Navigating Bitcoin and Ethereum’s Institutional Risks

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By now, you all know that I have named the upcoming bull run “Institutional Run”. This narrative will shape the next few months, and I want to focus my investment strategy on it. However, institutions also bring a lot of potential dangers, which unfortunately nobody talks about. So today, let’s address these dangers.

TL;DR:

Disclaimer: This report is for informational purposes only and not to be considered as financial advice. Always do your own research and consider your own risk tolerance before investing in cryptocurrencies, which are volatile and risky assets.

Everyone is eagerly anticipating the Bitcoin and now the Ethereum Spot ETFs. A few weeks ago, BlackRock filed an S-1 for an Ethereum Spot ETF. But what’s really behind this shift in attitude of the financial powers, and what risks are we facing? Before we can tackle this, we need to clarify a few fundamental things.

Fundamental Definitions and Considerations

Starting Situation

Let’s first look at the current situation around the Spot ETFs and the shift in attitude of the financial powers. Here’s an example: Larry Fink’s statements from 2017 and 2023. Back then, the CEO of BlackRock – mind you – said “Bitcoin was a system for money laundering”. A few weeks ago, we heard this statement: “Bitcoin is a flight to quality”. So, over the years, this shift in attitude has occurred, a 180-degree turn. I covered this a few weeks ago in ⁠reports. All this led to positive momentum in the market through the anticipation of Spot ETFs for Bitcoin and Ethereum by the major asset managers, especially BlackRock with over 9 trillion US dollars in assets currently. But other major asset managers and financial powers are involved, like Fidelity, Vanguard, etc. The idea was, of course, that a lot of new money would flow into the market through these products.

Future VS Spot ETFs

When you look at the difference between Future and Spot ETFs: We already have Future ETFs; they offer direct exposure, where Bitcoin is actually bought for these products. BlackRock will then have to buy Bitcoin for its clients, which will later be handed over to Coinbase as a custodian and stored there. So, there’s organic demand through the Spot ETFs. And when you have an asset with a limited supply, as is the case with Bitcoin – there will be a maximum of 21 million – and if billions flow into it, then it’s easy to do the math: The price will eventually rise if the money really flows in. There are various forecasts on this. For example, at Fundstrat, they have looked at this price equilibrium between supply and demand. They predict a price for next year, if a Spot ETF is introduced, between 140,000 and 180,000 US dollars. They also justify this based on data and facts, historically with various Spot ETFs. Whether it really turns out that way, we’ll see.

Proof of Work vs. Proof of Stake

There are significant differences between Bitcoin and Ethereum, and it’s due to the nature of the two coins. I can tell you right away: Ethereum carries greater dangers, but there are also risks with Bitcoin that we need to discuss, as they are indeed present. What’s the big difference? I know, especially with BlackRock’s Spot ETF application, many new people are back in the market. So, I’ll explain briefly again: What are the essential differences between Bitcoin and Ethereum? Blockchain technology is always about consensus. We don’t have a central authority that validates transactions and checks blocks.

Therefore, there must be a consensus through the decentralized structure. The absolute majority must agree for a transaction to be validated and the next block processed. Bitcoin uses Proof of Work, where real energy is used by mining companies and mining devices. It’s about the energy put into the network to gain market power. Ethereum is different. Since ETH 2.0, the system has been switched to Proof of Stake. Proof of Stake is about the share of the total network in coins, i.e., the stake one holds. The more coins one owns, the greater the market power.

Hostile Blockchain Takeovers

An interesting paper on this topic is “Hostile Blockchain Takeovers,” focusing on hostile blockchain takeovers. Such takeovers always aim to gain a majority in the network, a so-called 51% attack. In Bitcoin’s case, this would be possible if one had 51% of the hash rate. Then one could attack the system but would need a lot of money for many mining devices and infrastructure. In Ethereum’s case, one would simply need 51% of the staked ETH to gain the majority. This paper also compares the differences: What does it look like in Proof of Work versus Proof of Stake, what are the points of attack, and what countermeasures exist? For those interested, here’s the link to the paper: Hostile Blockchain Takeovers

Bitcoin’s Hashrate

Regarding Bitcoin, the good news is that the hashrate has continued to rise even in a bear market. The blue chart shows how much hashrate, or energy, is being put into the network. The higher the value, the more secure the network. And I think everyone agrees: A 51% attack on Bitcoin is unthinkable. To mount such an attack, one would need to build large infrastructures, purchase many devices, and invest a lot of energy, making it not financially viable. No institution or country currently has enough money to attack this system. Even a Spot ETF wouldn’t bring such a risk, because even if BlackRock or other financial institutions buy Bitcoin for their clients, they cannot attack the network with it. They would need the energy and infrastructure to do so.

The Concept of Hard Forks

Now let’s talk about Hard Forks in the blockchain. What are Hard Forks? This is where blockchains split. Anyone who wants to can rewrite Bitcoin, add new features, create their own fork, and then operate their own Bitcoin blockchain. The question is: Who does that? Probably no one, and we’ve seen this repeatedly in the past. A prominent example is in 2017 when Bitcoin Cash emerged. It aimed to change Bitcoin with technical features – Bitcoin has a 1-megabyte block size, and Bitcoin Cash wanted an 8-megabyte block size to make it more scalable. However, it wasn’t a really good idea, wasn’t widely accepted, and has since continued with several hard forks. We’ve seen various variants, like Bitcoin SV, among others. All these coins are hard forks.

