ETC Group’s paper provokes mixed reactions from Europe’s crypto ETP cohort
Researchers at European crypto ETP issuer ETC Group have spent the long summer months reading the prospectuses published by their peers in the sector.
The firm has subsequently published a paper entitled: ‘Why structure really matters in crypto ETPs’, (available on their site) which specifically calls out the differences between, and what it perceives as failings in, its rival European crypto ETP offerings.
The European crypto ETP vehicle offers investors the opportunity of gaining exposure to the price movements of cryptocurrencies like bitcoin (BTC) and ether (ETH). These ETPs trade on regulated European stock exchanges, for example Germany’s Deutsche Börse XETRA or the Swiss SIX Exchange.
The crypto ETPs have enjoyed extraordinary success across Europe over the past few years, despite being banned in the UK, but have struggled more in the so-called crypto winter, with bitcoin performance significantly down.
ETC Group reports that as of February 2022 there were 73 crypto ETPs in Europe, comprising USD7 billion in assets under management (AUM), representing more than 50 per cent of the global total.
ETC Group itself famously achieved growth of 34,259 per cent from its launch on 8th June, 2020 to 1st June 2021, reaching a peak in assets of USD1.7 billion, leading it to win the ETF Express Editor’s Award in the March 2022 European awards. At the time, it claimed to be the most liquid, 100 per cent physically backed bitcoin ETP in the world.
However, roll on a year and the firm has felt the chill of that crypto winter as its bitcoin product, distributed by European white labelling firm HANetf, has seen assets depleted to USD370 million, at the time of writing.
The study, conducted by ETC Group’s researchers Tom Rodgers and Hanut Singh, particularly focuses on crypto ETP issuers who lend their assets.
“Investors are unaware that these products, billed as ‘safer ways to invest in crypto assets’, are actually riskier as the underlying assets are being lent out instead of being held unencumbered in safe custody,” the firm said in a statement.
“This lending is more often uncollateralised with little transparency about the actual risks being taken - and who pockets the proceeds of the lending.”
“We feel strongly about this point that we could keep doing what we are doing and keep our heads down,” Bradley Duke, ETC Group’s CEO says. “But we feel there is a risk we could find ourselves in a situation where the regulator steps in and we end up with regulations we don’t need and want because market participants aren’t listening to precedent and what has happened in the past.
“We are bringing to light what is actually in the prospectus. It is boring but some people like to read a prospectus and if that information is not brought to light it’s right that investors understand the risks that they are facing”
“We have been around the block and saw what happened in 2008/9 when iShares was called out about the proceeds of lending out equities.
“To lend out cryptocurrencies which are backing a security is a different game entirely. The lending of crypto currencies is not stock borrow and loan where you have large entities with risk departments facing each other with a legal document that defines the relationship between the two firms – the obligations and collateral schedules and all the stuff we know from the ETF world.
“We can’t ignore that. We feel strongly that we need to make sure that we don’t end up in a situation where there is some sort of scandal or high-profile collapse of one of our peers.”
Commenting on the paper, Hany Rashwan, co-founder and CEO of 21Shares, says: “Investment is all about trade-offs between potential risk and return and we want to ensure investors can make informed decisions. 21Shares offers both lending and non-lending versions of our bitcoin ETP tracker so that investors can decide which option is right for them.”
Rashwan also takes issue with the paper, saying: “There are also a lot of false statements in that paper as well. 21Shares Bitcoin ETP (ABTC) does not engage in lending and 21Shares Bitcoin Core ETP (CBTC) allows for lending but does not currently engage in lending.”
Rashwan says: “The prospectus is designed to inform investors about the full array of risks that may impact any of the ETPs in our product range. For more specific information, investors can visit the 21Shares’ website to check if a particular ETP is eligible to lend. The product page for each ETP indicates whether or not the product is eligible to lend.
“For products currently engaged in lending, the website displays the amount on loan; the value of the collateral posted; the collateral ratio and the projected lending yield.”
Rashwan says that 21Shares USD Yield ETP is the only product actively lending right now.
“The paper is assuming 21Shares is lending the underlying based on the prospectus stating the following: ‘The Issuer may enter into lending arrangements whereby it lends certain Underlying or Underlying Components to third parties’ in the Risk Factors section. The prospectus is broad and covers extensively any activity that could increase risk for investors. The paper is also assuming 21Shares Bitcoin Single ETP – ABTC is performing lending activity whereas this claim is false,” Rashwan says.
“21Shares drafted the prospectus to cover all the ETPs issued under the same Special Purpose Vehicle. Some ETPs issued by 21Shares are performing lending activities as part of their strategy. 21Shares launched 21Shares USD Yield ETP, the ETP is lending USDC against collateral to provide yield to investors.
“On top of this ETP, 21Shares launched a low-cost version of the existing 21Shares Bitcoin ETP – 21Shares Bitcoin Core ETP. The ETP can participate in collateralised lending allowing CBTC to be the cheapest priced bitcoin ETP on the market, but it is currently not lending.”
