Todd Rosenbluth, Head of Research: This is a reminder that advisors and end clients must have a strong core of building block equity and fixed income ETFs, to allow them to use alternative investments and thematic strategies with higher risk profiles in exchange for potentially higher returns. If a bitcoin futures ETF like the ProShares Bitcoin Strategy ETF (BITO ) or direct exposure to crypto represented a low single-digit slice of their portfolio, then this is a minor bump and not a major crash to the portfolio.
Lara Crigger, Editor-in-Chief: As jaw-dropping as the FTX situation is, I don’t think it’s really changed any investor’s mind about the long-term attractiveness of crypto as an asset class. After all, one company — even an exchange — does not an asset class make. (It probably helped soothe some nerves that Binance didn’t end up buying FTX!) Yes, we’ve seen some outflows from the Amplify Transformational Data Sharing ETF (BLOK ), which is a good proxy for the crypto equities space. But all things considered, the outflows have been pretty mild (>$10 million).
It’s the same deal in bitcoin futures. If you were bullish on crypto before, you probably haven’t moved any assets out of bitcoin itself (In fact, in the past week, we’ve seen net inflows into BITO). And if you were bearish, well, you’re probably looking at what’s going on with a sense of relief. Maybe you’re even putting some money into the ProShares Short Bitcoin Strategy ETF (BITI ). (BITI has seen inflows of $32 million over the past week.)
It’s wild to think that a situation as bonkers as FTX’s isn’t making big money move, but at least from an ETF perspective — it isn’t. Probably because the money already had moved earlier this year, once the “crypto winter” settled in.
Dave Nadig, Financial Futurist: It’s definitely worth remembering that legally, ZERO of the dollars in FTX (not FTX.us) were subject to US regulation unless they crossed the border to get there, in which case the users did it in violation of the law. So have fun with your lawsuit.
The inexcusable stuff, though, is the U.S.-based institutional pools caught up in funding FTX as an entity. There’s zero excuse for the outrageous due diligence failure. The note from FTX’s new CEO today is just the most savage thing I’ve ever read.
Crigger: Yeah, when the guy who oversaw Enron’s bankruptcy says he’s “never seen such a complete failure of corporate controls,” you know you done f***ed up. But there’s not much the SEC could have done to prevent this, is there?
Nadig: Literally zero. FTX is a non-U.S. business. To the extent they broke their own walls and crossed into FTX.us, then there could be issues. But so far, it largely seems contained to FTX/Alameda, neither of which is subject to any U.S. jurisdiction unless they committed a cross-border financial crime. But if there is a cross-border thing, then I think it would go to the Treasury (FinCEN), which has to go through ICL (International Criminal Law) proceedings. Put another way; I’ll be dead before anything happens from the U.S. side of things, really. Maybe it puts a fire under some real Crypto rules.
That said, I think the Bahamian authorities will use this to prove they’re not just going to rubber stamp financial crime.
Roxanna Islam, Associate Director of Research: I wrote about this in my most recent Crypto Logs note: “Crypto Logs: ‘Crash Course’ On Custody.” But overall, I think there are two separate questions to address:
1) Is this the end of the crypto industry?
No. While consumer confidence has been shaken, most long-term investors realize FTX is just one company engaged in fraudulent activity and does not represent the crypto industry, as Lara said. We all know the crypto industry needs more regulation, and this incident confirms that. The crypto industry does not offer investors the same protection as the banking or securities industry, especially considering that investors are using offshore platforms like FTX because maybe [the exchange is] getting celebrity endorsements or offering high staking yields.
2) How will crypto investors now think about custody?
I think this is the more significant part of the question. Investors (especially buy-and-hold investors) might turn to private wallets again, where they maintain ownership of the private key. Lara has also mentioned BITO above. BITO has an almost perfect correlation with the price of Bitcoin, but it tracks futures prices and doesn’t hold the asset, so the investor wouldn’t be exposed to the same sorts of liquidity risk.
The Grayscale Bitcoin Trust GBTC also tracks the price of Bitcoin very closely, but GBTC stores assets in offline or “cold” storage with a custodian (meaning that assets are less vulnerable to a cyberattack) and does not borrow or lend the underlying assets (reducing the risk of a liquidity event).
Then there are the crypto equity ETFs, like BLOK or the Invesco Alerian Galaxy Crypto Economy ETF (SATO ) — you can get some exposure to the price movements of crypto without worrying about investing directly in Bitcoin.
U.S.-based exchanges, like Coinbase (COIN), also offer exposure. Coinbase is a publicly traded company regulated by the SEC, which also releases audited financials once a year and is much easier to perform due diligence on than a company like FTX, which is not only offshore but also closely tied to a trading firm. Coinbase stores the majority of assets in cold storage and, maybe more importantly, holds its client assets 1:1. Coinbase will not trade or lend your assets without your permission, meaning you can withdraw your funds anytime you want.
Crigger: Do y’all think that FTX’s implosion is a good argument for only investing in U.S.-based crypto equities, (and crypto ETFs/other vehicles that only invest in U.S.-based equities?) Seems like there’s just too much danger to stray too far from home.
Nadig: I think it’s fair to say investing in any unregulated industry is speculative! But I also think we’ve learned how hard it is to understand where the real risks might be “housed.”
Take BLOK; it has 80% of its holdings in North America. The top holdings are firms like IBM (IBM) and Accenture (ACN); I don’t think anyone’s all that worried about them. But they also own Galaxy Digital, which has acknowledged some $80 million in exposure to FTX. While I suspect that’s not bank run/panic territory, there are FTX exposures across these firms we’re still discovering.
Islam: A good portion of the crypto industry is actually outside of the U.S. Many of the crypto miners, for instance, are Canadian companies. And arguably, a lot of the world is ahead of the U.S. regarding crypto regulations. So I think there’s a big difference between investing in non-U.S.-based crypto equities and putting your money in an offshore exchange or platform.
Rosenbluth: I’ll just note that this brings us no closer to a spot in Bitcoin ETF listed in the U.S. The SEC has been consistent in being concerned about fraud and manipulation. This is a front-page example that those risks remain.
Islam: But I think it’s worth pointing out that a spot Bitcoin ETF would maintain custody of the assets without trading or lending them out, so it is an entirely different situation than what happened with FTX.
Be sure to catch the VettaFi Voices, as well as a host of experts, at Exchange, on February 5–8, 2023 in sunny Miami, Florida. To learn more about the event and register, please visit the Exchange website.
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