BlackRock’s Stance on Hard Forks

The key point about Hard Forks is this: In 2017, if you owned a Bitcoin before the fork, you ended up with one Bitcoin and one Bitcoin Cash. So, the sum you had was then available on both blockchains, allowing you to decide which one to keep or sell. The intriguing part of this story, and why I’m telling you this, is due to BlackRock’s interesting statement in its filing regarding potential future forks of Bitcoin. Here’s the link to the filing so you can read it yourself: BlackRock Filing

BlackRock states that they will decide which blockchain to follow in the event of a fork! There’s no guarantee that they will choose the more valuable variant! So, if the majority wants to stay with the original variant, BlackRock could opt for the new variant for its ETF, and all ETF holders would receive only exposure the new variant in return. BlackRock could potentially pocket the old variant. This poses a risk for those buying through the Spot ETF. However, those who buy Bitcoin and hold it in their own wallet don’t face this risk. Yet, BlackRock, with its market power and the significant capital likely in this ETF, could play a decisive role in such forks.

Greenpeace’s PoS Initiative

But why are we discussing this scenario? Because of the dangers that some people want to make BTC a Proof of Stake Blockchain. It’s not far-fetched when you consider past reports, such as the campaign by Greenpeace, which is partly funded by Ripple, the company behind XRP. So, there are substantial institutions behind it. But what exactly is this “Change the Code” initiative? Here’s the link for more information: Change the Code

Greenpeace, notably, is advocating for a shift in Bitcoin’s system from Proof of Work to Proof of Stake. Why this is a bad idea, we’ll get to in a moment. But this shows that such interest groups exist, and there might be an interest in eventually switching Bitcoin to a Proof of Stake variant. BlackRock, in its filing, stated they reserve the right to choose which blockchain to follow in case of a fork. So, if they opt for a Proof of Stake variant of Bitcoin, those who invested in the ETF would essentially only hold the Proof of Stake variant. This is a potentially dangerous scenario and not so far-fetched, considering these reports.

Greenpeace’s campaign has been running for over a year, funding ads that spread misinformation about Bitcoin and its environmental harm. There’s a clear interest in moving away from Proof of Work.

PoS Risks due to BlackRock’s Power

Let’s consider why Proof of Stake carries greater dangers. Even Vitalik Buterin expressed these concerns on September 30. He said a 51% attack is possible by large staking providers and decentralized organizations. The danger is definitely there. One only needs 51% of the staked ETH. Cases like Steem and Ethereum Classic have already happened. You don’t need to build infrastructure, just the capital.

With 51% of the staked ETH, you control the network. Regarding a Spot ETF, BlackRock has the potential to buy ETH for its clients, hand it over to Coinbase, and a big question is: What happens to these ETH? Will they be staked or just left idle? It makes no sense to leave them idle, as they could improve their own investment by staking and earning rewards, unlike others who don’t stake. Looking at how much ETH is currently staked, we see 28 million, which is 62 billion. BlackRock would currently only need 31 billion USD in ETH to potentially attack the system. With 9 trillion US dollars under management, this is conceivable. For comparison, Grayscale alone holds 6.1 billion US dollars in ETH in their trust. It seems possible for BlackRock to collect and stake 31 Billion US dollars in ETH through its clients and asset managers promoting Ethereum.

Likelihood of these Events

Is this likely? As for Bitcoin, a 51% attack seems very unlikely due to the system’s nature – it’s not financially viable, and it takes more time. In Proof of Work, it’s harder to mount an attack due to the need to build infrastructure. This can’t be done quietly; it takes time, and countermeasures can be implemented. In Proof of Stake, it’s possible. The question is whether it’s worthwhile for BlackRock. If they engage in staking, they would earn returns. It’s doubtful that ETF holders would receive staking rewards.

The risks exist in both systems. In Bitcoin, the risk lies in attempts to change the code or exert market power through the ETF. The broader community is likely to stick with Proof of Work, but if BlackRock opts for Proof of Stake, it could impact the blockchain. In Ethereum and staking, the danger is more apparent. However, there must be a malicious intent to harm the system. BlackRock will make a lot of money with the ETF and probably with staking. Why then would they want to attack it?

The only reason would be to gain market power and better control transactions. Why would they do this you may ask. Well, we have to think bigger. Who would like to censor and control transactions? Our governments!

Censorship Risks

Coinbase, as the custodian, is a regulated company that will likely conduct the staking. BlackRock is a regulated company, and if the government or politics dictates, ‘We have this rule now, and you’re validating in the network, you must censor these transactions,’ it will be even easier than it already is in Ethereum to enforce such measures.

You see guys, the risks may not be big in the moment, but they are present and they are not that far fetched. The important question for us now: What do we have to do?

Takeaways

  • Own the actual BTC or ETH, don’t invest via the ETF as you will loose money by missing staking rewards and/or loose money on potential hard forks.

  • During 2024, we have to evaluate these risks because if they become more present, we might have to rethink our portfolio allocation.
You see this is a fascinating topic, and I’m interested in your opinions. Let me know your comments on Discord.

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