Do Bitcoin ETFs herald a new era for cryptocurrencies?

Late in the afternoon of Wednesday 10 January, the SEC voted 3-2 to approve Bitcoin ETFs.

This has been a long time in the making, having been speculated about for months – so much so that the price of Bitcoin rose only 1% when the news broke.¹ However, that comes on the back of very strong performance in 2023, up 157%,² with the bulk of that happening in the fourth quarter. 

Bitcoin bulls will now point to the 2021 high of $68,000 as the next target, and will cite the May ‘Halving’ event (when the reward for verifying a block of Bitcoin transactions will be halved) as another driver of positive returns.

Going mainstream?

The advent of ETFs will make it much easier for retail investors to gain access to Bitcoin, as they will no longer have to go through the hoops necessary to trade in the underlying unregulated market. If this gains traction, it should in turn lead to less volatile price action. However, it should be noted that the SEC has opined on Bitcoin ETFs only so far – ETFs for cryptocurrencies such as Ethereum have been pushed out to May at the earliest.

Nonetheless, SEC approval is likely to lead to further speculation that cryptocurrencies are here to stay and that they have a place in the global financial system. It is on this point that we still have strong reservations.

We do not see a need for additional currencies and do not think the supposed benefits of cryptocurrencies hold up to scrutiny.

Fast or secure – not both

For the most part, it is a trade off between security and speed. No matter where you land on that spectrum there are significant drawbacks. At the secure end, where Bitcoin sits, the cost is high energy consumption and a slow pace of transaction verification. As competition grows to verify transactions and win the reward, ever greater processor capacity is required, further increasing the energy use.

At the other end of the spectrum, speed comes at the cost of lower security: something that is unlikely to appeal in a global payment system. In addition to that, since the concept of blockchain is that transaction verification agents retain the whole history of transactions on the chain to ensure the validity of the next block, a rapid rate of transaction verification will quickly lead to ledger bloat, where the history of transactions is so great that only supercomputers can handle them. 

This is especially true of cryptocurrencies at the less secure end of the spectrum, as attacks are based on multiple transactions being sent in quick succession to try to break the network. However, bloated ledgers will increasingly become a problem for all blockchains as they transition from infancy into mainstream use.

Real-world uses of the blockchain

That is not to say we do not see any benefits of blockchain technology. We have already witnessed successful bond launches on blockchains in the past couple of years, leading to faster verification and settlement processes and reducing the risk of failed settlements. These enhancements are likely to be beneficial in a myriad of other applications. 

The shortcomings of the technology do not negate its usefulness, they merely steer its application. For mainstream use, we think the vast quantities of data in scope would require multiple blockchains, each specialising on a specific function. There would be a need for both private and public blockchains. 

However, we do not see the need for compensation by cryptocurrency. Instead, we believe the growing popularity of the technology will spur on central banks to develop their own digital currencies, which would then continue to serve as the medium of exchange.

1. Source: Bloomberg as at 12 January 2024.

2. Source: op. cit.