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Is Spot Bitcoin ETF A Trap For Naive Investors?

Last Updated January 17, 2024 8:51 AM
Giuseppe Ciccomascolo
Last Updated January 17, 2024 8:51 AM
Key Takeaways
  • The SEC has approved the first spot Bitcoin ETFs, making it easier for investors to approach BTC.
  • While spot Bitcoin ETFs can be a convenient way to invest in Bitcoin, they also come with some risks.
  • Regulators have warned investors about the risks of investing in spot Bitcoin ETFs, especially for naive ones.

In January 2024, 11 Bitcoin-focused exchange-traded funds (ETFs) made their debut on major exchanges such as the New York Stock Exchange (NYSE), Nasdaq, and Chicago Board Options Exchange (CBOE). This noteworthy success occurred after the United States Securities and Exchange Commission (SEC) reluctantly granted approval following a court mandate, as expressed by its chairman, Gary Gensler.

Gensler emphasized the necessity of investor caution, highlighting the speculative and volatile nature of the underlying asset. He underscored the multifaceted use cases of Bitcoin, including but not limited to illicit activities, money laundering, sanctions, and ransomware.

Should investors – in particular naive ones – be careful when investing in spot Bitcoin ETFs?

Larry Fink’s Breakthrough

Bitcoin’s inherent volatility persisted even on its symbolic journey to maturity, a reality acknowledged by BlackRock CEO Larry Fink. Fink, often credited, or blamed, for steering cryptocurrency into mainstream acceptance on Wall Street, initiated this process in July 2022. At that time, Fink, overseeing the world’s largest asset management company with $10 trillion under management, publicly recognized Bitcoin as a potential alternative to gold.

What makes this narrative intriguing is the unexpected alignment of Fink, a titan of Wall Street, with the early adopters of Bitcoin. Fink has not expounded on the epiphany that led him to embrace cryptocurrency, but the shift occurred. The momentum generated by Fink’s endorsement suggests this development is far from its conclusion.

After Bitcoin ETFs approval, Fink also endorsed ETFs for Ethereum, the second-largest cryptocurrency by market capitalization. He also expressed his belief in these developments as “stepping stones towards tokenization,” affirming his anticipation the financial landscape will ultimately gravitate towards broader tokenization trends.

Analysts and crypto experts believe Fink had a huge role in making Bitcoin “more institutional”, bringing it to the attention of traditional investors. But investors, especially new ones, should consider the risks of investing in a Bitcoin ETF.

Why Investors Should Be Careful

Thanks to ETFs approval, all kind of investors – even retail and naive ones – can now approach Bitcoin. Investing in an ETF, in fact, doesn’t mean you need to buy Bitcoin. The means it’s much less expensive to put money into this financial instrument.

But, despite Fink’s enthusiasm and all the headlines celebrating the SEC’s greenlight, there are some risks for investors. The ETFs were launched to make it easier for small investors to have exposure to cryptocurrency. They were also designed to make them feel more at ease, thanks to the reputation enjoyed by traditional finance companies that focus on Bitcoin.

In theory, you can take the plunge, as long as you don’t put sums at stake that you can’t afford to lose. But are small investors able to withstand the very high volatility of Bitcoin? Here are some risks linked to investing in Bitcoin ETFs if you’re not a navigated investor.

Additional Costs

Another aspect to examine revolves around the supplementary costs linked to Bitcoin ETFs. These financial instruments often have management fees, which, in certain instances, might surpass the expenses associated with directly holding Bitcoin. Despite this, many investors may deem such compromises acceptable, given the enhanced security and peace of mind ETFs can provide within the realm of crypto asset management.

Crypto Market Unpredictability

It is crucial to remember that the cryptocurrency market is renowned for its inherent unpredictability. This distinguishes it from more conventional financial markets. ETFs, designed to mirror the price movements of their underlying assets, would, inevitably, mirror this volatility. The nature of the cryptocurrency market introduces the potential for significant changes in the price of a spot Bitcoin ETF. It also adds complexity to the forecasting of its long-term performance.

Potential Price Discrepancies With Bitcoin

A further potential drawback is the likelihood of a spot Bitcoin ETF’s price deviating from the actual value of Bitcoin. Market dynamics and administrative intricacies could influence the ETF’s price, independent of Bitcoin’s actual value. This may result in situations of overvaluation or undervaluation compared to BTC.

Vulnerability to Legislative Decisions

Finally, the introduction of a spot Bitcoin ETF could deepen Bitcoin’s connection to legislative dynamics. Adverse regulatory decisions could have adverse effects on the ETF’s value, potentially affecting the overall valuation of Bitcoin. Investors should be aware of this heightened exposure to regulatory risk and carefully factor it into their investment considerations.

Regulators’ Warning

Several regulators around the world have warned inexpert investors about putting money into a Bitcoin ETF. If Gensler said a law forced him to vote in favor of the ETF, his colleagues across the globe cautioned investors and raised some concerns.

In Europe, Consob’s chairman, Paolo Savona, said  digital assets only acquire market value when someone purchases them, typically using legal tender. That, as Keynes pointed out, always carries a debtor upon its creation – whether it be the State, central bank, issuing institution, or depositary banks. Savona asserts that the absence of a debtor for cryptocurrencies legitimizes the stance of monetary authorities. He classified them as non-legal tender, meaning they do not function as a medium for settling payments or debts.

However, he also noted the challenge faced by financial authorities and legislators in assimilating cryptocurrencies into the existing institutional framework designed for traditional financial activities. This perspective stands in stark contrast to the outlook championed by Fink, showcasing a divergence in their worldviews.

Furthermore, the European Securities and Markets Authority (ESMA) , the main regulator of financial markets in Europe, warned investors. Some days before SEC’s approval, ESMA said  it’s necessary to expedite the enforcement of European regulation on crypto-assets (MICA) and promptly designate the competent national authorities.

ESMA said: “This proactive approach is imperative to swiftly fortify the safeguards for savers who find themselves increasingly vulnerable to the escalating threat of crypto-related scams.”

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