Investors viewed bitcoin spot ETFs as an opportunity to gain exposure to bitcoin’s price without having to hold bitcoin directly. Unfortunately, the initial effect was a simple reshuffle of existing bitcoin investments into ETFs, often from publicly traded bitcoin miners.
Similarly, investors rotated money from GBTC, a high-fee trust, into spot ETFs with far lower fees. However, as awareness of these ETFs has proliferated and the price of bitcoin has rallied to all-time highs, net new inflows into bitcoin ETFs have become a reality. There is over $50 billion now in bitcoin ETFs.
One natural question, given the size of the custodial bitcoin market, is whether bitcoin ETFs are insured. BlockFi, Celsius, Gemini, QuadrigaCX, and FTX have spooked depositors with victims of these collapsed platforms understandably wary of third parties holding bitcoin on their behalf.
Celsius, in particular, once claimed it passed along depository insurance from the FDIC — a federal insurance program reserved for bank accounts. The FDIC and Treasury Department countered that claim and demanded that Celsius Network eliminate that claim as false advertising. Celsius subsequently declared bankruptcy; its founder is facing devastating federal and class action lawsuits.
How the FDIC works and why crypto marketers should be nervous
Read more: FDIC issues notice that banks misreported figures… but for who?
Quietly neglecting bitcoin insurance for a decade
For nearly a decade, Grayscale’s flagship GBTC trust and other bitcoin fund managers relied on custodians like Coinbase, BitGO, and Bank of New York Mellon for holding their bitcoin in custody. Unbeknownst to most investors, however, many of these custodians underinsured their holdings to a disturbing paucity.
Coinbase, for instance, holds over $45 billion in bitcoin on behalf of its customers. As of February 16, it only insured $400 million — less than 1% of the value of its holdings. Similarly, Coinbase only bought $320 million worth of crime insurance — a pittance compared to the value of its assets.
One ~400 million dollar insurance policy covers all the crypto at Coinbase.
Tens of billions worth of Bitcoin in publicly traded ETFs share an insurance policy with your cousin’s Dogecoin he bought and left on Coinbase after Elon tweeted about it. https://t.co/MpL018y64X
— Rob Hamilton (@Rob1Ham) February 17, 2024
Custodians have underinsured its bitcoin holdings for over a decade.
When forced to disclose the complete truth in public SEC filings, many publicly traded bitcoin companies admit the embarrassing shortfall of insurance on their bitcoin holdings. MicroStrategy, for example, admits that “only a small fraction of the value of the entirety of our bitcoin holdings” are insured.
Riot Platforms writes even more frankly, “We may be unable to secure insurance policies for our bitcoin assets at rates or on terms acceptable to us, if at all, and we may choose to self-insure.”
Digital asset holders may, of course, buy an insurance policy for their personal holdings. Certain companies offer hardware wallet or multi-party insurance. However, the alarming reality of the institutional custodial industry has simply been the choice to not insure over 99% of the bitcoin held in custody.
Read more: More bitcoin ETFs offer yield — but where is it coming from?
SIPC insurance to the rescue — sort of
As a reprieve of sorts, the new fleet of bitcoin ETFs offer a type of bitcoin insurance that has never existed before for US investors: SIPC insurance.
First of all, the Securities Investor Protection Corp (SIPC) doesn’t cover investors’ bitcoin deposits at natively digital asset investment firms like Coinbase, Kraken, or Gemini. Although offerings like Gemini Earn qualify as securities, SIPC does not insure securities nor bitcoin held by unqualified entities.
Instead, SIPC insures customers that the securities they hold in brokerage accounts cannot be stolen by the brokerage company or clearinghouse. SIPC does not insure the assets backing those securities, such as businesses, gold, oil, or bitcoin. Instead, SIPC only guarantees that a paper certificate or other digital representation of the asset — the security itself — remains the property of the customer.
SIPC provides $500,000 of insurance per customer at conventional brokerages like Schwab, Etrade, or Robinhood.
As a result of this coverage, bitcoin ETF investors enjoy SIPC insurance of up to $500,000. Again, the customers do not enjoy SIPC insurance on their actual bitcoin, which is held by custodians of the ETF sponsor. To be clear, SIPC simply insures customers’ bitcoin ETF shares against covered losses like theft by brokerages or clearinghouses.
SIPC typically protects consumers from brokerages going bankrupt. It doesn’t, however, protect them from investing in companies (or funds, like ETFs) that subsequently collapse due to market forces.
SIPC simply insures the shares of bitcoin ETFs. So, although SIPC is a very narrow guarantee, the insurance is admittedly a new form of backing that the bitcoin industry has never meaningfully enjoyed prior to this year.
