update 23 November 2021

What Is A Bitcoin ETF?

On October 19th, 2021, the first Bitcoin US Bitcoin ETF launched on the New York Stock Exchange. This was a long-awaited event for the crypto community, which viewed it as a significant milestone for the industry.

The debut was hyper-successful, too. Within just a day, the ETF generated over $800 million in trading volume. It was the second most lucrative stock market debut ever on the NYSE, behind Black Rock’s carbon fund.

Why the enthusiasm? What is a Bitcoin ETF, and what makes it such an important development for crypto?

How A Bitcoin ETF Works

For the uninitiated, ETF stands for “exchange-traded fund”. These are stock-market traded securities that track the performance of indexes, sectors, commodities, and other assets. Their nature makes them more accessible to investors than other index-tracking vehicles. They also allow buyers price exposure to support that would be difficult to own, such as gold.

Thus, Bitcoin ETFs are exchange-traded funds that track the performance of Bitcoin. Those interested in the top cryptocurrency purely as an investment vehicle may find these products incredibly convenient. They allow Bitcoin to effectively be purchased with the ease of stocks and tracked alongside the rest of one’s portfolio.

Advantages Of A Bitcoin ETF

Some may be wondering: why purchase shares of a Bitcoin ETF rather than actual Bitcoin?

It’s a fair question. Unlike most other assets – gold, for instance – Bitcoin does not have significant transportation or custody costs. It is often regarded as “digital gold” to highlight this very benefit. The cryptocurrency can reach anyone, anywhere in the world, at the speed of light. It may be stored and transferred by anybody with an internet connection, at any time, in any amount, with no added costs. So why use a derivative?

Firstly, as mentioned, there is added convenience and familiarity with purchasing Bitcoin as another stock. However, cryptocurrency storage and transfer through exchanges is still a foreign process to many – especially the non-tech savvy and elderly. Besides technical difficulties, newbies may be prone to hackers that target crypto holders who don’t store their private keys properly. Similarly, as transactions are peer-to-peer, scammers frequently use Bitcoin because it cannot reverse their thefts.

Most of all, an ETF opens up an entire institutional market segment that’s prohibited from investing in cryptocurrencies due to charter restrictions: Michael Saylor – CEO of Microstrategy, a significant Bitcoin investor – elaborated on this last month.

“What you have is a universe of people that can own certain types of securities and certain types of properties by charter,” he said. “When the sector evolves, when we have a bitcoin ETF in the US, billions and billions of dollars will flow into Bitcoin that under no circumstances would have found their way into Bitcoin otherwise.”

Overall, ETFs benefit Bitcoin exposure without the trouble of adopting a whole new asset class.

Futures vs Spot Bitcoin ETFs

Bitcoin ETFs may differ by what exact product they purchase to track their shares. They generally fall into two camps: futures ETFs and spot ETFs.

Futures ETFs

Futures ETFs purchase Bitcoin futures contracts to underpin their shares. Bitcoin futures are a derivative instrument wherein two parties agree to buy and sell Bitcoin at a predetermined price at a future date. Bitcoin futures are typically cash-settled rather than Bitcoin-settled. Thus, effectively, purchasing or selling one is a bet on the future price of Bitcoin.

Bitcoin Futures ETFs may inaccurately track the actual price of Bitcoin during periods of strong market sentiment. If investors expect the price to skyrocket later, futures will likely trade at a higher price and vice versa. This could be a downside of futures ETFs, as they allow investors to arbitrage the difference between the futures and spot markets.

Futures ETFs also present less upside for investors, as explained by Global Macro Investor CEO Raoul Pal. The indirect nature of the investment leaves various intermediaries to take its users’ profits.

“This vehicle means that the arbitrageurs take their slice, the ETF provider takes their slice, the lawyer who set up the fund takes their slice, the administrator, the auditor… everybody is taking a slice out of your pie.”

The first Bitcoin ETF in the US – The ProShares Bitcoin Strategy ETF – is futures contract based. Pal and others in the crypto community showed great concern over its approval due to its downsides. However, SEC chairman Gary Gensler has demonstrated an openness to such a product due to the investor protections under the CME.

Spot ETFs

Spot ETFs are a far simpler product. The ETF provider uses investors’ funds to purchase actual Bitcoins, which underpins the value of the fund’s shares.

Multiple countries besides the United States have already approved such a product. For example, the world’s first Bitcoin ETF – The Purpose Bitcoin ETF – became available for trade on the Toronto Stock Exchange (TSX) in February. More recently, Australian regulators recently released guidelines on establishing Bitcoin and Ether ETFs, permitting them as a product.

Conclusion

Bitcoin ETFs provide a helpful new avenue to get a more extensive investor base into Bitcoin. They allow regular people to bypass the cryptocurrency learning curve and for institutions to work around charter restrictions preventing their investment. Spot Bitcoin ETFs are generally preferable to Futures based ETFs, but the SEC is yet to approve one due to investor protection concerns.

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