February 21, 2024

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Eric Ervin, CEO of Onramp Invest, gives a big thumbs-up to bitcoin ETFs, but cautions that they don't provide all the advantages of owning crypto directly.

Then, Colin Butler at Polygon Labs says zero-knowledge and smart contract capabilities on Ethereum will enable real world asset tokenization on a greater scale, enticing more investors into those markets.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Benjamin Schiller, head of opinion and features at CoinDesk

From the Analyst

When Bitcoin ETFs Are Right for Investors (And When They're Not)

There's no doubt that the approval of bitcoin ETFs in January was a historic moment for the U.S. crypto market. It's impactful from an acceptance as well as an access standpoint. Investors interested in digital assets heaved a big sigh of relief as the SEC finally relented, while financial news reporters can focus on which of the "Newborn Nine" ETFs will gain the top seat in terms of assets under management and volume. This is a sign of progress, something that a dedicated handful of industry leaders have been painstakingly trying to promote over the last several years through letters, repeated application submissions, and even, for a few, lawsuits. The BTC ETF approval feels like a big step in the right direction.

But now the question becomes more practical: Investors can have a bitcoin ETF, that's great, but is that enough? While the bitcoin ETFs are a remarkable innovation in cryptocurrency investing, they may not be right for everyone. I'm a huge fan of ETFs and all they have done to democratize investing. It is one of the most important financial innovations of the 21st century, but placing bitcoin into an ETF is a bit like putting training wheels on a Ferrari… and that is okay. I am not saying that to suggest that the spot bitcoin ETFs are anything less than brilliant. However, I am suggesting that there is so much more when you take the training wheels off.

When the BTC ETF is right for investors

Part of the reason bitcoin ETFs are so valuable is because they provide investors an opportunity to test the crypto waters in a way that's familiar (ETFs for gold, for instance, have been available since the early 2000s). It opens the door to an entirely new generation of investors. It allows people to access one of the essential pieces of the crypto asset ecosystem: the price. By owning a fund that owns bitcoin, you gain indirect exposure to the potential price appreciation of bitcoin, and you offload the responsibilities of custody, acquisition, and disposition to tried and true institutions: household names like Blackrock, Grayscale, Fidelity, and Ark Invest, to name a few.

For allocators, and investors who are just getting started in the asset class or are specifically interested in this one feature, ETFs provide exposure to a potentially growing asset class with little effort and extra assurance through brand trust. The fees, for the most part, are low, and access is simple and easy. There's also the added benefit of now being able to add bitcoin to retirement plans like 401Ks and IRAs, an option for which we've seen increased demand over the last few years.

With any luck, we'll see more crypto ETFs launch for investors this year, with the potential for an Ethereum ETF looking somewhat promising. However, for the moment it's just bitcoin, and that's our perfect segue.

When it's not: the "one-way bridge"

Dave Nadig, a thought leader in the finance space, really put the bitcoin ETF into perspective in a recent piece entitled "Why a Bitcoin ETF Doesn't Matter, " which he published ahead of the SEC approval. He highlights all the upsides for ETF-driven BTC market growth but ultimately refers to it as a "one-way bridge." And that's going to be the problem for many investors. Why? Because there are so many other great benefits from direct investing that are lost when you don't own the asset directly.

Here are three reasons I think direct ownership is important:

Diversification. Think of buying a bitcoin ETF like buying a Netflix subscription and only having access to one movie, or getting the final score of the Superbowl but never getting to watch it. Having exposure to only bitcoin is the same as owning only one stock, which, as everyone knows, supremely limits your performance potential in the market. There are so many other assets to consider as a part of a balanced, comprehensive digital asset portfolio, and ETFs reduce this potential.
Access to the ecosystem. Decentralized finance is all about building bridges by eliminating intermediaries, increasing on-demand liquidity, and creating seamless global connectivity. It's a 24/7 market with instantaneous transaction capability and mobile accessibility where you can access various cryptocurrencies and even swap them in-kind through fast decentralized exchanges (DEXs). It's this network structure that makes cryptocurrencies so powerful, and that gives bitcoin its wide appeal. In other words, it gives investors access to the broader decentralized landscape.
Tax harvesting. The standard rules surrounding wash sales of investment assets don't currently apply to the crypto market. For this reason, the market's inherent volatility can be beneficial for tax loss harvesting , allowing you to sell assets at a loss and repurchase them while still being able to repurchase them shortly after. By investing indirectly through an ETF, you automatically lose the ability to take advantage of the volatility.

Although bitcoin is arguably the most recognized and established cryptocurrency, it's just the tip of the iceberg. By investing in BTC through an ETF provider, investors are taking a trip across a one-way bridge. They don't actually own the asset directly, they own an interest in a fund that owns the asset directly.

