Coinbase dominance over Bitcoin ETF custody raises concerns

Coinbase is the custodian of eight of the 11 approved Bitcoin ETFs, and several blockchain specialists and ETF consultants have raised concerns about this high concentration on one platform.
The extensive involvement of Coinbase in these ETFs extends beyond mere custodianship. The digital-asset exchange is poised to provide a comprehensive suite of services, encompassing custodial, trading, and lending functions, to prominent players like BlackRock.
However, this concentration of responsibilities within a single entity, Coinbase, is sparking concerns among experts in the blockchain and ETF sectors. 

This is a horrendous level of centralization within the proposed Bitcoin ETFs. It seems Fidelity @DigitalAssets is the only one doing it right. pic.twitter.com/YhpC0DHl62
— Jameson Lopp (@lopp) December 3, 2023

Notably, the SEC has expressed reservations about the risk concentration created by Coinbases’s custody of all major ETFs. The SEC has engaged in a legal confrontation with Coinbase, alleging that the company operates an unregistered exchange and broker-dealer, accusations that Coinbase vehemently denies.

So 10 out of 11 #Bitcoin ETF’s private keys are held via Coinbase outside of Fidelity?

The self custody cypher punk in me clearly envisions how that is impending future security risk? Doesn’t anyone else?

— Dawdu (@_DAWDU) January 15, 2024

David Schwed, the Chief Operating Officer at Halborn, a blockchain security firm, voiced concerns over this development in a recent conversation with Bloomberg. According to Schwed, the financial market infrastructure is traditionally segmented into distinct roles to avoid such responsibility concentrations. He argues that having a single entity like Coinbase handle all aspects of a trade’s lifecycle could be problematic.
The reliance of ETF issuers on Coinbase’s services has been flagged as a concentration risk. Dave Abner, a principal at Dabner Capital Partners, an ETF consultancy, similarly expressed surprise to Bloomberg that issuers are not mandated to use multiple custodians to safeguard against potential risks.
In response to these concerns, Coinbase Chief Financial Officer Alesia Haas has stated that the company strives to mitigate conflicts of interest, and the company’s custody business is not implicated in the ongoing SEC case.
A critical aspect of Coinbase’s role is its exclusive partnership with BlackRock as the sole trading agent for its Bitcoin ETF, operating through Coinbase Prime. Furthermore, Coinbase’s lending service, albeit a smaller organization segment, is vital for the Bitcoin ETF mechanism. It allows issuers like BlackRock to borrow Bitcoin or cash on a short-term basis for trading.