Rashwan believes that 21Shares investors understand the prospectus. “It is also clearly stated on 21Shares’ website product page if products are entering into lending activity or not. Our customers have no concern and in fact have asked us for these products which is why we built them. There are also 38 products that we offer that do not lend so customers can either buy products that lend or buy products that do not lend. We have the option for both.”
The ETC paper also comments on an interview given to The Financial Times on 4 July 2022 where Rashwan said that one of the Swiss company’s products, Bitcoin Core ETP (CBTC), would ‘opportunistically lend’.
Rashwan says: “CBTC does not currently lend. 21Shares would indeed opportunistically lend the underlying on CBTC to institutional grade borrowers when the market conditions allow it. At this stage, CBTC is not entering into lending activities as the requirements are not met but we do expect the market to mature and therefore being able to lend a portion of the underlying, fully collateralised.
“Collateralised lending allows CBTC to be offered to investors at a total expense ratio of 21 bps, which is far below the fees associated with competing products. For investors who prefer exposure to BTC without lending we offer 21Shares Bitcoin ETP (ABTC).”
Other providers in the European crypto cohort mentioned in the paper agree with the paper’s basic principles that investors generally need to be more informed on what they are buying in the European crypto ETP space.
CoinShares’ Townsend Lansing, head of product, says: “He is raising a good point about digital assets and ETPs that can provide new forms of revenue from yields from staking or lending which haven’t been possible before - it’s worth talking about that and whether investors understand the risks, rewards and transparency required.”
Martin Bednall, is CEO of new arrival on the crypto issuer scene, Jacobi Asset Management, which plans to launch the Jacobi Bitcoin ETF which will be listing on Euronext Amsterdam in the coming weeks, having received regulatory approval from the Guernsey Financial Services Commission (GFSC) in October 2021.
Bednall says, of the paper, that it is: “A good note highlighting issues that investors should be concerned about in ETN structures. It’s a welcome note from our perspective.”
Jacobi is also mentioned in the paper, criticised for not making it clear that it is not a Ucits ETF and for its lack of clarity on its fees, and also for a disclaimer that the firm says is standard in all fund prospectuses.
Bednall says: “As the note says, our ETF is not a Ucits ETF as ESMA doesn't allow crypto exposures in Ucits funds, however it is still a fund holding the crypto assets rather than having collateral arrangements governed by complex contractual arrangements.
“The paper makes a point that there is a disclaimer from the regulator in our scheme of particulars (prospectus) but every single ETF in Europe has a similar disclosure, it is pretty standard across the world and doesn’t impact the regulated status of the ETF. The fact they have called this out shows the ETN issuer doesn't interact or get approval from the regulator for their products.”
Bednall continues: “The main point is that investors should be aware of the structure of the note and the risks that may be within those structures such as the rehypothecation of collateral. Not all ETNs are built the same and you should look under the hood to understand the product.”
Regarding the fees, the Jacobi product has a TER of 1.5 per cent which will be made clear in the final documents produced at launch, Bednall says.
Criticism of the CoinShares products within the paper, focused on the synthetic crypto product XBT.
Lansing says: “XBT was fundamentally the first to market product and created when service providers weren’t willing to engage and involves credit risk and we recognised the need at the same time to be competitive and to build a physically backed range.”
He continues: “We tend to focus on the CoinShares physical range as XBT is more a legacy product; having said that, we continue to support it as it has a very strong brand in the Nordics.”
In fact the XBT product has recently seen the highest inflows in CoinShares’ data.
Beyond that, Lansing is not a supporter of the ETC Group’s method of commenting on the industry. “We don’t like this approach. We think the industry should be involved in helping investors understand the products – it’s never good to throw mud internally,” Lansing says.
Laurent Kssis is Managing Director and Head of Europe for Hashdex, whose firm is not mentioned in the paper, but who is a veteran of the European crypto ETP industry, having worked at both CoinShares and 21Shares.
Kssis says: “Not all debt structures out there are equal which is true, and a debt instrument has the capability of lending out, as often undergone by banks’ issuance programme like which they conduct everyday.”
He agrees that securities lending is an issue: “But in a debt instrument you have a collateral agent that guarantees and intervenes should the issuer default - otherwise the programme would not exist.”
He also notes that the lending programme can generally be up to 5 per cent or maybe 15 per cent at most. “And it is expected that there will be a minimum of 120 per cent collateral and the collateral agent will demand that in its terms and conditions agreed with the issuer.”
Kssis makes the further point that some of the new crypto ETP providers in Europe are regulated as Special Purpose Vehicles, not as fund management groups, with all the additional regulation that requires.
“Ultimately regulation is the right way forward,” he says. “This is a market that is not regulated and has been able to thrive based on the European directive to have prospectus approved by the home country regulator.
“To that effect, if the regulators intervene - and will - and set out a regulatory landscape - this will be good for all companies.”