What is a Bitcoin ETF? A Simple Explainer
Bitcoin Exchange-Traded Funds (ETFs) have taken center stage, introducing a new way for investors to engage with the Bitcoin market while retaining the familiarity of TradFi (traditional finance).
On 11 January 2024, the United States Securities Exchange Commission approved 11 spot Bitcoin ETF applications. Soon after, Bitcoin saw an inflow of over $3 billion in just one day. Clearly, something’s brewing!
This article will give you an overview of what Bitcoin ETFs are (spot Bitcoin ETFs in particular).
Understanding Bitcoin ETFs
An exchange-traded fund (ETF) is an investment fund that helps track the price of an underlying asset or index and is traded on stock exchanges, similar to stocks.
When this concept is applied to world's most dominating cryptocurrency “Bitcoin”, a Bitcoin ETF allows investors to gain exposure to Bitcoin's price movements without the complexities of owning the actual cryptocurrency. These ETFs can be traded on traditional market exchanges rather than cryptocurrency exchanges.
This approach offers several benefits, including ease of investment, reduced risk of theft or loss, and regulatory oversight.
Imagine being a gold enthusiast and want to invest in gold but don't want the hassle of securing physical gold bars. A gold ETF will allow you to invest in the physical asset without actually owning it.
Similarly, a Bitcoin ETF lets you invest in Bitcoin's price movements without buying and storing actual Bitcoin.
Benefits of Bitcoin ETFs for investors
There are several factors that benefit a bitcoin ETF investor but the following benefits will help you understand why Bitcoin ETFs are becoming an increasingly popular option for investors.
Here are a five of them:
- Accessibility and east of investment
- Regulatory oversight and security
- Reduced risk of theft and and loss
- No problem of slippage
- A new diversification avenue
- Accessibility and Ease of Investment
Bitcoin ETFs are traded on conventional stock exchanges, making them accessible to a different type of investors — those who do not want to trust centralized crypto exchanges and are not willing to get into the nitty gritty of decentralized exchanges.
Simply put, it allows global individuals to invest in Bitcoin without navigating the complexities of cryptocurrency exchanges, non-custodial wallets, and private keys.
- Regulatory Oversight and Security
Unlike direct cryptocurrency investments, Bitcoin ETFs are subject to regulatory oversight, providing a layer of security and legitimacy. This oversight can offer investors peace of mind, knowing that the ETFs comply with specific standards, regulations and would not be subjected to regulatory issues.
- Reduced Risk of Theft and Loss
Investing in a Bitcoin ETF mitigates the risks associated with digital assets' physical storage and security. Investors do not have to worry about the potential loss or theft of Bitcoin, as they do not hold the cryptocurrency directly.
- No Problem of Slippage
Buying BTC on decentralized exchanges comes with the downside of slippage. Slippage, in simple terms, is the price difference between the expected price of a trade and the price at which the trade is actually executed, often occurring in volatile markets or with large orders due to the market maker.
With ETFs, the slippage issue is generally less pronounced. This is because ETFs are traded on regulated stock exchanges, where more established market mechanisms and liquidity providers help to ensure that the execution price of a trade is closer to the quoted price at the time the order is placed.
- A New Diversification Avenue
Bitcoin ETFs provide an opportunity for investors to diversify their investment portfolios. By adding exposure to Bitcoin, investors can benefit from the unique price movements and characteristics of the cryptocurrency market, which differ from traditional asset classes.
Now that we know about the benefits of possessing Bitcoin ETFs, let’s gather more information about it.
Types of Bitcoin ETFs
There are two types of Bitcoin ETFs:
- Futures ETF
- Spot ETF
Both the types of Bitcoin ETFs offer unique ways for investors to gain exposure to the digital asset's price movements.
Futures Bitcoin ETF
A Futures Bitcoin ETF issues publicly traded securities which offers exposure to the price movement of bitcoin futures contracts.
The Futures ETF is based on futures contracts rather than holding Bitcoin directly.
The first futures Bitcoin ETF was launched in Canada, marking a significant milestone in the crypto investment landscape. These ETFs involve a commodity pool that trades in Bitcoin futures contracts, typically aiming to mimic the spot price of Bitcoin.
Say you want to invest in the future price of coffee without buying coffee beans. A Coffee Futures ETF invests in contracts predicting future coffee prices, not the beans themselves.
Similarly, a Futures Bitcoin ETF invests in futures contracts, allowing you to speculate on Bitcoin's future price without owning actual Bitcoin.
Spot Bitcoin ETF
A Spot Bitcoin ETF directly holds Bitcoin, offering investors exposure to the actual price movements of Bitcoin. This type of ETF is considered more reflective of Bitcoin's real-time value.
Spot Bitcoin ETFs securely hold Bitcoins in a digital vault managed by registered custodians. These ETFs buy Bitcoins and store them in a digital wallet, often using multiple layers of security, including cold storage.
Now, if you want to invest in gold but don't want to buy and store physical gold bars. Instead, you invest in a Gold Spot ETF. This ETF buys and holds gold, and your investment in the ETF represents a share of that gold. As the price of gold changes, so does the value of your ETF shares.
Similarly, a Spot Bitcoin ETF holds actual Bitcoin and by investing in this ETF, you own a share of the Bitcoin it holds, exposing you to Bitcoin's price movements without directly owning the cryptocurrency.
Key Differences Between Futures ETF And Spot ETF?
