The Hidden Risk Of Bitcoin ETFs Nobody Is Talking About

Custodia Bank CEO Caitlin Long claims there’s a “hidden risk” surrounding a handful of Bitcoin ETFs eyeing imminent launch in the United States, following BlackRock’s recently updated S-1 filing.

According to the founder, sponsors may attempt to generate more profit from their funds using securities lending, which “can pose a lot of hidden risk to investors.”

The Threat Of Securities Lending

Long’s concerns swelled in response to an apparent race to the bottom on management fees among Bitcoin ETF applicants, who are theoretically meant to profit by taking a yearly cut of their investors’ BTC.

On Monday, BlackRock’s revised prospectus revealed that its management fee would be a modest 0.3%. Simultaneous updates from competitors like VanEck and Bitwise unveiled fees as low as 0.25% and 0.24% respectively – figures surprising even to analysts who have expected a fee war to break out for months.

“When fees are lower than costs, please please please ask yourself how the asset manager is making money managing the fund,” Long wrote to X on Monday. “With no-fee funds, the answer is usually securities lending.”

Securities lending involves temporarily transferring shares or bonds to a borrower, who provides other assets as collateral and pays a borrowing fee to the lender. The practice is often used as part of short selling, hedging, and arbitrage strategies.

According to Long, securities lending has popularized within the fund management business over the past 15 years as a way of generating profit beyond mere fees. In the context of an ETF, this would not include lending of the fund’s underlying Bitcoin itself, which would be illegal for any grantor trust.

According to Bloomberg ETF analyst Eric Balchunas, ETFs registered under the Investment Company Act of 1940 can “lend out up to 33% of their holdings, and they typically put 70% or more of the profit back into the ETF.”

Long argued that such lending creates “potential hidden risk with little disclosure” for investors, such as how cash proceeds generated from lending are re-invested.

Will ETF Issuers Lend Out Their Shares?

Many analysts expect the SEC to approve applicants’ 19b-4 applications by January 10, which is the deadline for the Ark Invest/21Shares ETF to be approved.

In response to Long, Hany Rashwan – CEO of 21Shares’ parent company 21.co – clarified that their application clearly rules out using securities lending from its business model.

“The Trust, the Sponsor, and the service providers will not loan or pledge the Trust’s assets nor will the Trust’s assets serve as collateral for any loan or similar arrangement,” the filing read.

Unlike Long, CoinMetrics co-founder Nic Carter interpreted ETF sponsors’ low fee arrangements as a sign that they are expecting massive inflows to their products. On Monday, Bitcoin reached a twenty-two-month high of $47,100.