Three unexpected risks from Wall Street’s foray into bitcoin

Bitcoin has officially gone mainstream in the U.S. after the approval of 11 spot bitcoin ETFs. Products by issuers such as BlackRock, Fidelity and Bitwise debuted on Thursday and exceeded $7 billion in cumulative trading volume over the first two days of trading.

For years, the crypto industry has been waiting for this approval to bring a huge inflow of fresh funds into the market, which is now open to the largest legacy finance firms and crypto-curious retail investors who are not ready for the technicalities of crypto.

However, bitcoin meeting Wall Street has its risks, too. Some long-time bitcoiners point at potentially increasing concentration of bitcoin ownership in the hands of a small group of institutions, potential rehypothecation and changes in the way the bitcoin community governs itself.

A single point of failure
The most obvious concern noticed by many prominent crypto individuals is that all the bitcoins backing the ETF shares will be held by only a handful of assigned custodians. Most of the issuers listed Coinbase as their custodian, with exceptions of VanEck, who chose Gemini, and Fidelity with its own custody product.

Jameson Lopp, co-founder and CTO of a bitcoin custody firm Casa, points out that in such situation, the custodian becomes a single point of failure and there are “relatively few ‘doors’ that would need to be knocked upon by government agencies,” if they wanted to seize the bitcoin locked in the ETFs, he told The Block.

Jeffrey Ross, the founder and managing director of an asset management firm Vailshire Capital, believes this concern is “overblown.” Theoretically, there is a risk of a custodian to make a mistake and lose large amounts of clients’ bitcoin, but large finance firms like the current ETF issuers have measures in place to prevent such accidents from happening, he told The Block.

As for a potential government seizure, people draw analogies with the Roosevelt-era ban on gold ownership. However, back then, the U.S. dollar was backed by gold, making it an essential component of monetary policy, and bitcoin is not in the same position, Ross said. “There is no reason for the government to seize bitcoin from Americans,” he added.

A new type of double-spending attack
Another potential concern can be the so-called financialization of bitcoin, or the transfer of practices from traditional finance into the bitcoin economy, which until now has been functioning more or less by its own standards.

“The ETFs are a double-edged sword for the bitcoin ecosystem,” says Caitlin Long, founder and CEO of Custodia. “The big drawback is that new forms of leverage-based financialization of bitcoin will happen. The SEC did the right thing by prohibiting custodians from lending the bitcoin that backs the ETF units, but there will be commingling, collateral substitution and leverage on the layer above that,” Long told The Block.

Bitcoin-based securities will essentially create bitcoin IOUs (“I owe you”), says Casa’s Lopp. This means that with ETFs, instead of actual bitcoins stored in hardware and software wallets, people will own something that represents the value of bitcoin but has none of its essential properties like decentralization, permissionless nature and visibility on a public ledger.

“Since you can’t verify a company’s balance sheet, you can’t be sure that your IOU is redeemable for the asset it represents,” Lopp said in a blog post last year.


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