(Kitco News) – The launch of spot Bitcoin (BTC) exchange-traded funds (ETFs) in the U.S. was heralded as a breakthrough moment for the crypto industry as it enabled institutional investors to access the top crypto through regulated financial instruments – opening the door to trillions in investor capital for the first time.
The ETFs enjoyed a hot start, quickly amassing more than $53 billion in assets under management. As of June 26, the ETFs hold a combined 871,000 BTC, representing 4.42% of the current circulating supply.
While many crypto proponents have rejoiced at the newfound adoption, others have warned that the ETF launches have put Bitcoin on a path to complete control by large money investors, similar to how many feel the price of gold is now controlled by the gold derivatives market, with paper gold dictating the price of the underlying physical asset.
Kitco Crypto reached out to multiple industry experts to get insights on what level of ETF adoption poses a threat to the decentralized nature of Bitcoin, and most agree that at a certain point, having too many Bitcoins held by large funds could negatively impact the top crypto.
“In a perfect world, all Bitcoin holders would self-custody,” said Andreas Brekken, founder and CEO of SideShift.ai. “This would ensure true decentralization. However, it’s important that we do not let perfect become the enemy of good. The Bitcoin ETFs are creating a new generation of Bitcoiners – and this is ultimately a good thing for the industry.”
“While flows into spot BTC ETFs have pulled back from the pace seen directly after they launch, it's possible they could pick up again once the bull market resumes,” he said. “Bitcoin ETF inflows follow the market in lock-step. When the Summer lull predictably turns into mania, ETF inflows will resume.”
Brekken suggested that crypto fans should be on the lookout for “When the US Treasury starts holding Bitcoin in its foreign currency reserves,” which would make the U.S. government the largest holder. “We call this hyper-bitcoinization,” he said, before noting that “it’s important to understand that the U.S. Treasury would still not be able to control the network since there is no staking.”
Addressing concerns regarding the ability to control Bitcoin’s price, Brekken said the design of the top crypto makes it less vulnerable to the control that precious metals have faced.
“There is always a risk of gold being counterfeit with metals such as tungsten, and in addition it is traded as dubiously-backed paper,” he said. “Bitcoin is not vulnerable to this kind of manipulation because it is, by definition, open and transparent and because it allows for self-custody.”
While some have warned that funds holding a large percentage of Bitcoins could enable an attack on the network, Sebastian Heine, Chief Risk and Compliance Officer at Northstake, said: “The concern about a 51% attack does not apply here since Bitcoin miners control the network, not BTC holders.”
“However, the concentration of large positions could lead to market manipulation, similar to the JP Morgan whale incident in traditional finance,” he said. “BTC holdings do not equate to network control or influence. However, it would result in a higher concentration of BTC in a few hands, reducing the distribution of holdings.”
If more Bitcoins are locked in ETFs than circulating on the market, Heine said, “This would reduce the available supply, potentially leading to a supply shock and skyrocketing prices as the market realizes the scarcity.”
He added that this could make Bitcoin susceptible to control and manipulation similar to what is seen in the gold market. “This is possible in most markets and is easier in smaller markets. However, the SEC has scrutinized market manipulation issues, so thorough regulatory oversight is expected,” he said.
“Bitcoin ETFs are a double-edged sword,” Heine concluded. “They increase accessibility and institutional investment but may compromise the ethos of decentralization and self-custody, leading to potential market impacts. Balancing innovation with core Bitcoin principles is crucial to support the original ethos.”
Robert Persichitte, CPA and affiliate professor at Metropolitan State University of Denver, pointed to the effect of a large percentage of certain stocks held by ETFs to explain the issue.
“Two companies (Vanguard and BlackRock) own 15% of Apple through their mutual fund holdings,” he said. “They can vote on shareholder performance and guide the direction of the company. Theoretically, they could also influence the platform if the same thing happened with Bitcoin. It could even be worse because it's unclear if the rules about market manipulation and minority shareholder protections apply.”
