The recent launch of spot Bitcoin ETFs in the US has brought a new wave of excitement to the financial world. The approval saw ten different ETFs go live in January, and competition within the ETF space is heating up, with fees being the major differentiator between the various issuers. Competing on fees eventually reaches the lower bound and won’t prove to provide much dividends for issuers trying to attract new capital, so they need to find new ways of appealing to different demographics.
One way ETF issuers can stand out from the crowd is their custody method, with only Fedility offering in-house custody of the Bitcoin, while all other ETFs are using third parties. This gives investors a chance to hedge against different custody models; instead of having all their Bitcoin exposure with one custodian, they can spread out that risk across ETFs with different custodians or custody models.
As Bitcoin spot ETFs compete for capital flows, another trend has emerged in the form of on-chain address transparency: Bitwise, which offered the cheapest fees of all ETFs, were the first provider to share the public addresses of their Bitcoin holdings. This bold move raises questions about differentiation, transparency, and its potential impact on the market.
Differentiation in a crowded field
With multiple Bitcoin ETFs now available, asset managers are eager to stand out. Sharing wallet addresses and being fourth coming about your holdings offers a unique selling proposition. It showcases a commitment to radical transparency, potentially appealing to investors seeking greater trust and assurance about their holdings.
Bitwise, the first to make this move, positioned it as “walking the walk with Bitcoin’s ethos” and setting the standard with a don’t trust but verify approach.
By showcasing your on-chain balance, you provide proof of reserve and signal to the public you’re conducting business above board and willing to accept scrutiny from any blockchain sleuth, competitor or industry watchdog.
This is not to say that sharing a public address is perfect transparency; if the keys to a wallet were ever lost or part of the controlled multi-sig is lost, then while those funds remain visible on-chain, they are unreachable and, for all intents and purposes, lost forever.
One way to prove that an ETF is still in control of an address is to provide cryptographic proof that can be verified from time to time.
Transparency: A double-edged sword
On the surface, being forthcoming with your public addresses seems to offer unparalleled transparency, especially as others have failed to offer the same level of openness. Anyone can verify the ETF’s Bitcoin holdings on the blockchain, fostering trust and mitigating concerns about potential asset mismanagement.
However, there are downsides:
Exposing large public holdings could attract opportunistic actors targeting the wallets and watching them for trading opportunities. As large funds are moved, they could drive narratives to front-run buys or sells to try and profit from these ETFs having to rebalance their holdings.
Revealing holdings might provide valuable insights to competitors, potentially aiding them in formulating trading strategies and even creating bots to watch your addresses and trigger trades based on your address activity. This could hinder an ETF’s ability to secure the best deals and optimise returns.
While the addresses only belong to the ETF, some might argue that indirectly exposing investor funds through aggregated holdings raises privacy concerns. It also leaves the wallet balance open to interpretation, with the cryptocurrency community thriving on pushing out rumours.
Over collateralised ETFs
Now that Bitwise’s address has been made public, they also have to deal with the risk of online trolls, and it didn’t take long before the first shenanigans began with some users donating small amounts of Bitcoin to the address, causing the fund to be over collateralised.
While this is all rather silly, and those donations would be eaten up by on-chain fees anyway, it can turn into something more complex or sinister. Given the fact that Ordinals and Inscriptions exist, if an ETF has acquired Bitcoin with a rare sat, they sit with the issue of whether they cash in on the market for this collectable or not.
A similar issue arises with some inscribers donating Inscriptions to the ETF address. Does the ETF issuer ignore these “assets”, or do they try to extract the current premium from this secondary market?
The tainted coin conundrum
Another potential pain point that could arise from broadcasting your public address is the fact that someone could send your address “tainted Bitcoin” from OFAC-sanctioned addresses.
If you’re a US-based financial company and you’ve got Bitcoin in your wallet with ties to North Korea or Iran, it is likely not going to be a good look for your business, and you’ll need to do your fair share of PR disaster management, and depending on the success of the communication which could affect the share price negatively.
Navigating the trade-offs
The decision to share addresses is ultimately a strategic one, with each ETF provider weighing the potential benefits against the risks. While transparency can attract investors seeking trust, it comes at the cost of potential security vulnerabilities, competitive disadvantages, and privacy considerations.
ETFs like Bitwise are racing ahead and breaking new ground, and we have no idea how regulators will view this trend. Will they be for it and push other ETFs to implement the same strategy, or will there be other methods of proving ownership of funds, like zero-knowledge proofs?
We will have to wait and see.
They will find you eventually.
Other ETFs have chosen not to reveal where their public holdings are stored, but that has not stopped blockchain analytics firms and even independent researchers from trying to track down their digital footprint.
According to industry research firm Arkham Intelligence, they claim to have already identified addresses linked to other major players like BlackRock, Fidelity, and Franklin Templeton. Arkham also released information on VanEck and WisdomTree, showing holdings of around 2,770 BTC ($111 million) and 191 BTC ($7.67 million), respectively.
While these claims remain unverified, this suggests efforts are underway to uncover holdings of other Bitcoin ETFs. If ETFs want to remain in the dark, they will need to apply some privacy tactics like using multiple addresses and compartmentalising addresses so they have no relationship to one another by linking transfers, which isn’t easy to manage at scale.
The fact that CoinJoins might not be attractive or practical for ETF custodians also makes it harder for them to mask their footprint for the long term. Custodians could also try to peg Bitcoin into second-layer options like the Liquid or Roostock side chain to try and break their connections on the chain, but this adds to fees and complexity of fund management.
It’s still early days for Bitcoin ETFs, and the practice of sharing public addresses remains an evolving trend. Whether it becomes an industry standard or remains, a unique selling proposition for a few bold players remains to be seen.
What’s clear is that this transparency experiment will be closely watched by investors, regulators, and the wider crypto community, shaping the future of Bitcoin investment vehicles.