Unveiling the Overlooked Threat to Bitcoin ETFs

• Concerns Regarding Coinbase's Role as Bitcoin ETF Custodian
• The Role of Coinbase
• Asset Concentration and its Risks
• Reassessing The "Qualified Custodian" Designation
• Difference Between Crypto and Traditional Assets
• The Ongoing Threat of Crypto-crime
• Importance of Oversight and Staffing
• Resources at Crypto Custodians
• Need For Increased Cybersecurity Standards
• Adapting to the Future of Digital Assets

Concerns Regarding Coinbase's Role as Bitcoin ETF Custodian

The anticipated approval of the first Bitcoin$42,260 -0.64% ETF presents questions about security and custodianship. Notably, the majority of ETF applicants, with the exception of a few like Fidelity and VanEck, have chosen Coinbase as the custodian.

The Role of Coinbase

Coinbase's reputation is not the primary concern despite its central role. The platform has not yet been a victim of a known hack, which is why many conventional institutions have faith in its expertise. Nevertheless, it's essential to understand that no target is entirely impervious to hacking. Given sufficient time and resources, any system can be breached.

Asset Concentration and its Risks

The real worry lies in the extreme asset concentration within a single custodian. Due to the cash-like nature of crypto assets, this situation raises significant concerns.

Reassessing The "Qualified Custodian" Designation

The current "qualified custodian" status should be reconsidered as it does not assure the secured blockchain-based assets are ideally or even effectively secured. Ideally, more oversight by better-trained regulators under more stringent state and federal standards should be applied to digital asset custodians.

Difference Between Crypto and Traditional Assets

Most custodians today secure bonds, equities, or digitally tracked fiat balances. Unlike these legal agreements which cannot be stolen, Bitcoin is a bearer instrument similar to cash and gold. A successful crypto hack is equivalent to a bank robbery; once the assets are in the thief's hands, they are virtually irretrievable.

The Ongoing Threat of Crypto-crime

The forces of global crypto-crime are formidable and resolute. For instance, North Korea's Lazarus Group hacking team is believed to have stolen $3 billion worth of crypto over the past six years. The inflows to a Bitcoin ETF are projected at above $6 billion in the initial trading week alone, which would result in these funds becoming a prime target for thieves.

Importance of Oversight and Staffing

Financial institutions use a three-layered model of risk management: business management layer for implementing security practices, the risk layer for monitoring these practices, and the audit layer for validating their effectiveness. Furthermore, an exterior IT oversight, external auditors, and numerous state and federal regulators review their operations. However, implementing such measures requires a substantial headcount.

Resources at Crypto Custodians

Comparatively, Coinbase has less than 5,000 employees even after recent expansion. BitGo, another approved custodian, has only a few hundred employees. Genuine oversight necessitates redundancy which these institutions might struggle to meet, especially when safeguarding tens of billions of dollars in bearer instruments.

Need For Increased Cybersecurity Standards

It is crucial to refine the cybersecurity standards for the qualified custodian designation. The current designation is overseen by state and federal regulators mostly focused on traditional banking and not necessarily cybersecurity or crypto experts. Unfortunately, there are no industry-wide standards for cybersecurity and risk management practices by crypto custodians. This lack of standards not only exposes investors but also the entire emerging sector to opaque risk with potentially significant repercussions.

Adapting to the Future of Digital Assets

The approval of Bitcoin ETFs is a step forward in digital assets' integration into the financial system. As these advancements continue, regulators genuinely interested in investor protection should focus on adapting to this new world. Rigorous cybersecurity standards are just as vital to financial stability as honest disclosures and financial audits in this new world.

Edited by Jonathan Stoker