(Bloomberg) — 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.
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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.
Read more: Crypto Skeptic Gensler Becomes Reluctant Backer of Bitcoin ETFs
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.
Brett Tejpaul, head of Coinbase Institutional, said Coinbase offers bundled services in custody, trading and financing to provide a seamless process. Clients who use different providers may end up introducing more risks, he added.
While Coinbase’s shares rallied by nearly 400% last year along with the surge in Bitcoin, the new ETFs may only add 5% to 10% to the company’s revenue, according to a recent note from Mizuho. The analysts estimate that the ETFs may only add $25 million to $30 million in custody fees, as well as up to $210 million in incremental Bitcoin trading revenue on the platform. That’s a relative drop in the bucket compared with Coinbase’s total revenue of $2.15 billion in the nine months ended Sept. 30.
Some current customers may start buying Bitcoin through ETFs instead of on Coinbase — which charges higher trading fees. Even if they don’t, Dan Dolev, Mizuho’s senior fintech analyst, says low ETF asset-management fees will likely drive fee compression across the entire space, including for Coinbase.
Coinbase’s Haas said she doesn’t expect to see trading-fee pressure immediately following the arrival of Bitcoin ETFs, though the company could face fee compression in the long term. “We believe the spot ETFs will be additive to the crypto market and Coinbase,” said Greg Tusar, Coinbase’s head of institutional products.
Custody fees are much lower than trading fees, and may yet go down further as competition heats up in that business. And there are alternatives to Coinbase: Fidelity Investments is using its digital-asset unit to safekeep Bitcoin for its ETF. Gemini, the crypto exchange co-founded by Cameron and Tyler Winklevoss, is also vying to play a role, and already landed VanEck Bitcoin Trust as a client.
The ETFs are likely to diversify to use multiple custodians over time, as they wish to reduce their reliance on a single company — even if they aren’t ordered to do so. Haas is prepared for that potentiality. While Coinbase has been what she called a trusted choice for numerous other exchange-traded products and regulated funds, she acknowledged that issuers may choose to have a secondary custodian for “redundancy and diversification” as assets grow. She pointed out that ETF issuers in traditional financial markets typically have multiple custodians, though she expects Coinbase will retain a significant portion of the assets.
For some, the fact that Coinbase is arguably more scrutinized, as a public company, than many others is an advantage — and that could attract more business longer term. Matt Hougan, chief investment officer at Bitwise, said his firm picked Coinbase for custody because the company is “the largest and most established.”
“They want their customers to be as comfortable and confident trading on Coinbase as they would on Nasdaq,” said Campbell Harvey, a finance professor at Duke University.
For now, Coinbase is relishing its moment of victory. As the Bitcoin ETFs made their debut on Thursday, the mood was buoyant at the company’s sleek New York office, located in Hudson Yards on the west side of Manhattan. “None of us slept,” said Emilie Choi, Coinbase’s chief operating officer. “We were too excited.”
Whether that buzz continues remains to be seen.
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