“They could shape the platform to better suit their needs. Consequently, they could push the whole market to have centralized tendencies,” he warned, before elaborating on why he doesn’t think this will happen.
“Big banks' influence on U.S. mega-cap companies is a relatively new trend that has been decades in the making,” Persichitte said. “Because experts paraphrase research, people (incorrectly) believe the best investment strategy is to put 100% of your investments into an S&P 500 fund. These funds are heavily biased toward incredibly large companies like Apple. It is unlikely that the trend will reverse to favor digital assets.”
Matt Webb, co-founder of wevr.ai, said the topic of Bitcoin price manipulation has been something he’s been thinking about since the ETFs launched in January.
“I believe Bitcoin ETFs as a mechanism for TradFi market makers like Blackrock, Vaneck, and Fidelity to continue accumulating and holding Bitcoin for their clients, and the follow-on effect with having a large portion of supply [locked up], is already in motion,” he said. “My belief is that the past nine months of positive gains in the crypto market came from these funds accumulating Bitcoin.
“Although they may not have the holdings of Greyscale or MicroStrategy, I believe they have a large say in price movement,” Webb said. “As long as there is profit to be made in crypto, they'll continue to accumulate, and control the market, which will lead to the retail investor losing out. This cycle hasn't had much retail hype, and I think it's a sign of TradFi making their mark on crypto.”
Just more FUD
“Bitcoin is today a store of value for hundreds of millions of people around the world and Bitcoin Spot ETFs extend this to those investors who can’t self-custody or work with crypto exchanges - that is very positive indeed,” said Matthew Le Merle, Managing Partner and CEO at Blockchain Coinvestors. “As a store of value, rapidly increasing demand and slowly growing or flat supply would normally result in upward movements in value and price over time. In that regard, the biggest impact of the Bitcoin Soot ETFs over time should be to encourage price to go up.”
“Concerns about potential impacts of Bitcoin Spot ETFs on decentralization and control are, we believe, just more FUD,” he said. “Theoretically, if the ETFs had more than 50% of Bitcoin under management, and if they chose to exercise their influence on Bitcoin governance decisions, then there could be an issue. But in practice, so long as price goes up over time, we don’t see any likelihood of this concentration happening.”
Le Merle said the real issue for Bitcoin is the need for developers to continue to work towards achieving Satoshi Nakamoto’s original goal for the asset.
“The big issue for Bitcoin is not the increasing global demand for it as a store of value-driven partially by ETFs and other traditional investment products,” he said. “Instead, we feel the issue for Bitcoin is the need to show continuous evolution towards Satoshi’s original vision - a global decentralized peer-to-peer cash which provides more than a long-term store of value.”
Rather than focus on the fear of Bitcoin being controlled, Le Merle said people should be “excited that the world wants Bitcoin, and both decentralized and centralized finance companies are making it available to the world's 8 billion people.”
Dan Hoover, Chief Operating Officer and Chief Compliance Officer at Castle Funds, also sought to downplay concerns about control.
“The consensus mechanism of the Bitcoin network is driven by the Bitcoin miners, not by the holders,” he said. “Accordingly, the ‘decentralization’ question is not a question of governance (as it might be in networks such as Ethereum) but of reliance on a limited set of trusted market service providers.”
“While the ETF providers' asset-gathering to date has been impressive, it is still a very small portion of Bitcoin's $1.2TN market cap,” he added. “It seems unlikely that holders of such a small portion of the market could effectively manipulate the price, especially given that the Bitcoin market is open for 5x as many trading hours each year as the ETFs (which close for nights, weekends, and US holidays).”
He said what is of concern is “the reliance of these products on a few service providers (such as Coinbase) to custody the Bitcoin, do the money-laundering and other compliance checks, monitor the regulated futures markets for signs of manipulation, and provide pricing information for the Bitcoin as of a non-standard daily ‘closing time’ of 4 pm in New York (digital asset market data providers typically treat midnight GMT as the daily ‘close’).”
