ETPs: the sensible option for crypto investors

Dec 12th, 2022 | By | Category: Alternatives / Multi-Asset

By Bradley Duke, Founder and co-CEO, ETC Group.

Bradley Duke, CEO of ETC Group

Bradley Duke, Founder and co-CEO of ETC Group.

In the wake of the failure of FTX, many crypto investors quite rightly worry about the possible collapse of other crypto “exchanges” and worry about leaving any crypto 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 internalization platforms.

An exchange is highly regulated and matches orders channeled from regulated brokers. There is most often a CCP in the middle and much monitoring of market abuse. While FTX was acting as a crypto broker, unlike a broker in traditional finance, no regulation was in place requiring customer deposits to be segregated or rules around capital and liquidity adequacy.

In November we witnessed an interesting phenomenon in bitcoin. In a month where the FTX story unfolded and the price of bitcoin fell 17%, the number of wallets holding bitcoin for under one month jumped by 25%, from 2,434,057 to 3,079,997. We also saw that so-called ‘shrimps’ wallets (as opposed to large ‘whales’) holding under 1 BTC, added 96,200 bitcoins worth $1.55bn to their balances in November. Perhaps some were buying the dip but probably the more likely reason is small investors moving their bitcoin balances off crypto exchanges and into their own hardware or software/Web3 wallets and away from co-mingled exchange wallets because they were concerned about losing their crypto holdings to a collapse.

Source: ETC Group.

Crypto ETPs are firmly rooted in the highly regulated world of traditional finance. Investors get the benefit of exposure to crypto without having to engage at all with crypto exchanges. The ETPs trade just like equities on regulated exchanges and units of the ETP are stored safely in one’s account at a regulated broker.

There are three clear benefits of purchasing crypto ETPs rather than purchasing crypto directly:

  1. Investors don’t have to deal with unregulated or under-regulated crypto exchanges where execution quality can be very poor and, as we saw with FTX, your crypto may not be segregated, could be used for high-risk activities without your knowledge or benefit, and may be wiped out entirely. Crypto ETPs trade on highly regulated exchanges via regulated brokers, so you are getting the protection of decades of regulation.
  2. Investors don’t have to worry about storage and “being your own bank”. There is no doubt that managing your own crypto wallet is, for the uninitiated, fraught with risk. Passwords get lost. Seed words get lost. Private keys may inadvertently be shared online. Phishing and hacking are real risks. With ETPs, the crypto backing the ETP is stored in institutional-grade custody often with insurance against loss from hacking or white-collar crime. The units of the crypto ETP are stored safely in your brokerage account along with the rest of your portfolio of stocks, bonds, and ETFs.
  3. Brokers have a regulatory duty of ensuring that investors access products that suit their risk appetite. For example, for a pensioner whose investment objective is the conservation of capital, the broker would not make high-risk, high-volatility products available to them. Crypto ETPs are regulated instruments so must be risk graded for the purposes of suitability.

Of course, not all crypto ETPs are the same. There is a big range in quality across crypto ETPs in the way they are structured, in how investor security is bolstered, in how liquid the ETP is on exchange, and in the choice of crypto custodian. It is up to the investor to do their homework on the available products before purchasing.

At ETC Group, we come from a regulated, traditional finance background, and have made it our core mission to issue crypto ETPs with the highest standards of investor security built into the products. The crypto that backs our ETPs is never lent out or encumbered in any way. We introduced the concept of an independent administrator to validate all crypto movements to prevent white-collar crime and have a bankruptcy remote structure with an independent trustee that has a pledge over the assets, to ensure that, unlike with FTX, even if the company ceases trading, segregated investor assets will always be protected and investors will be made whole.

(The views expressed here are those of the author and do not necessarily reflect those of ETF Strategy.)

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