Your Bitcoin Isn't Real
Key Takeaways
Introduction to Paper Bitcoin
If you've been in crypto for more than a few days, then you may well have heard the term paper Bitcoin being thrown around. Paper Bitcoin refers to investments that give indirect exposure to Bitcoin, such as futures, ETFs, and even balances held on exchanges.
Many have alleged that there's more paper Bitcoin than real BTC backing it. These claims include BlackRock not holding the BTC it claims backs its ETF, Michael Saylor not actually buying billions in BTC, or that crypto exchanges don't have enough BTC to honor withdrawals. At the same time, critics say paper Bitcoin has an outsized influence on BTC's price, much like derivatives do in other markets like precious metals.
What Are Paper Assets?
In short, it's whenever someone invests in an asset without directly touching the asset itself. Take gold for example. In case you didn't know, most gold trading happens through paper contracts such as futures, options, forwards, ETFs, and unallocated accounts. In other words, most gold traders aren't buying physical gold, just paper contracts that give exposure to gold's price.
Just like with paper gold, paper Bitcoin refers to BTC exposure gained through futures contracts, options, and derivatives-based ETFs and trusts. All of which allow investors to trade BTC's price action without actually owning the underlying BTC directly.
The History of Paper Bitcoin
If you don't count crypto exchanges, paper Bitcoin has technically been around since December 2017. This was when the Chicago Mercantile Exchange (CME) launched Bitcoin futures, marking the first time institutional investors could trade BTC on a regulated exchange. Of course, this is pretty common today, but back then, this was a hugely bullish step that reshaped the future of the crypto market. In fact, its initial launch just happened to coincide with the very peak of the 2017 bull market. Coincidence? I think not.
The Exchange Problem
In Bitcoin's earliest years, several crypto exchanges were known to operate in ways that ultimately left users unable to access their BTC. Take Mount Gox, which once handled roughly 80% of Bitcoin trades globally, and which infamously collapsed in 2014 after losing hundreds of thousands of BTC through hacks, mismanagement, and accounting failures. Customers who trusted the exchange with their funds were left with paper Bitcoin, basically IOUs, which resulted in huge losses.
Mount Gox wasn't alone. Bitcoinica was another exchange suffering repeated hacks in 2012, losing tens of thousands of BTC. Bitfloor was hacked in 2012 as well and eventually closed down, while Bitfinex was relieved of around 120,000 BTC in 2016. And of course, there was the now-defunct FTX, which infamously used customer money for trades and investments and even company expenditures and political donations. Meanwhile, its loyal customer base was left with paper account balances that ultimately meant nothing.
All of these incidents share one thing in common. Customer balances were credited on exchange ledgers, but the BTC wasn't actually there. Essentially, users were holding paper balances of BTC rather than anything verifiable on chain. Naturally, this has fueled controversy around paper Bitcoin that continues to this day.
The Five Categories of Paper Bitcoin
Crypto Exchanges
The first and largest category is via crypto exchanges which are estimated to hold around 15% of BTC's total supply according to Glassnode. Crypto exchanges are perhaps the most notorious category of paper Bitcoin issuer because there has long been skepticism that exchanges have the BTC on hand to honor customer withdrawals, which wouldn't be all that surprising given the sector's history of hacks and scams.
It wasn't until after the collapse of FTX that exchanges started doing proof of reserves. As the name suggests, proof of reserves provides on-chain evidence that exchanges actually hold the crypto that they claim to. Proof of reserves has its own shortfalls, such as exchanges not regularly updating these balances, but it's better than nothing and a big step towards transparency.
Bitcoin ETFs
The second largest category of paper Bitcoin issuer is the Bitcoin ETFs. At the time of shooting, these ETFs collectively hold almost 1.6 million BTC, roughly 7% of the total supply. As some of you will know, ETFs hold shares in a regulated fund that track BTC's price and are managed mainly by asset managers like BlackRock and Fidelity. It's a compliant way to gain exposure with just a ticker and a brokerage account. No self-custody risk, no private keys, and no on-chain monitoring required.
