Fitch Ratings has issued a warning regarding the "high market value risk" associated with Bitcoin-backed securities, potentially complicating the expansion of crypto-linked credit products among institutional investors. The agency's assessment highlights the inherent price volatility of Bitcoin, structural complexities, and counterparty risks as key factors contributing to the speculative-grade credit profiles of these financial instruments.
Bitcoin-backed securities are financial instruments that typically pool Bitcoin or Bitcoin-linked assets and issue debt against that collateral. This allows investors to gain exposure to Bitcoin without directly selling their holdings, while Bitcoin owners can monetize their assets. However, Fitch Ratings emphasizes that the volatile nature of Bitcoin's price can quickly erode collateral value, leading to potential losses.
In its assessment, Fitch referenced the significant drop in Bitcoin's value in March 2020, where it lost 49% of its value within 24 hours, as an example of the rapid losses that can occur. This inherent volatility necessitates conservative collateral coverage and rapid deleveraging mechanisms to mitigate potential risks. Coverage levels, which refer to the ratio of Bitcoin collateral to the amount of debt issued against it, can be quickly compromised by sharp price declines, triggering margin calls and forced liquidations.
The agency also pointed to the failures of several crypto lenders during the 2022-2023 downturn, such as BlockFi and Celsius, as examples of how collateral-backed models can quickly unravel during periods of market stress. These collapses underscore the importance of robust risk management practices and highlight the potential for significant losses in the crypto market.
Fitch Ratings also notes that Bitcoin-backed securities rely heavily on third parties, such as custodians, collateral agents, and liquidation managers. The failure or mistakes of these parties can also lead to major losses. This dependence introduces additional counterparty risks that must be carefully considered.
Fitch's warning could influence how banks, asset managers, and other institutions evaluate emerging financial instruments tied to volatile asset classes like Bitcoin. The agency's evaluations play a significant role in shaping investment decisions and risk assessments within the financial industry. The assessment follows a prior warning from Fitch about elevated risks for US banks with significant digital asset exposure, citing potential reputational, liquidity, and compliance risks.
