo has also been a long-term cryptocurrency bear, but said late last year that Australia’s securities regulator was working to regulate the space to increase investor protections.

Sheila Warren, CEO of the US lobby group Crypto Council for Innovation, says the dramatic events of the past week will lead to more appropriate and informed regulatory policies in the crypto space.

“This milestone will shift public perception, painting bitcoin as a legitimate component of a diversified investment portfolio,” she says. “A spot bitcoin ETF is a bridge between traditional finance and the burgeoning world of crypto.

“Allowing investors to partake in the bitcoin journey without the technical hurdles of direct ownership is a significant step towards inclusivity.”

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