And therein lies the problem. Spot Bitcoin ETF issuers have not disclosed their Bitcoin wallet addresses. This makes it hard to verify if they actually hold the BTC that is supposed to back their ETF shares. Although granted, some third-party platforms like Arkham Intelligence have discovered some of their wallets, so it's not all fairy dust, which is certainly good news.
Bitcoin Treasury Companies
The third largest category of paper Bitcoin issuer is Bitcoin treasury companies. As I record this, they collectively hold 1.1 million BTC, or roughly 5% of the total supply. If you've been keeping up with the crypto space in recent years, you'll know the world's largest Bitcoin treasury company is Strategy (formerly MicroStrategy), which started buying BTC in 2020. This made Strategy the first Bitcoin treasury company, inspiring hundreds of other companies to follow suit.
But how does this fall under the paper Bitcoin category? Well, these companies frequently add BTC to their holdings as part of their business. When investors buy shares in these companies, they're betting on the company's success, not the underlying BTC. Essentially, they're investing in the holder, not the holdings.
Not only that, but just like spot Bitcoin ETF issuers, most Bitcoin treasury companies have not disclosed their wallet addresses, not even Strategy. This is a little concerning, especially when you consider that there have been lots of questions about why Strategy's big Bitcoin buys have recently had next to zero impact on BTC's price. Some have alleged that this is because no actual BTC is being bought.
Government Holdings
The fourth largest category of paper Bitcoin issuer is governments. As most of you will know, several governments are supposedly sitting on their own national stockpiles of BTC, either due to seizures, state mining, or strategic reserve policies. But again, it's not clear how much BTC they actually hold, as guess what? Few governments have disclosed their wallet addresses.
The US is the foremost state Bitcoin holder with supposedly 328,000 BTC, followed by China with 190,000 BTC and the UK with 61,000 BTC. In total, governments hold about 646,000 BTC or roughly 3% of Bitcoin's total supply. What makes this category truly unique is that it's paper Bitcoin at the state level with the potential to shape geopolitical narratives or indeed influence monetary policy.
DeFi and Wrapped Bitcoin
The fifth category of paper Bitcoin issuer is DeFi, specifically BTC on other chains. This mostly takes the form of so-called wrapped Bitcoin that involves creating an ERC-20 token supposedly backed by actual BTC. These wrapped Bitcoin tokens like WBTC or Coinbase's CBTC are then used for borrowing, lending, liquidity mining, or yield farming.
Unlike other forms of paper BTC, most wrapped Bitcoin protocols do offer proof of reserves, which makes it possible to verify that the BTC is actually there. At the time of shooting, wrapped Bitcoin protocols hold over 380,000 BTC, just under 2% of the total supply.
Why does wrapped BTC count as paper Bitcoin? Well, you basically hand BTC to a custodian expecting to redeem it one-for-one later on. This redemption may not be guaranteed, though, and as we've learned, even proof of reserves isn't perfect. The BTC backing these wrapped tokens might not always be there.
How Paper Bitcoin Affects BTC's Price
The short answer is that it's had a very positive impact both directly and indirectly. That's because paper Bitcoin has made BTC more accessible, attracting significantly more capital.
Exchanges and Price Discovery
Exchanges support BTC's price by making it possible for more investors to buy it. Before Mount Gox launched in 2010, people mined BTC when mining was much easier or bought it directly from others on a peer-to-peer basis. Safe to say, exchanges have made buying BTC far simpler and safer, and exchanges have since evolved to provide a whole bunch of tools and investment products like futures, which are essential for price discovery. Without them, BTC trading would be illiquid, fragmented, and Bitcoin and indeed crypto as a whole might have long been forgotten.
