Bitcoin ETFs: Even worse for crypto than central exchanges

In recent weeks, there has been a notable increase in interest from traditional finance in cryptocurrency-based exchange-traded funds (ETFs). BlackRock, after facing concerns from the Securities and Exchange Commission (SEC) regarding its initial filing, submitted a fresh application for a Bitcoin ETF on July 3. Preceding this, Fidelity led a group of investment firms in submitting applications to the SEC for Bitcoin-based ETFs. Additionally, HSBC has become the first bank to offer Bitcoin (BTC) and Ether (ETH) ETFs to customers in Hong Kong.

In the Bitcoin realm, positive news often has unintended negative consequences in the long run, while short-term negative news can strengthen the case for Bitcoin. A notable instance of the latter occurred during the 2017 “Blocksize War,” which led to a division within the Bitcoin community. The split resulted in the creation of Bitcoin Cash as a larger block camp and the implementation of the Segregated Witness upgrade in Bitcoin by the smaller block camp. Although the short-term aftermath was chaotic, with many critics celebrating Bitcoin’s demise, it ultimately served as a crucial lesson in decentralized consensus. Furthermore, it paved the way for the layered scaling achieved through the Lightning Network, which we benefit from today.

To illustrate the adverse effects of seemingly positive news, we don’t need to look too far into the past. Until late 2022, FTX stood as a prominent example of crypto gaining mainstream recognition, thanks to its Superbowl ads, stadium naming rights, and prominent features in glossy magazines. However, in the end, FTX turned out to be a ticking time bomb that caused significant damage and setback to the industry’s credibility for years to come.

And again, as it goes, the seemingly bad news — FTX collapsing and losing a lot of money for its users — will become positive in the long run, as people will take better care of their Bitcoin in the future, thus limiting the systemic risk of large custodian blow-ups.

Evade the fakes

The downfall of FTX and the subsequent ripple effects in the market have demonstrated that centralized exchanges are not suitable for everyday investors seeking to capitalize on Bitcoin’s tremendous potential. Similarly, the concept of Bitcoin-linked exchange-traded funds (ETFs) is even more problematic. In fact, ETFs present a worse proposition than centralized exchanges because they completely eliminate the possibility of withdrawing the actual Bitcoin, which is the most crucial aspect of Bitcoin itself: the ability for individuals to have control over their funds without relying on trust in others.

There are additional risks associated with ETFs that extend to the broader market. The existence of “paper Bitcoin,” which refers to claims without actual backing by Bitcoin, can distort the market and undermine Bitcoin’s inherent monetary policy. In the past, exchanges that issued paper Bitcoin, like FTX, were constrained by withdrawal runs and eventual collapse. As a result, the fake Bitcoin claims were eradicated along with the ill-fated exchanges.

However, the situation would likely be different with ETFs. Since there is no option to withdraw the underlying asset, paper Bitcoin can be generated without limits. If Bitcoin ETFs dominate the Bitcoin investment landscape, there is a real possibility of flooding the market with millions of paper Bitcoin, leading to a suppression of Bitcoin’s price.

With Bitcoin, holding it means owning it

In the context of Bitcoin, ownership is very closely linked to control over the cryptographic keys associated with specific Bitcoin addresses. Now, it might be true that someone can own Bitcoin in a legal sense without having direct control over the keys — such as when owning an exchange account or holding an ETF share — but that is simply not a good idea in the Bitcoin world.

Bitcoin’s digital nature, perfect portability and global liquidity make it especially susceptible to embezzlement, theft or just basic mismanagement. The only way to truly own Bitcoin is to control the keys.

Some might welcome a possible short-term price pump associated with an approval of a major Bitcoin ETF (such as BlackRock’s), but the long-term impact on Bitcoin adoption would be likely negative (including the long-term price of Bitcoin). The only adoption that actually matters involves self-custody — everything else is a trap.

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