Risks Hidden Behind Bitcoin Spot ETF
Apart from considering the transaction fees of various platforms, have you ever thought about the impact on ETF if the Bitcoin spot supporting it is stolen? Especially considering Coinbase, which is currently the custodian for 8 issuers, will it compensate for all losses?
Summary:
SEC Commissioner Crenshaw, who voted against the Bitcoin spot ETF: What are my reasons for opposing it?
Background:
Coinbase exposes two major risks for Bitcoin spot ETF: insufficient holdings and basis trading increasing market volatility.
Table of Contents:
Hidden Risks behind Bitcoin Spot ETF
Will Coinbase Compensate if BTC is Stolen?
Purchased $320 million in Commercial Insurance
Bitcoin is not FDIC Insured
What if Coinbase Goes Bankrupt?
Last week, the U.S. Securities and Exchange Commission (SEC) simultaneously approved 11 Bitcoin spot ETFs, with Coinbase, a U.S.-listed cryptocurrency exchange, providing important services to these ETF issuers, including BlackRock and Grayscale, among 8 other institutions, for BTC custody services.
Further Reading:
Will Coinbase Monopolize Cryptocurrency Custody and Become the Ultimate Winner in the Bitcoin ETF Era?
Hidden Risks behind Bitcoin Spot ETF
We know that each share of Bitcoin spot ETF requires actual Bitcoin as support. Issuers need to purchase and redeem Bitcoin in a timely manner based on the popularity of each ETF to stabilize the Bitcoin price fluctuations.
However, as we know, Bitcoin, as a digital asset stored on the blockchain, can only be kept in encrypted wallets, and the corresponding private key is the only tool that can transfer these Bitcoins.
However, in the crypto world, there is a risk of theft for any cryptocurrency assets in a wallet, and ETF issuers are no exception. As a regulatory agency, the SEC also acknowledges this risk in related documents:
Of course, large institutions like Coinbase usually use cold wallets and multi-signature mechanisms to further enhance security. Coinbase, which has been established for more than a decade, has not recorded any massive asset theft incidents, but the possibility of accidents happening is never zero.
Will Coinbase Compensate if BTC is Stolen?
In response to the risk of BTC theft, Coinbase, as the largest custodian of Bitcoin spot ETFs, has indeed taken corresponding measures. According to the application filed by BlackRock with the SEC, Coinbase has purchased $320 million in commercial insurance:
It is worth noting that this insurance by Coinbase will be shared among all its customers. However, once a theft event actually occurs, the $320 million insurance amount is likely to be insufficient for the current ETF scale. Users who have purchased a large amount of spot ETFs may suffer huge losses, while these issuers may not be significantly affected.
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Source: BlackRock Application Document
What’s even more alarming is that this may further tighten regulations and lead to stricter review of future crypto products by the SEC.
Bitcoin is not FDIC Insured
It is also worth mentioning that Bitcoin, as a digital asset, is different from real-world assets like cash and is not protected by the FDIC (Federal Deposit Insurance Corporation) or the SIPC (Securities Investor Protection Corporation):
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Source: BlackRock Application Document
What if Coinbase Goes Bankrupt?
Another possibility is what happens if Coinbase fails due to poor management?
According to the document, since custody of digital assets is a historical precedent, the Bitcoin entrusted to Coinbase by institutions may be considered assets borrowed by Coinbase in the event of bankruptcy. In that case, these entrusted Bitcoins are likely to be considered as Coinbase’s bankruptcy liquidation assets, causing ETF issuers to lose all their Bitcoins and suffer a significant blow.
Of course, the probability of Coinbase suddenly going bankrupt is not very high. Issuers may replace custodians in advance or use multiple custodians to reduce reliance on a single company. This article is just a possible risk reminder and contemplation, hoping to help readers better understand the operation of Bitcoin spot ETFs.
For more information, you can visit BlackRock’s S-1 application document submitted to the SEC.
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