Key Highlights
- Bitcoin-backed securities are risky because sharp price swings can quickly reduce the value of collateral.
- Fitch Ratings said these securities rely on third parties like custodians and liquidation managers, and their failure or mistakes can lead to major losses.
- Past crypto bankruptcies, including FTX and Gemini, show how quickly investors can lose money and emphasize the need for strong safety measures.
In a report published on Monday, Fitch Ratings, a global credit rating agency, warned that Bitcoin-backed securities carry high market value risks and should be handled carefully.
In the report, titled “Assessing Risks in Bitcoin-Backed Securities: A Primer,” the firm said that “the inherent market value volatility, structure and counterparty risks in these instruments warrant conservative collateral coverage and rapid deleveraging mechanisms.” In short, these securities let people invest in Bitcoin without selling, but they come with heavy risk due to the volatility of the cryptocurrency.
How Bitcoin-backed securities work
Bitcoin-backed securities are ways for investors to use their Bitcoin as collateral. These products usually work through a special-purpose vehicle that holds Bitcoin as collateral and then issues debt backed by it. Investors buy these debts to get exposure to Bitcoin, while those who own Bitcoin can monetize their holdings without having to sell them. According to Fitch, this can help investors avoid taxes. However, this setup can be dangerous if Bitcoin prices fall drastically.
The agency said a sudden price swing could quickly reduce the collateral value in a very short time and lead to losses. “Bitcoin’s worst loss over a 24-hour period using intra-day data was a 49% drop in March 2020,” Fitch noted.
Risks from third parties
Fitch also pointed out that securities products depend heavily on third parties, which adds to the risk. For safety, custodians, collateral agents, and liquidation managers are responsible for holding the assets and selling them if needed.
The agency said that these roles are important. Some crypto-focused firms understand digital assets well, but many of them are new and do not have enough track records. However, large traditional banks may be more stable but often lack the expertise or technology to manage crypto assets properly. This often leads to high risk, which often includes system failures, hacking, and loss of Bitcoin holdings if a custodian goes bankrupt.
Lessons from past crypto lender bankruptcies
Fitch pointed to recent crypto lender bankruptcies as examples of these risks. In 2022 and 2023, several major crypto firms, including FTX and Gemini Trust, failed, freezing customer funds, which resulted in lawsuits. These failures led to a decline in the crypto market, with the overall value losing more than $2 trillion in value in 2022. Many cryptocurrencies, especially Bitcoin, saw a huge price drop of more than half within months.
With this in mind, Fitch said investors should consider using conservative coverage rules and quick deleveraging methods to reduce these risks.
In short, Bitcoin-backed securities are often tied to the volatile crypto market and depend heavily on third parties to manage and protect the assets. That being said, they expose investors to the price swings in the market, as well as the risk of the firm managing them. If the firms in charge fail, go bankrupt, or make mistakes, investors can lose money fast. However, it’s important to understand this risk so investors can make safer choices.
At the time of writing, Bitcoin is trading above $90,000. Over the last few months, the token has been trading sideways, ranging between $83,000 and $94,000. However, trading activity in the last 24 hours has gone up by181%, resulting in about $41.8 billion in trading volume, with its market cap sitting at $1.82 trillion, according to CoinMarketCap.
Also Read: Bitcoin Selling Pressure Eases as Long-term Supply Slows
