The debut of US spot-Bitcoin ETFs thrusts Coinbase Global Inc. into the center of crypto’s biggest mainstream moment to date. Yet what may seem like an enviable position also creates a welter of risks for the company and its partners.
The first exchange-traded funds investing directly in Bitcoin began trading last week after the US Securities and Exchange Commission finally approved applications from almost a dozen investment firms, including heavyweights such as BlackRock Inc. and Franklin Templeton. The launches, which follow a years-long industry push, were heralded as a pivotal development that will stoke broader adoption of the world’s biggest cryptocurrency.
The majority of these ETF issuers will be dependent on Coinbase for the functioning of their funds in one way or the other, with the digital-asset exchange lined up to provide custodial, trading and lending services to BlackRock and others.
Yet even as Coinbase stands to gain from Bitcoin’s leap into traditional markets, the arrangements highlight what some see as a potentially dangerous concentration of risk. Meanwhile, the emergence of a bevy of funds offering cut-rate fees on Bitcoin investment vehicles poses a separate threat to revenue at Coinbase’s core trading platform.
“By design, our financial-market infrastructure is segregated into different roles,” David Schwed, chief operating officer at Halborn, a blockchain security firm, said. “When you have one entity that’s responsible for the entire life-cycle of the trade, I think that causes concerns.”
Coinbase’s multiple roles are a key worry of the SEC itself, which is embroiled in a legal battle with the company after accusing it in June of running an unregistered exchange, broker-dealer and clearinghouse for tokens it deemed to be securities. Coinbase has disputed the allegations, claiming the SEC is overstepping its bounds.
In announcing the approvals Wednesday, SEC Chair Gary Gensler pointedly noted that the agency isn’t endorsing any of the funds’ arrangements, nor does it “approve or endorse crypto trading platforms or intermediaries, which, for the most part, are non-compliant with the federal securities laws and often have conflicts of interest.”
Coinbase, already the world’s largest crypto custodian, is the most-popular choice of custody provider among Bitcoin ETFs. But issuers also are flagging the potential that the company will have to restrict or curtail some services it provides, according to their risk disclosures.
“There is definitely concentration risk because of so many firms using Coinbase as a crypto custodian,” said Dave Abner, principal at Dabner Capital Partners, an ETF consultancy. “Even if that turns out not to be a problem for the SEC, to me it seems like an unnecessary risk for investors and I’m surprised that a multi-custodian setup isn’t required of issuers, just to protect against unforeseen problems.”
Alesia Haas, Coinbase’s chief financial officer, said the company works “diligently to avoid conflict of interests” and that the market structure in traditional securities may not be a fit for crypto. A spokesperson added that Coinbase’s custody business “is not at issue in our case with the SEC.”
Coinbase is currently the only trading agent for BlackRock, which will buy and sell Bitcoin for its ETF through Coinbase Prime. And its lending business, a smaller part of the organization, is yet another critical cog in the Bitcoin ETF machine. Issuers such as BlackRock can borrow Bitcoin or cash from Coinbase for trades on a short-term basis.
But the financing capacity of Coinbase — coming from the company’s own balance sheet — could potentially create a bottleneck for such trades. To be sure, BlackRock at least has multiple ways to manage trades, even if financing isn’t available.