Overall, the major loss investors take when investing in a bitcoin ETF is the benefit of self-sovereignty. Part of the promise of bitcoin is that anyone can self-custody their value rather than rely on a fractional reserve banking system. The censorship resistance of bitcoin also prevents the chance of having assets frozen or being de-banked (which is becoming a growing problem ). The ability to self custody bitcoin drastically reduces counterparty risk. It's the same old story, but it still rings true: not your keys, not your crypto.

Ask your advisor

Unlike a few years ago when crypto was just starting to circulate into mainstream markets and most people were new to digital assets, financial professionals can now be relied on to help you understand the emerging market. We built Onramp to support digital asset management and trading for RIAs because we know this market can be over-complicated, and investors need advisor input more than ever when deciding to allocate to this new frontier.

We're excited to see the crypto industry making such powerful strides in the market because these steps forward only increase opportunities for investors. This is just the beginning.

– Eric Ervin, CEO Onramp Invest, a Securitize company

Institutional Outlook

New Technology Will Have Institutions Lining Up for Crypto

2024 will be the year that transforms traditional asset management. Institutional investment in blockchain technology has been anticipated for years, but that is about to become a reality.

Key capabilities, particularly the development of the zero-knowledge Ethereum Virtual Machine, or zkEVM, are capable of enabling tokenization of real-world assets and setting the stage for a fundamental transformation of the global financial system.

Institutions need mainnet-level security, infinite scalability, and massive liquidity potential. With the advancements in developer tools and mathematically proven security measures, the necessary components are finally assembled to fulfill this promise.

This will, in turn, lead to mainstream blockchain adoption.

Transparency Through Chain Abstraction

The zkEVM, which is capable of performing smart contract transactions within a zero-proof environment, has firmly established itself in blockchain infrastructure. Now institutional investors can tap into a proven ecosystem of Ethereum-based blockchains, with its robust security guarantees, decentralization, and transactional transparency, at a far lower cost, rapid settlement times, and with potentially unlimited scaling capacity.

The picture of success for Web3 is to create a "chain of chains," in essence, a seamless user experience across the entire ecosystem. Part of the liquidity advantage comes through being able to integrate different applications spanning from gaming, DeFi, and permissioned institutional platforms. Each of these requires custom-tailored blockchain architectures with varying levels of permission, privacy, cost, security, and incentive designs.

With the technical decisions about chain design abstracted away, developers can build on a secure infrastructure and focus on optimizing for a single use case. They are able to elevate the capabilities of the application layer so any blockchain interactions happen transparently. The end-game means a broadened blockchain ecosystem where institutional investors gain access to the high liquidity of the entire Ethereum ecosystem plus the security benefits of zero-knowledge transactions.

Institutional-Scale Liquidity Aggregation

The zkEVM facilitates tremendous liquidity potential by enabling near-instant settlements, allowing for seamless transactions and liquidity transfers between chains. A user can take liquidity from one chain and do a decentralized exchange (DEX) transaction seamlessly on another chain.

Institutional scale requires institutional levels of liquidity. In the near future, we will see not only tokenization products brought to the ecosystem but also more sophisticated financial tools like derivatives. Major technological innovations are necessary to make this happen, largely driven by the aggregation of all the liquidity in the space within a single layer capable of efficiently managing these resources.

Looking to the Future

Blockchain tech offers around-the-clock trading and access to previously inaccessible assets and vehicles, yet institutions require customizable chains, and integrating with legacy systems poses significant challenges. The capabilities of zkEVMs introduce a level of security and integration potential that changes everything.

Recently, Hamilton Lane and Brevan Howard became users of the new real-world asset tokenization platform Libra, developed with the Polygon Chain Development Kit (CDK). Polygon CDK is permissionless software which enables developers to create new chains with varying degrees of decentralization, security, and functionality, enabling customizability for developer compliance needs such as matching of users with suitable financial instruments, whether it's a hedge fund, collateralized lending, or other investment product.

As we move forward, the ecosystem's primary enablers for institutional investors are to enhance the developer experience and provide security and safety backed by mathematical proof. This will reduce operational costs and bring about ways of integrating legacy systems in a way that supports compliance and security requirements.

- Colin Butler, Global Head of Institutional Capital at Polygon Labs

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

A TRILLION: All the bitcoin (BTC ) in circulation are, yet again, worth more than $1 trillion, after more than two years dwelling below that threshold. That's not nothing. There are only seven stocks with market capitalizations that high. This feels like a moment to take stock of what this bitcoin thing is. Even Wall Street types now mention it as a store of value – in plain English, a place to safely park money. Not bad for something conjured less than two decades ago and secured by the number-crunching work of computers around the globe.
A COINBASE CRITIQUE: JPMorgan analysts got a lil spicy about Coinbase's quarterly earnings report, saying they wished the crypto exchange had been more forthcoming about its new business serving bitcoin ETFs as custodian for their assets. "Management touted its involvement in the U.S. spot Bitcoin ETF as a net positive, but we're still uncertain of its true earning impact as we see both positives and negatives," they wrote.

Want more? For the latest news affecting the crypto markets, listen to CoinDesk's Markets Daily podcast.

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