Bitcoin futures contracts
Futures ETF bet on the future price of Bitcoin
Spot ETF buys and trades Bitcoin at market price
Based on futures contract prices
Based on the current market price of Bitcoin
Generally easier to get regulatory approval, as futures are traded on regulated commodity exchanges
Faces more regulatory challenges, as it involves direct handling of the cryptocurrency
Suitable for short-term trading strategies and hedging
Better suited for investors looking to gain long-term exposure to Bitcoin's price
Quick Recap of Spot ETFs Approval in the United States
The path leading up to recent approval of Spot Bitcoin Exchange-Traded Funds (ETFs) by the U.S. Securities and Exchange Commission (SEC) involved a series of rejections, legal challenges, and changing regulatory perspectives over more than a decade.
Initially, the SEC had consistently rejected applications for Spot Bitcoin ETFs. For example, in 2018, the Winklevoss twins' second attempt to get a spot Bitcoin ETF approved was denied. The SEC’s main concern was the largely unregulated nature of Bitcoin. This trend of rejection continued over the years with applications from various asset managers like SkyBridge, Fidelity, Bitwise, and Grayscale being turned down.
A significant development occurred in 2021 when Fidelity Canada launched a spot Bitcoin ETF, becoming the largest asset manager with such a product at that time. However, in the U.S., the SEC continued to deny applications for spot Bitcoin ETFs, including a notable rejection in 2022 of applications from SkyBridge, Fidelity, Bitwise, and Grayscale.
The turning point came in 2023, with Grayscale's lawsuit against the SEC after its application to convert GBTC into a spot-based ETF was denied. This legal challenge led to a critical decision by the U.S. Court of Appeals for the District of Columbia. The court found that the SEC failed to adequately explain its reasoning in disapproving Grayscale’s proposed ETP, leading to the order being vacated and remanded back to the Commission.
In response to these legal developments and the evolving regulatory landscape, the SEC approved 11 applications for spot Bitcoin ETFs in January 2024. This approval includes conditions such as full disclosure requirements for ETF sponsors, listing and trading on registered national securities exchanges, and the application of existing rules and standards of conduct.
The approved issuers include:
Grayscale Bitcoin Trust
Bitwise Bitcoin ETP
VanEck Bitcoin Trust
Ark/21 Shares Bitcoin Trust
Franklin Bitcoin ETF
WisdomTree Bitcoin Trust
Invesco Galaxy Bitcoin ETF
Wise Origin Bitcoin Trust by Fidelity
Hashdex Bitcoin ETF
Valkyrie Bitcoin Fund
iShares Bitcoin Trust
The approval of these ETFs allows investors to have direct exposure to Bitcoin without the need to store the asset in crypto wallets. It is considered a significant step in legitimizing and integrating cryptocurrencies into mainstream financial markets, potentially opening opportunities for institutional and retail investors.
The SEC, however, made it clear that this approval is specific to ETPs holding the non-security commodity Bitcoin and does not imply endorsement of Bitcoin itself or the broader crypto market. The Commission remains cautious about the risks associated with Bitcoin and crypto assets, emphasizing that the vast majority of crypto assets are subject to federal securities laws.
Drawbacks of Bitcoin Spot EFTs Approval
Although Bitcoin Spot EFTs approval is a historical win for the cryptocurrency community, there are also concerns about the risks and volatility associated with Bitcoin investments.
- High Management Fees
Bitcoin ETFs often come with higher management fees compared to traditional ETFs. These fees can reduce the overall returns for investors over time.
High fees are particularly noticeable in niche or specialized ETFs like those for Bitcoin, where the costs of managing the fund, including security measures for holding cryptocurrency, are higher.
- Tracking Error and Low Liquidity
Some Bitcoin ETFs, especially those newly launched ones, may face issues with tracking errors, where the ETF fails to replicate the underlying asset's (Bitcoin) performance accurately. Additionally, lower liquidity can be a concern, particularly in volatile market conditions, leading to wider bid-ask spreads and potentially impacting the ability to buy or sell shares quickly at desired prices.
- Limited Trading Hours
Unlike the cryptocurrency market, which operates 24/7, Bitcoin ETFs are traded on stock exchanges with set trading hours. This limitation can be a disadvantage during high volatility in the crypto market, as investors cannot react to market movements outside regular trading hours.
Conclusion: A Win, But At What Cost?
The approval of a Bitcoin ETF is seen as a win because it legitimizes Bitcoin as a credible investment asset, attracting institutional investors. This mainstream recognition can increase Bitcoin's market stability and maturity, potentially leading to broader acceptance and integration into traditional financial systems.
However, from another perspective, it's viewed as a loss, as Bitcoin's original intent was to operate outside traditional finance (TradFi). Institutional involvement might contradict the decentralized ethos of Bitcoin, as large-scale investments from major institutions could lead to increased centralization. This centralization is contrary to the foundational principles of Bitcoin, which aimed to democratize finance and reduce reliance on central authorities.
Thus, while the ETF represents progress in market acceptance, it also raises concerns about Bitcoin's foundational ideals being compromised.
Bitcoin ETFs, particularly Spot Bitcoin ETFs, represent a significant development in the cryptocurrency market. They offer a more accessible way for investors to gain exposure to Bitcoin, leading to broader adoption of cryptocurrencies.
If you want to hold Bitcoin directly, rather than through an ETF, we invite you to try out Transak.
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In this article:
- Understanding Bitcoin ETFs
- Benefits of Bitcoin ETFs for investors
- Types of Bitcoin ETFs
- Futures Bitcoin ETF
- Spot Bitcoin ETF
- Key Differences Between Futures ETF And Spot ETF?
- Futures ETFs
- Spot ETF
- Quick Recap of Spot ETFs Approval in the United States
- ETF Name
- Drawbacks of Bitcoin Spot EFTs Approval
- Conclusion: A Win, But At What Cost?