“Unless the ETF sponsors take action to mitigate these conflicts of interest, increasing flows into these products would then increase reliance on parties such as Coinbase,” Hoover warned. “This could, in turn, amplify the effects of any difficulties (such as future regulatory action, cybersecurity incidents, etc.) on the markets.”
“Regarding the question of price manipulation more broadly, we believe that the unregulated offshore Bitcoin derivatives market has shown a much larger propensity for price impact,” he added. “These exchanges do not generally operate under laws requiring anti-manipulation safeguards, such as customer identification, large position reporting, or prohibitions on wash sales.”
“They also provide much higher levels of leverage than required on US exchanges without the ‘margin call’ model used on U.S. exchanges,” Hoover said. “Instead, these offshore exchanges typically ‘auto-liquidate’ positions once the margin is exhausted, regardless of price impact. This can lead to large swings in the price of the underlying (such as Bitcoin) once liquidation levels are reached.”
“Bitcoin is not a Proof-Of-Stake network; therefore, significant holdings of Bitcoin do not pose a risk to the network decentralization, which is instead, driven by the decentralization of miners,” said Oleg Fomenko, co-founder at Sweat Economy.
He said that having more Bitcoins locked in funds than circulating in the market would lead to a low liquidity environment, which could be positive for price.
“Low liquidity in the market is likely to mean a higher asset price for Bitcoin. However, the concentration of liquidity in the hands of a few players might mean that we will see more volatility at a time of market shake-up,” Fomenko said.
“It is conceivable that large BTC holders or Bitcoin whales will try to use their funds to manipulate the market,” he added. “However, this will largely depend on the degree of freedom ETF teams have from their investors. If there is a disconnect between the fiat liquidity and BTCs on hand, then it is likely that the investment teams will try to manipulate the market in the hope of outsized returns. It is also possible that any attempt at market manipulation would spectacularly backfire — wiping them and their investors out. Pass me that popcorn!”
Bitcoin is designed to combat control and manipulation
“As the blocksize wars demonstrated, in Bitcoin, user-based consensus is what drives changes or modifications to the Bitcoin network,” said Mauricio Di Bartolomeo, Co-Founder of Ledn.
“In other words, even if very powerful and very wealthy holders want to change the rules, presumably to benefit at the expense of other members of the ecosystem, the users or nodes have the option to either 1) not update the software to run under the new rules, and/or 2) fork the ‘new’ chain altogether and continue supporting whatever network they support,” he said. “That’s a long way of saying that I don't think that ETF issuers accumulating Bitcoin is a risk to the network’s decentralized governance method.”
The reason the network is resilient to control is “because Bitcoin runs on Proof of Work and Nakamoto consensus, meaning that the holders of the network’s native assets do not have any more influence than an average user of the network,” Di Bartolomeo said. “Having said that, this risk is very real for blockchains that run on Proof of Stake algorithms, where in some cases the voting power of a user is directly proportional to the native network assets he/she holds.”
“The mechanism under which Bitcoin gets minted into ETF units and redeemed from the same is very robust and fast,” he added. “The ‘unlocking’ of the coins could happen very fast if and when needed. And, given that ETF unit prices must track spot markets, both markets would remain in balance as any price discrepancies would be closed out by market makers.”
Due to this design, he said it's unlikely that the funds will be able to manipulate the price of Bitcoin. “The funds themselves would not be the facilitators of this type of price manipulation. This could be done already by state actors (if they wanted to do so), through the futures and spot markets by using FIAT currency to drive prices in a particular direction,” he said.
Di Bartolomeo also said he sees the current lull in inflows as just a brief pause, and soon, inflows will resume.
