The BIS Has Some Words On DeFi and Bitcoin ETFs

It's all an illusion

Parker Jay-Pachirat
December 07, 2021

Hi all, Parker here. Hope everyone’s recovering from their time at Basel (aka NFT week) in Miami... I know I had major FOMO! 

Anyways, today I’ll be diving into the Bank for International Settlements’ (BIS) Quarterly Review, which was released on Monday. For one of the first times ever, the group discussed one of my favorite subjects: DeFi. The BIS is the central bank of central banks, and has only recently started talking more about this space. Back in September, FTT Expert John Collins covered a speech from the BIS about Central Bank Digital Currencies. There was a lot that was said then that was echoed in this new report, but the group seemed to take an even stronger tone this time around. 

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The Illusion of DeFi

The BIS opens its section on DeFi by asserting its bias, stating the report “...examines DeFi from a financial stability perspective, drawing attention to vulnerabilities.” Throughout the report, the team goes on to make a few key points. Most notably, the report argues that decentralization in DeFi is an illusion, that DeFi will rely on traditional finance so long as it utilizes centralized stablecoins (which, increasingly, many DeFi protocols aren’t). 

The report continuously emphasizes its view that DeFi “has the potential to complement traditional financial activities”. The report concludes by asserting three main arguments: 

  1. DeFi “could play an important role in the financial system.”
  2. DeFi has the potential to threaten the traditional financial system.
  3. DeFi should be regulated in the exact same ways as traditional finance.

Taken in conjunction, these arguments reveal a few interesting suggestions. First, that the BIS is legitimizing DeFi in recognizing its value and potential for longevity. Second, that it feels threatened by both the unfamiliar characteristics of DeFi and DeFi’s potential to disrupt traditional finance. And third, that it hopes to mitigate this threat by regulating DeFi as if it were traditional finance- rendering DeFi’s core ethos obsolete. 

The last two lines of the report are perhaps the most telling, stating: “[Policy entry points] should allow public authorities to contain DeFi related issues before this ecosystem attains systemic importance. Regulatory safeguards would also help to ensure the innovative potential of DeFi brings overall benefits to finance”. By regulating DeFi like traditional finance, the BIS would not only be able to exclusively silo DeFi into benefitting traditional institutions, but also mitigate the risk DeFi poses to disrupting those traditional institutions entirely. 

Launch of the First US Bitcoin ETF: 

The BIS report also goes into the recent Bitcoin ETF launched by ProShares, pointing out that it was “one of the most heavily traded ETFs in market history,” after bringing $1B in assets in just a few days. More interestingly (to me at least…but I’m a nerd), the section focuses on the differences between traditional ETFs and this one. The BIS admits that, because of the way that the BITO ETF is structured, it might be more expensive than it needs to be. That’s because the SEC was particularly wary of bitcoin ETFs that were holding bitcoin on unregulated exchanges; BITO solved that by creating a futures ETF that doesn’t actually hold bitcoin, but is made up of future contracts that are traded on the CME (Chicago Mercantile Exchange.)  Commodities like gold are traded on the CME, and the BIS writes that this bitcoin ETF is very similar to a commodities ETF. According to the report, BITO would have “underperformed spot prices by 18% on a cumulative basis” over the last 4 years.

The BIS finds two potential issues: both seemingly more about the fixed equities trading sector than bitcoin itself. 

  1. People can buy up really long dated Bitcoin futures knowing that the BITO ETF will have to purchase them in the future, essentially front running the ETF (BIS’s words, not mine). 
  2. Depending how big the ETF gets, it could play an outsized role in the market if shit hits the fan. It can already create additional volatility, but it could also cause ripples in the bond market since the BITO ETF also holds Treasury Bonds and Cash.

One thought I want to leave you with that ties into all of this a bit is that crypto could very well impact elections in the not-so-distant future. Julie recently interviewed Bradley Tusk of Tusk Ventures on Tux Time to discuss this topic. With all of the money, consumer demand and power now in the space, everything from state and community level races to national standards could be seeing big changes. Thoughts? Tweet us! 

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