CME Futures and Legitimacy
The first real paper Bitcoin emerged with the CME Bitcoin futures in 2017. Obviously, the CME Bitcoin futures didn't have a direct impact on BTC's price since they didn't involve investing in the underlying asset. However, they did have an indirect effect, which was to legitimize Bitcoin and crypto more broadly as an asset class worthy of institutional attention.
Whereas the 2017 bull market ended with paper Bitcoin (the CME futures listing marking the top), the 2021 bull market began with paper Bitcoin. That's because Strategy made its first $250 million purchase of BTC on the 11th of August 2020, becoming the first ever Bitcoin treasury company. As such, you could say Strategy's paper Bitcoin had a direct and indirect impact on BTC's price. It had a direct impact because Strategy was buying actual BTC and it had an indirect impact which was to further increase Bitcoin's legitimacy in the eyes of investors.
ETFs and the 2024 Bull Market
It's a similar story with the 2024 bull market which was kicked off by the listing of the spot Bitcoin ETFs. By now you'll know that the ETFs were by far the most bullish paper Bitcoin category. They were instrumental in helping push BTC's price to its historic high of $126,000.
Broadly speaking, when spot ETFs experience heavy inflows, BTC's price goes up. And when there's heavy outflows, BTC's price goes down. With net outflows starting in October last year, well, BTC has basically been tanking ever since.
Government Impact
As for the governments, meanwhile, they haven't necessarily had a direct impact on BTC since most of the BTC they hold was seized rather than purchased (El Salvador and a few other countries notwithstanding). That said, though, governments indirectly impact BTC's price by reducing its liquid circulating supply. With fewer coins available on exchanges, basic supply and demand dynamics take over. If supply drops while demand stays constant or rises, prices go up.
Continuing to hold BTC also sends a signal to some that these governments believe Bitcoin is worth holding as they would have otherwise sold. Some countries have done exactly that, with Germany infamously selling its BTC in 2024.
Wrapped Bitcoin and DeFi
When it comes to the wrapped paper Bitcoin, it has had a subtle but direct effect on BTC by making it easier for investors to use it as collateral for loans. This has likely resulted in less BTC sales around the margin as investors will borrow against it instead of selling it.
The catch though is that when markets are volatile like they've been recently, this DeFi leverage can create lots of liquidations.
Controversies and Allegations
Over the years, paper Bitcoin has sparked plenty of controversy with some debating whether it could eventually undermine Bitcoin itself. In most cases, allegations center on companies claiming to hold BTC that they might not actually have.
Strategy Under Scrutiny
The main target of these allegations has been Strategy. We all know that Michael Saylor is probably Bitcoin's biggest permabull, obsessed with buying as much BTC as humanly possible. As I record this, his company holds well over 700,000 BTC, which is a truly mind-boggling amount.
However, skepticism has grown over whether Strategy really holds the BTC it claims to, with many asking for proof of reserves. What's scary, though, is that Strategy has repeatedly refused, citing security concerns, fears that routine movements could spook the market, and a handful of other reasons besides.
While this reasoning does actually make some sense, it's also just added fuel to the fire. Some critics even claim the company has been buying Bitcoin derivatives or rehypothecating its BTC. For those unfamiliar, rehypothecation is when a custodian or exchange reuses its held BTC as collateral or for lending, creating multiple paper claims on the same asset. In other words, some critics allege that Strategy's BTC is tied up in loans or collateral rather than held directly in wallets under the company's control.
These questions have continued to resurface, leading Saylor to respond in January this year by saying, "We buy real Bitcoin. We audit our custodians. We don't rehypothecate. You shouldn't either."
As mentioned earlier, some of Strategy's holdings have been tracked across multiple wallets by on-chain analysis firms like Arkham. That said though, the accuracy of this tracking isn't 100%. And at least 110,000 BTC remain unaccounted for. To be clear, though, this doesn't mean Strategy doesn't hold it, just that it hasn't been identified by on-chain sleuths yet.