“Most of the current flows have been existing Bitcoiners buying ETF through their retirement accounts. Most of the net new volume will come from treasury positions and financial advisors recommending clients to take positions,” he said. “Financial advisors have not yet started recommending Bitcoin allocations because of the short life span that spot Bitcoin ETFs have, and also because they don’t want to recommend clients buy an asset at all-time highs. As the market corrects and forecasts increasingly call for central banks to cut rates, I think you’ll see these allocations start to ramp up now.”
Manipulation concerns are overblown
“The market cap of BTC is currently $1.2 trillion, with around 19.7 million BTC in circulation today and only 21 million being the maximum supply by 2140,” said Nick Cowan, Group CEO of Valereum PLC. “That means there are only 1.3 million BTC left to mine. Of the 19.7 million already in circulation, around 4.5% ($54.64 billion or 906,000 BTC) are currently owned by the ETFs.”
“However, BTC is a proof-of-work network, not a proof-of-stake like Ethereum 2.0,” he added. “It is the miners of BTC that control the network, not holders. But Miners cannot change Bitcoin’s rules. If they attempted to change the rules in the software on their nodes, for example, to be rewarded more for their service, then their nodes would become incompatible with the other nodes in the network, effectively risking a split or fork in the network.”
Cowan noted, “The ‘economic majority’ of the network must agree, which includes businesses, developers and users. Individual miners or pools can take actions that disrupt part of the network operations, but this could hurt Bitcoin’s credibility and thus their revenue. As of today, there are a few examples of situations where miners tried to use their influence, none of which changed how Bitcoin works.”
“Therefore, it would seem unlikely that BTC ETFs could become a threat to the network,” he said, adding that having more Bitcoins locked in funds than circulating in the market wouldn’t mean much for the network.
“For general liquidity in the market, ETFs are open-ended funds that buy and sell their underlying assets based on supply and demand; increased subscriptions result in more BTC being bought, and redemptions result in the reverse,” Cowan said. “Currently, ETFs own <5% of circulating BTC and if this level were to rise to over 30%, then there is an argument that the underlying liquidity of BTC would reduce!”
However, he did see the possibility of ETFs being used to control or manipulate the price of Bitcoin if they capture the majority of the circulating supply.
“When large institutional investors own enormous chunks of a circulating asset, it is logical that they require good news to offload their holdings (they need big news to shift their sizeable positions), and seek to acquire sizeable positions (accumulation) on negative news,” he said. “As Warren Buffet says, ‘Most people will get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.’”
The threat is real
According to Phil Ryan, co-founder of MAPT.ODL, “The threat to Bitcoin's network and decentralization becomes significant when a few large entities, such as ETFs and institutional funds, accumulate a substantial proportion of the total Bitcoin supply.”
“If these entities were to control around 20-30% of the total Bitcoin supply, it would give them considerable influence over the market,” he said, warning that “significant holdings could impact governance and decision-making processes, undermining the decentralized nature of Bitcoin.”
“The accumulation of Bitcoin by spot BTC ETFs can pose a threat to the broader network and its decentralization,” he reiterated. “As these funds gather more Bitcoin, the distribution of Bitcoin ownership becomes more centralized. This centralization risks undermining the decentralized ethos that Bitcoin is known for. It can lead to increased market manipulation and reduced trust in the network’s integrity, as a few large holders could potentially control significant market movements.”
Ryan added that if more Bitcoins are locked in funds than circulating on the market, it could lead to several issues, including reduced liquidity, price manipulation, and centralization of control.
“Reduced Liquidity: Fewer Bitcoins available for trading can decrease market liquidity, causing higher price volatility and making it difficult for users to buy or sell large amounts without significant price impact,” he said. “Price Manipulation: Large holders, such as funds, could manipulate Bitcoin prices more easily, leading to an artificial inflation or suppression of prices; Centralization of Control: This scenario would contradict Bitcoin’s foundational principle of decentralization, as power and control would be concentrated in the hands of a few entities, reducing the overall resilience and trust in the Bitcoin ecosystem.”
