Launch of Bitcoin ETFs Could Worsen Crypto’s Existing Volatility Problem

bitcoin, cryptocurrency, market value

The law of unintended consequences makes it so that a positive impact in one place has a negative ripple effect somewhere else.

It may be the case that bitcoin-mania, as it were, and its wider acceptance (and availability) on Wall Street may give rise to speedbumps that impede cryptos’ presence within mainstream commerce.

To that end, we’ve seen the first bitcoin exchange traded fund (ETF) come to market this week, where, as CNBC reported, the ProShares ETF saw brought in $550 million in fund inflows in its first day, representing a record for ETF launches. In terms of the mechanics of the fund, ProShares (and of course other ETFs) invests in what are known as futures contracts, which are agreement to buy or sell bitcoin at an agreed-upon price, at an agreed upon future date (say, three months from now).

As CNBC noted, the ETF is a way for investors to trade directly through their investment accounts, rather than going onto dedicated crypto exchanges to do so.  In essence, we contend, the ETF is a derivative bet on the direction of bitcoin’s price.

Heady Gains in Bitcoin 

At this writing, bitcoin is trading at about $62,300, down from recent highs of more than $66,000 and yet well off recent nadirs of around $41,000 roughly a month ago. Part of the rise might be attributed to anticipation of the ETF launch and that others will follow.

Read more: Bitcoin Futures ETF Trading Could Get SEC Green Light

And yet even as the ETF came to market, as reported by Yahoo Finance, SEC Chair Gary Gensler said there still is room for concern within the  $2.5 trillion cryptocurrency market.

“Investors aren’t protected the way they are, whether they go into the stock or bonds markets that we’ve overseen so long,” said Gensler, as quoted in Yahoo Finance’s All Markets Summit Monday. “Without that, I think it really is, as I’ve said to others, a bit of the Wild West.”

The recently-launched ETF focused on options contracts rather than direct trading in bitcoin itself (which would give rise to a “spot” market ETF). And, as such, the volatility may not be as marked as would be seen with funds that have direct crypto holdings.

As bitcoin itself surged to record highs, optimism started to build over the prospects of the SEC green-lighting a bitcoin spot ETF. Whereas a bitcoin futures ETF is pinned to options contracts traded on the Chicago Mercantile Exchange, there is no ETF yet available that’s linked to bitcoin itself (referred to as a “spot” or “physical” ETF).

But in any eventuality that such spot, or more direct ETFs become a reality, or a slew of other ETFs are launched, it may be the case that we start to see even more volatility with bitcoin and other cryptos.  In a paper a few years ago available on the SEC’s website by a trio of finance professors, aptly titled “Do ETFs Increase Volatility?” the argument is that, yes, volatility can increase.

The paper argues that “ETFs provide intraday liquidity to their investors. As a result, they attract high-frequency demand, which translates into price pressure on the underlying securities, due to the arbitrage relation between the ETF and its basket. This trading activity is potentially destabilizing for the underlying securities’ price,” the professors posit, and can lead to “noise” in trading.

With “added” volatility in the mix — for bitcoin and for other cryptos that presumably might make their way into fund holdings — it might be the case that pricing instability dissuades their use in mainstream commerce. When bitcoin, for example, cannot be “pinned down” as to what the value may be when converted into fiat on either side of the transaction, it is less efficient as a vehicle used in payments. So: Wall Street’s gain (in terms of more “trading opportunities”) may come at a cost … an unintended one.