By Bradley Duke, founder and co-CEO, ETC Group.
Bradley Duke, founder and co-CEO of ETC Group.
In the wake of the FTX bankruptcy, many cryptocurrency investors rightly worry about the possible collapse of other cryptocurrency “exchanges” and worry about leaving cryptocurrency or fiat balances on these exchanges.
I put “exchanges” in quotes because these are not exchanges like the Deutsche Börse or the NYSE, these are really unregulated broker insourcing platforms.
An exchange is highly regulated and matches orders channeled by regulated brokers. Very often there is a CCP in the middle and a lot of market abuse monitoring. While FTX acted as a cryptocurrency broker, unlike a broker in traditional finance, there were no regulations in place requiring segregation of client deposits or capital and liquidity adequacy rules.
We saw an interesting phenomenon in bitcoin in November. In a month where the FTX story unfolded and the price of bitcoin fell 17%, the number of wallets holding bitcoin for less than a month jumped 25%, from 2,434,057 to 3,079,997. We also saw that so-called “shrimp” wallets (as opposed to large “whales”) holding less than 1 BTC, added 96,200 bitcoins worth $1.55 billion to their balances in November. Maybe some were buying the dip, but probably the more likely reason is that small investors are moving their balances into bitcoin turned off cryptocurrency exchanges and in their hardware or software/Web3 wallets and away from intermingled exchange wallets because they were worried about losing their cryptocurrency holdings to a collapse.
Source: ETC Group.
Cryptocurrency ETPs are firmly entrenched in the highly regulated world of traditional finance. Investors get the benefit of cryptocurrency exposure without having to engage with cryptocurrency exchanges at all. ETPs are traded just like shares on regulated exchanges and units of the ETP are held securely in your account with a regulated broker.
There are three clear advantages to buying crypto ETPs over buying cryptocurrencies directly:
- Investors are not dealing with unregulated or under-regulated cryptocurrency exchanges where the quality of execution can be very poor and as we have seen with FTX your cryptocurrency may not be segregated, it may be used for high risk activities without your knowledge or benefit, and may be completely deleted. Crypto ETPs are traded on highly regulated exchanges through regulated brokers, so you get the protection of decades of regulation.
- Investors don’t have to worry about storage and “be your own bank.” There is no doubt that managing your cryptocurrency portfolio is, for the uninitiated, fraught with risk. Passwords are lost. The seed words are lost. Private keys can be inadvertently shared online. Phishing and hacking are real risks. With ETPs, the cryptocurrency backing the ETP is held in institutional-grade custody, often with insurance against losses due to hacking or white-collar crime. Units of the crypto ETP are securely stored in your brokerage account along with the rest of your portfolio of stocks, bonds and ETFs.
- Brokers have a regulatory duty to ensure that investors have access to products that suit their risk appetite. For example, for a retiree whose investment goal is capital preservation, the broker would not make high-risk, high-volatility products available to him. Crypto ETPs are regulated instruments and therefore must be risk-rated for eligibility purposes.
Of course, not all crypto ETPs are created equal. There is a wide range of qualities among crypto ETPs in the way they are structured, the way investor safety is enhanced, the liquidity of the ETP on the exchange, and the choice of crypto custodian. It is up to the investor to do their homework on the products available before purchasing.
At ETC Group we come from a traditional and regulated financial background and have made it our core mission to issue crypto ETPs with the highest standards of investor safety embedded in the products. The cryptocurrency backing our ETPs is never lent or encumbered in any way. We have introduced the concept of an independent trustee to validate all cryptocurrency movements to prevent white collar crime and have a remote bankruptcy structure with an independent trustee who has a lien on the assets, to ensure that unlike FTX, even if the company ceases trading, the assets of the segregated investors will always be protected and the investors will be integrated.
(Opinions expressed here are those of the author and do not necessarily reflect those of ETF strategy.)