He warned that “funds holding substantial amounts of Bitcoin could control or manipulate its price similarly to how the gold market has been influenced through derivatives.”
“By leveraging their large holdings, these funds could engage in coordinated buying or selling strategies to influence Bitcoin's market price,” Ryan said. “Such actions could distort the true market value of Bitcoin, undermine investor confidence, and create a more centralized control structure, which goes against the decentralized ideals that Bitcoin was built upon.”
“Bitcoin can be viewed as a pioneering experiment, or a ‘beta test coin,’ that showcased the potential of blockchain technology and decentralized finance,” he said. “However, due to its inherent limitations – such as scalability issues, high energy consumption, and extreme price volatility – it may not be the sustainable future of digital finance.”
“In contrast, commodities-backed stablecoins offer a more stable and practical solution for the future,” Ryan concluded. “These stablecoins, backed by tangible assets like gold or other commodities, can provide stability and trust, making them more suitable for mainstream adoption and long-term viability. They combine the benefits of blockchain technology with the stability of traditional assets, potentially leading to a more secure and decentralized financial system.”
“ETFs are a double-edged sword,” said Tim Delhaes, CEO at Grindery. “Sure, they offer a golden ticket for traditional investors to join the crypto party without the tech headaches, potentially skyrocketing adoption and value. Ultimately, something we all in the crypto community want.”
“But here’s the rub: as these ETFs gobble up more capital, they will become the 800-pound gorillas in the room, with the ability to swing the market willingly or not,” he added. “The key to keeping web3's soul intact lies in transparency. Just as sunlight is the best disinfectant, clear reporting for ETFs and their trading activities can help maintain the delicate balance between accessibility and decentralization.”
“While other solutions like improved custody practices and regulatory oversight play important roles, transparency should be the North Star guiding us,” Delhaes said. “We want Bitcoin (and crypto at large) to remain the people’s currency, not just another Wall Street playground.”
Crypto exchanges weigh in
According to analysts at the Bitget cryptocurrency exchange, “there's no need to worry too much about this issue.”
“Although the Bitcoin holdings of BlackRock, Grayscale, and MicroStrategy have each exceeded 200,000 BTC, apart from MicroStrategy itself purchasing a large amount of BTC, the holdings of BTC spot ETFs actually represent the ‘BTC asset management scale’ of these giants,” they said in a note shared with Kitco Crypto. “These BTC positions are not owned by a single entity but belong to their various clients, so the actual concentration of BTC holdings is not that high.”
“From an on-chain perspective, the top two addresses for Bitcoin holdings on the chain are from Binance and Bitfinex, and we rarely worry about the issues with such a structure of holdings,” they noted. “BlackRock, as a giant in asset management, is subject to more stringent regulation, so there's even less need to worry about the risk of concentration of holdings as the scale of BTC spot ETFs grows.”
Bitget analysts said that more Bitcoins being locked in the funds rather than circulating in the market means “increased market demand and a potential reduction in liquidity,” but would have little effect on Bitcoin security.
“Increased market demand: If the growth rate of BTC supply is lower than the market demand, i.e., the rate at which BTC is being locked into funds, this could further drive up BTC's price,” they said. “Potential reduction in liquidity: If a large amount of BTC is locked up as a reserve asset rather than circulating in the market, this could lead to a decrease in BTC's liquidity depth and increase BTC price volatility. However, considering BTC's current market value, this possibility is low, and more locked-up BTC is actually beneficial for BTC's price.”
In terms of security, “BTC network security is not affected by the number of BTC locked up,” they said. “It is influenced by the hash rate, node data and distribution (degree of decentralization), consensus algorithms, etc. So overall, more Bitcoin being locked in funds is positive in the short to medium term, as it will increase Bitcoin's scarcity and thus push up its price, while BTC network security will not be impacted by this.”
