Crypto ETFs - Taming the wild or bridging the gap?

The success of Bitcoin (BTC) ETFs, particularly BlackRock’s iShares Bitcoin Trust and Fidelity’s Wise Origin Bitcoin Fund, signals that the digital asset class has entered a new phase. By the end of 2024, these two ETFs alone had collectively attracted over US$62 billion in net inflows, drawing in mainstream institutional investors who were once wary of crypto’s volatility. With the approval of Spot Ethereum (ETH) ETFs by the US Securities and Exchange Commission (SEC) in July 2024 as well, the success of these new products, on paper at least, seems undeniable. Yet, behind these impressive figures lies an inherent paradox. While these ETFs promise simpler access to digital assets, they also risk undermining the very principles of decentralisation that made cryptocurrencies appealing in the first place.

The core philosophy of the Satoshi whitepaper is rooted in decentralisation with the vision of creating a peer-to-peer, trustless system outside the grasp of traditional financial institutions. Crypto was designed to sidestep intermediaries and the ethos was clear - distribute power and control away from central authorities.

Some OGs in the crypto community therefore have a distinct oxymoron to wrestle with: ETFs are inherently centralised. Custody, management, and trading are all handled by large institutions, which creates the very intermediaries that cryptocurrencies sought to replace. Moreover, ETFs must adhere to stringent financial regulations, placing them firmly within the framework of traditional finance and away from the “free spirit” allure of early crypto.

Despite the philosophical pushback, many others see crypto ETFs as a necessary compromise. They may dilute the pure ideals of decentralisation, but they also bring a much-needed dose of legitimacy and stability to the crypto space. These products make it easier for institutional investors to gain exposure to digital assets without the complications of direct ownership, custody, or security concerns. For those in the asset management world, crypto ETFs offer an accessible entry point into what is, for now, a volatile market.

Beyond accessibility, ETFs represent the maturation of the cryptocurrency market and a true sign that the space is evolving into the next phase. Thanks to increased regulatory clarity, improved liquidity, and growing infrastructure, it is easier than ever for ETFs to function effectively. The success of Bitcoin ETFs led to the growing interest in expanding the offering to include other digital assets like Ethereum and potentially we could see other token projects like Litecoin (LTC), XRP, Hedera (HBAR), and Solana (SOL) making that next step in 2025. There is even rumour of one for DOGE.

However, the attraction of now being able to invest in crypto through ETFs does not entirely remove the significant risks of this asset class, which remain volatile and susceptible to dramatic price fluctuations amongst other more legal and technical challenges.

While the approval of Bitcoin ETFs by the SEC was groundbreaking, the regulatory landscape for cryptocurrencies remains fragmented in the US and across the globe in sophisticated financial service centres which find that their legislation simply cannot keep up with the technological advancement. Offshore domiciled ETFs certainly then offer some advantages, including more flexible, predictable and stable regulatory environments and potentially quicker approval processes. However, they also carry additional risks. Investors must carefully assess the jurisdictional stability and the legal framework of these funds, as well as the reception they will receive from traditional banking institutions that they will still need to interact with. It is always a part of the consideration that offshore ETFs will also provide more favourable tax treatments in the relevant domicile, but this actually could add complexity to investors' portfolios, especially when considering cross-border tax implications.

Moreover, the centralisation of ETF management means these funds are susceptible to the same security breaches or failures as other financial products, which is a real concern in an ecosystem that has seen reliance on third-party custodians and exchanges cause some incredible wobbles when one of them fails.

Then, of course, there is the risk of market manipulation. While Bitcoin has matured significantly and is now at a volume that becomes very hard to control (although Michael Saylor is trying), smaller or less-established coins remain vulnerable to market forces with far less regulatory oversight than traditional securities. These risks are exacerbated when dealing with ETFs that track smaller tokens with lower liquidity.

In some ways, the rise of crypto ETFs reflects the inevitable convergence of cryptocurrency’s decentralised ideals with the demands of global finance. They are not the radical “stick it to the man” vehicles that Bitcoin once embodied, but they offer an entry point for traditional investors, and in that sense, they are an important part of the ecosystem’s growth.

For institutional investors, however, crypto ETFs are both an opportunity and a risk. For asset managers, investment committees, and fund selectors, the challenge is clear: how to embrace innovation without losing sight of the fundamental principles that make cryptocurrency so compelling in the first place.

At Harneys, we stand at the intersection of blockchain technology, digital assets, and regulatory expertise. Our team has been at the forefront of advising asset managers and fintech companies on launching and structuring digital asset-focussed funds since 2015. With a deep understanding of the unique challenges and opportunities in this space, we guide clients on regulatory compliance, crypto asset tracing, and structuring investment vehicles. For strategic advice on cryptocurrency ETFs and more, Harneys is your trusted offshore partner.