3 Risks of Cash ETFs for Bitcoin That No One Pays Attention to

With the approval of the first spot bitcoin ETFs in the US, the asset has finally entered the mainstream economy. These funds were launched last Thursday and their trading volume exceeded 7 billion dollars in the first two days. However, some experts are concerned about the risks that the entry of capital from the traditional market can bring to this ecosystem.

To Report Deblock, the digital currency industry has been waiting for the approval of these products for years to bring a huge flow of capital into its market. A market that is now open to the largest traditional financial and micro-investment companies that cannot invest directly in digital currencies.

However, Bitcoin’s intersection with Wall Street also has its risks. Some longtime Bitcoin investors point to the potential increase in concentration of Bitcoin ownership in the hands of a small group of institutions, its re-pledge and changes in the way the community is run.

An important breaking point

The most obvious concern among leading figures in the digital currency industry is that all the bitcoins backing the shares of these ETFs will be held by a small number of designated custodians. Most of the issuers have listed Coinbase as their custodian, with the exception of VanEck, which chose Gemina, and Fidelity, which uses its own custodian service.

Jameson Lopp, co-founder and CTO of Bitcoin Custody Company Casa, points out that in such a situation, these custodians will become a point of failure. He added:

If government agencies seek to confiscate the Bitcoin reserves of these ETFs, all they have to do is go to these few custodians.

Jeffrey Ross, founder and CEO of asset management firm Wilshire Capital, believes that Loop is worrying too much. He said about this:

Theoretically, there is a risk that custodians could make a mistake and lose a significant portion of clients’ Bitcoins, but large financial firms such as the issuers of these ETFs have taken steps to prevent such incidents from occurring.

Regarding the possibility of confiscation of these bitcoins by the government, he mentioned the prohibition of gold ownership during the Roosevelt era. Ross said:

Of course, back then gold was backed by the US dollar, making it an essential component of monetary policy, but Bitcoin is not. However, there is no reason why the US government should seek to confiscate Bitcoin.

A new form of double spend attacks

Another potential concern could be the monetization of Bitcoin, or the transfer of methods from the traditional financial structure to the Bitcoin economy, which has so far performed more or less by its own standards. Caitlin Long, founder and CEO of Custodia, says spot ETFs are a double-edged sword for the Bitcoin ecosystem.

The main drawback is that new forms of Bitcoin leveraged finance will be created. The US Securities and Exchange Commission did the right thing by prohibiting custodians from lending bitcoins backed by these ETFs. But in the end, we will see the mixing of assets, the substitution of collaterals and the application of leverage in their upper layer.

Bitcoin-based securities essentially mean they create a debt instrument for the asset, says Jason Loup. This means that by buying shares of ETFs, instead of bitcoins stored in wallets, people will own something that represents the value of bitcoin, but none of its essential features such as its decentralization, open nature, and transparent ledger.

Lupe said in a blog post last year:

Since you can’t verify the accuracy of a company’s balance sheet, you can’t be sure whether your Bitcoin debt is redeemable or not.

Long also noted in a post on X that there are examples of Wall Street firms that have inflated their stock offerings by buying and selling shares that don’t exist. Now, they can do the same tricks with Bitcoin.

Ross stated that while the current design of these spot ETFs does not allow issuers to lend bitcoins backed by ETFs, over time, more sophisticated derivatives will be created based on these ETFs, allowing for irresponsible behavior.

Currently, Grayscale, one of the issuers of these Bitcoin ETFs, has submitted an application to the US Securities and Exchange Commission to offer a Covered Call ETF, which is designed to earn money from opening a trading position on the Grayscale Bitcoin Trust. Ross said:

The United States Stock Exchange Commission should be trusted to monitor these issues, but this agency also has a history of not monitoring things.

He is both pessimistic and optimistic about this issue. The transparency of public blockchains means that companies can make their shares public. But companies are unlikely to provide this information unless people ask for it. Ross points out that this need will also arise after one of these companies is defunct. He added:

Some of Wall Street’s rag money in 2025-2026 will be Bitcoin.

Sovereignty wars

Another concern after the approval of spot bitcoin ETFs is that institutions issuing these products will hoard a lot of bitcoin, gain power in the bitcoin community, and begin trying to influence how the protocol is maintained in the future.

For example, if the Bitcoin blockchain were to split into two major groups, this could be problematic for issuers of these ETFs, who would now have to forego the proceeds of any forks or airdrops, which would result in a decrease in the value of the assets underlying their ETFs. Also, they may have an incentive to prevent such forks from being implemented.

Of course, Loup thinks this idea is far-fetched. In the Bitcoin “block size war” of 2016-2018, mining companies and service providers joined forces in favor of forking Bitcoin and increasing the maximum block size. However, the Bitcoin community ultimately decided to keep the block size the same.

The difference between then and now is that, unlike the companies that were active in the Bitcoin scalability debate in the past, ETF providers will not be doing as many transactions and interacting with the Bitcoin protocol. Loop said:

Therefore, we hope that they will have less motivation to become one of the active groups in the field of development of this protocol.

However, Ross expects that in 2025 we will see a new sovereignty war. he explained

The issuers of these ETFs will definitely try to make changes that are not very significant. They will probably try to extend the Bitcoin protocol to proof-of-stake or increase the current fixed supply, but real Bitcoin investors won’t let that happen.

Ross believes that bitcoin spot ETFs are only a temporary solution for the transition phase during which most people move from traditional financial instruments to bitcoin. Baby Boomers already have the most wealth, but their children will not need an intermediary between them and Bitcoin.

The more people own bitcoins, the greater the incentive to learn about bitcoins. The younger generation will inherit their parents’ wealth and sell these ETFs to buy Bitcoin.