As for controlling and manipulating the price of Bitcoin in a similar manner as gold, the analysts said, “It is possible to influence the price of Bitcoin using derivatives, similar to how derivatives function in other financial markets.”
“Although Bitcoin is a major player in the cryptocurrency space, its market capitalization is still relatively small compared to traditional assets like gold or stocks,” they said. “This smaller scale can make it more susceptible to price fluctuations triggered by large trades.”
“Derivatives such as futures and options provide leverage, allowing traders to control large amounts of Bitcoin with relatively little capital,” they added. “This can amplify their impact on the market, potentially leading to price manipulation.”
And when it comes to market depth, they noted that “In less liquid markets, large orders can significantly impact prices by altering the supply-demand balance. The market depth of Bitcoin varies significantly across different exchanges, which can be exploited to manipulate the market through large orders.”
Analysts at Bitfinex took the opposite side of the argument, warning there is cause for concern as ETF holdings grow.
"The Bitcoin network's security and decentralization are maintained by a wide distribution of Bitcoin holdings among many users. If a small number of entities, such as funds, accumulate a significant portion of Bitcoin, it could potentially threaten this balance,” they said in a note shared with Kitco Crypto. “While there isn't a precise threshold at which this becomes a critical issue, concerns typically arise if any single entity controls more than 10-15% of the total circulating supply. This concentration of holdings could influence network decisions and undermine the decentralized ethos of Bitcoin.”
“An attack on the network can also occur when one party controls more than 50% of the hash power,” they added. “A large concentration of Bitcoin in the hands of a few institutions could theoretically manipulate the network. However, it is almost impossible to attack or manipulate the network.”
They noted that estimates show “an attack on the entire Bitcoin network once with a 51% mining hash could cost about $40 billion and would only generate approximately $2.5 billion in revenue. In addition, the Bitcoin mining difficulty adjusts to maintain a steady block generation rate regardless of the number of miners. So, large holders wouldn't have direct control over transaction processing.”
“Also, the Bitcoin blockchain is public, making large transactions visible,” they said. “Attempts at manipulation would be easily detectable. The competition in this market is also huge with a lot of pre-existing and well-funded institutions, and the number of institutional investors is constantly growing, mitigating the power of any single entity."
Bitfinex analysts said they do see a small number of funds holding a large concentration of Bitcoin as “posing a threat to decentralization, but this is a remote risk.”
“If these funds collectively hold a substantial portion of the total Bitcoin supply, they could potentially exert significant influence over the market and network decisions, but it would require acting in concert and would be detrimental to the value of Bitcoin, so it is difficult to imagine what might motivate such activity,” they noted. “Furthermore, like physical gold ETFs, we can foresee a future where Bitcoin ETFs have self-custodial options, which means that not all the Bitcoin owned by ETF holders would be in custody of the ETF issuer.”
"If a significant portion of Bitcoin is locked in funds, it could reduce the liquidity available in the market, and this reduction in circulating supply can lead to increased price volatility, as there would be fewer BTC available for trading,” they warned. “It could also lead to higher transaction costs due to reduced liquidity.”
“Furthermore, if these funds decide to sell large portions of their holdings, it could cause significant price drops, leading to market instability,” they added. “At the moment, though, the amount of Bitcoin held in ETFs is a small proportion of the total circulating supply.”
When it comes to manipulating the price of Bitcoin, Bitfinex analysts said: “There is a risk that large funds holding significant amounts of Bitcoin could manipulate the market, and to some extent, this is already visible with trading desks not being active over the weekend causing the market to move in tight sub-1% ranges.”
“If these funds coordinate their actions, they could influence Bitcoin prices by buying or selling large amounts, which is similar to how the gold market has been influenced through derivatives,” they concluded. “However, Bitcoin's transparency and the public nature of blockchain transactions can make such manipulations more detectable. Regulatory frameworks and oversight are crucial to prevent and mitigate such risks.”