ETF Allegations
As you can imagine, another top target of allegations related to paper Bitcoin have been the spot Bitcoin ETFs. In late 2023, before the first spot ETF even hit the market, some were skeptical about whether these funds like BlackRock's iBit would actually hold the BTC they claim to, especially given that custodial wallet addresses weren't publicly provided.
However, these questions were quickly answered by Bloomberg ETF analyst James Seyffart, who reassured us that "Cash creation does not mean the fund won't hold spot Bitcoin or that a Bitcoin ETF will be a fractional reserve product," adding that "the funds will hold spot Bitcoin."
Just to put everyone's mind at ease, BlackRock's BTC stash can also be spotted on Arkham, which clearly shows them holding over 756,000 BTC, the same amount backing iBit. But again, these wallets have not been officially verified or disclosed. Third parties had to find them.
Coinbase Accusations
More recently, there have been accusations made against Coinbase with critics accusing it of selling paper Bitcoin to BlackRock. This allegation was addressed by Coinbase CEO Brian Armstrong in an AMA call last month, asserting that the BTC they've been selling is real.
Hacking and Security Risks
Similarly, there have been concerns that companies handling paper Bitcoin could be hacked or exploited. To be fair, history shows us this could indeed happen. Recall that Mount Gox and Bitfinex are just two examples of exchanges that ran into difficulties after mishandling the funds needed to back customer deposits.
If something similar were to happen today, like a major custodian being hacked, it would spark market chaos. BTC would likely tank, not just from compromised BTC being sold, but because it would shake confidence among investors that the current custodial setups are secure.
Incidentally, this is something that Arthur Hayes discussed with us during an interview back in June 2024. In his words, "If I think about the two-to-three-year risk, I would say a major crypto custodian gets hacked and loses $50 billion to $100 billion in crypto and that would be the end of the cycle."
The Future of Paper Bitcoin
How will paper Bitcoin shape the crypto market going forward? While it may carry the risks we just discussed, those concerns are deep-rooted in Bitcoin's earlier years when custodians and exchanges weren't nearly as reputable or as secure as they are today. These days, paper Bitcoin plays a key role in supporting the crypto ecosystem with ETFs driving both adoption and BTC's price action.
The Self-Custody Ideal
In an ideal world, every crypto enthusiast would fully control their own private keys 100% of the time rather than use exchanges as trusted custodians. After all, self-custody embodies the very ethos of Bitcoin: true ownership, censorship resistance, and protection against counterparty risk.
The problem, though, is self-custody remains a huge barrier for mainstream adoption. Managing private keys is often seen as complex and intimidating, especially for non-technical users. Mistakes can be costly, and lost keys result in permanently lost funds.
Thankfully though, wallets are becoming more user-friendly. They can be set up in minutes, and many now have features that aim to abstract away as much complexity as possible. And best of all, this security doesn't have to cost you an arm and a leg.
Wrapped Bitcoin as an Alternative
Maybe you want an alternative to paper Bitcoin that offers more versatility than BTC itself. One option you could consider is wrapped Bitcoin, which you'll recall opens the door to DeFi use cases. For instance, you could earn a yield with it and reinvest to buy more BTC. And best of all, wrapped BTC reserves are transparent and verifiable on chain, unlike paper Bitcoin, which is inherently opaque. As the saying goes, don't trust, verify.
Then once you're ready, you could simply redeem your wrapped Bitcoin for actual BTC. Sort of like showing your receipt to get a refund.
The ETF Redemption Breakthrough
What's crazy though is that you can now do this if you hold shares in Bitcoin ETFs because in July last year, the SEC approved paper Bitcoin ETF shares to be exchanged one-to-one for the physical BTC backing them. Obviously, this is a fairly recent development, but logic suggests that we could see similar things happening with other paper Bitcoin derivatives in the future.
This mechanism could even serve as a template for other markets such as precious metals. For example, gold ETF shares could one day be exchanged for the actual gold backing the fund. In other words, traditional markets could be massively improved. All thanks to the example set by crypto, which is when you say it out loud, kind of ironic.