ETFs
How Bitcoin ETFs Change the Risk-Reward Ratio for Institutional Investors
As expected, the deployment of Bitcoin spot exchange-traded funds (ETFs) in the US market has had a considerable positive impact on the digital asset sector. He triggered a stampede retail investors and set bitcoin investment records (BTC) and in ETFs.
More importantly, being part of a product approved by the U.S. Securities and Exchange Commission (SEC) has changed bitcoin’s risk-reward ratio, bringing crypto back into institutional investment conversations. This sparks new interest from some companies and encourages others to restart projects that had been put on hold. The door to the traditional financial system has been reopened.
Note: The opinions expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.
Institutional investors view risk from many aspects, including: products, counterparties and risks associated with the underlying asset itself. In traditional finance (TradFi), all this is well understood.
Products have become commoditized, with many companies offering similar products. Counterparties – market makers, custodians, clearing houses, etc. – which help absorb trading risk are well known. The different asset classes are also well understood and there are traditional ways of assessing the risks of a particular asset.
Over the years, much of the risk and volatility has been removed from the system. It’s the black swan events that create problems. The risk is low, but so are the rewards. Opportunities to beat the market are hard to find.
What we have seen in crypto is a series of events that have had a negative impact, but are predictable given the lack of regulation and controls in the sector. The risk of these events occurring is too high for institutions to reap outsized rewards.
Bitcoin ETFs reduce risk in all three dimensions.
ETFs have been available in the US market for over 30 years. Everyone understands the product. Purchasing the asset in a securitized product is simpler than purchasing bitcoin outright for cash. Many investors find it better to pay a management fee to have someone else handle custody, settlement risk, and other operational aspects of Bitcoin trading. They no longer have to take these risks directly.
The presence of big brands like BlackRock, Fidelity and others reduces counterparty risk. There are many native cryptocurrency custodians, liquidity providers, and market makers, but they are relatively unknown in the world of TradFi.
ETFs introduce some of the dependent counterparties in the crypto universe to general investors. Knowing that big TradFi players have done due diligence on their finances, processes, procedures and security practices reduces the fear factor. Additionally, it shows them who they can turn to for help if they want to hold bitcoin and other digital assets and conduct spot transactions themselves in the future.
By approving bitcoin as an underlying product in the ETF space, the SEC has reduced risk at the base level of the asset – namely the fear that crypto could be banned entirely in the United States. Obviously, greater regulatory clarity could further reduce asset risk, but market demand for ETFs has pushed the agency to address some important issues. This has also pushed ETF issuers to put in place many simple elements that reduce the risk that institutional players expect to see.
All of these elements create trust in the market, which is crucial to getting digital assets back on the path to the mainstream. There are many ideologies, jargons, and technical terms surrounding cryptography. But it’s essentially another asset class that uses a different technology.
Before FTX, many people put these risks aside and focused on price appreciation and market access. After FTX, people say: I want to get involved, but I need to know that I’m protected on a basic level. ETFs do this, while exposing institutional investors to crypto-dependent counterparties. They put the industry back on a positive path.
There are two things currently keeping institutions away from digital assets. One is philosophical. They don’t believe or like Bitcoin or crypto. Then there is a second camp for which the risk/reward ratio is not yet attractive enough. For these people, the success of ETFs makes it increasingly difficult to stay on the sidelines, especially when customers demand crypto products.
The day will come when the main risk in Bitcoin and other digital assets will be at the base level of asset performance – just as it is in TradFi. It won’t be one decision or one product that will magically make this happen. It’s going to be a long process, but eventually all questions about products, counterparties and regulations will disappear.
The only question will be: do you want to invest in digital assets or not?