Expanding beyond its original purpose as a digital currency, cryptocurrencies and its whole industry have evolved significantly over the years. Accordingly, the changes have led to the emergence of one of the most notable developments in the crypto space: Bitcoin Exchange-Traded Funds (ETFs).
Financial instruments like these have merged the traditional financial and digital realms, providing investors with new ways to invest in Bitcoin.
What are Bitcoin ETFs?
By definition, a Bitcoin ETF is a financial instrument that allows investors to gain exposure to the leading crypto BTC through traditional stock exchanges rather than cryptocurrency exchanges.
Basically, an ETF is an investment fund that tracks an underlying asset and trades it like a stock on an exchange. A Bitcoin exchange-traded fund would function similarly, where one share of the ETF will fluctuate following the price of Bitcoin.
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History of Bitcoin ETF
Bitcoin ETFs have been proposed for years, with the first proposal submitted over a decade ago.
In July 2013, the Winklevoss Twins, the people behind crypto firm Gemini, and its Bitcoin Trust filed the very first proposal for a Bitcoin ETF. After 5 years, the U.S. Securities and Exchange Commission (SEC) rejected the Winklevoss’ second Bitcoin ETF proposal in June 2018. This rejection was followed by similar decisions in October 2019 when Bitwise’s Bitcoin ETF proposal met the same fate and in February 2020 when Wilshire Phoenix’s project faced a rejection by the SEC.
Amidst these rejections, the landscape of Bitcoin ETFs began to shift after a few years. In September 2020, the world saw the debut of the first Bitcoin ETF, albeit not in the United States but on the Bermuda Stock Exchange.
December 2020 saw renewed interest in the United States when VanEck filed a fresh proposal for a Bitcoin ETF after multiple withdrawals of previous applications. The regulatory tide also turned north of the border, with Canada taking the lead. In February 2021, Canada launched its first Bitcoin ETF, the Purpose Bitcoin ETF (BTCC), followed by the Evolve Bitcoin ETF (EBIT) and the CI Galaxy Bitcoin ETF (BTCX) in the same month.
October 2021 was a historic moment in the United States when the ProShares Bitcoin Strategy ETF (BITO) became the first U.S.-listed Bitcoin ETF, opening doors for a broader investor base to participate in Bitcoin’s potential.
In June 2023, the SEC approved the 2x Bitcoin Strategy ETF (BITX) from Volatility Shares, adding a leveraged Bitcoin ETF to the mix. London-based Jacobi Asset Management also launched Europe’s first Bitcoin ETF, highlighting the growing international acceptance of such investment products.
Finally, in August 2023, a landmark development took place when Grayscale successfully appealed to the SEC to convert its Bitcoin Trust into an ETF, further expanding the accessibility and legitimacy of Bitcoin investment options.
How does it work?
It is similar to other ETFs wherein a fund tracks a market index and trades on an exchange like a stock. However, instead of holding stocks, bonds, or commodities, a Bitcoin ETF holds Bitcoin as its underlying asset.
Furthermore, Bitcoin ETFs give investors the potential to amplify profits or losses by using leverage, which means that they can make larger profits or losses than they would if they simply bought or sold Bitcoin directly.
Local KOL’s Opinion on ETF Applications
In August, BitPinas Editor-in-Chief Michael Mislos and Mintoo Director Patrick Lao discussed the reasons why the cryptocurrency industry is eagerly anticipating the approval of Bitcoin ETF applications. They specifically focused on the significance of Grayscale Bitcoin Trust (GBTC) and its recent legal victory against the U.S. Securities and Exchange Commission (SEC).
Lao stressed the advantages of transforming Grayscale Bitcoin Trust (GBTC) into a Bitcoin ETF, particularly in benefiting major institutional investors like pension and sovereign wealth funds. This conversion would increase liquidity and offer real-time tracking of Bitcoin’s value.
He noted that GBTC’s minimum investment requirements can cause it to trade at a discount or premium to its net asset value. GBTC’s long-term objective has always been to become an ETF, addressing these issues and making it more accessible to institutional investors. Lao believed that once Grayscale’s ETF application is approved, it would substantially improve liquidity and provide real-time Bitcoin value tracking.
Mislos questioned why institutional investors wait for a Bitcoin ETF when they can use centralized exchanges. Lao explained that CEX limitations such as centralization and custody, ETF on the other hand, offer a safer, more convenient option.
Pros and Cons
- Accessibility: Bitcoin ETFs allow investors to buy Bitcoin without owning or storing it.
- Regulation: Regulated Bitcoin ETFs offer security to investors concerned about crypto risks.
- Liquidity: ETFs are traded like stocks, providing liquidity and flexibility.
- Diversification: Some Bitcoin ETFs hold multiple cryptos, reducing risk.
- Tax Efficiency: ETFs often provide tax advantages, such as capital gains tax treatment.
- Counterparty Risk: Bitcoin ETFs invest in Bitcoin through a third party, which poses risks if the custodian or issuer faces financial difficulties.
- Fees: ETFs have fees that can eat into returns.
- Limited Control: Investors don’t control Bitcoin private keys, so they can’t access, transfer, or use the cryptocurrency directly.
- Market Premium/Discount: ETFs can trade at a premium or discount to net asset value (NAV), affecting efficiency.
- Market Volatility: Bitcoin ETFs are subject to market fluctuations and speculative trading, just like any other investment.
- Dependency on Regulatory Approval: Bitcoin ETFs need regulatory approval to launch and operate. Delays or denials can impact investor access.
Bitcoin Futures vs. Bitcoin Spot ETFs
A Bitcoin futures ETF tracks the price of Bitcoin futures contracts, an agreement to buy or sell an asset at a predetermined price on a specified date in the future. The price of a futures contract is affected by factors such as interest rates, inflation, and supply and demand.
Futures ETF allows investors to purchase and sell BTC futures without owning the underlying asset; this shields them from market volatility. However, they also cannot stake or use the coins for voting.
On the other hand, a spot ETF tracks the price of Bitcoin itself. This mechanics allows investors to buy shares of a spot ETF directly. Accordingly, spot ETFs are not subject to the same risks as futures ETFs, as they are not based on derivatives.
The key distinction between futures ETFs and spot ETFs is that futures ETFs rely on derivatives–take its value from an underlying asset– while spot-based ETFs use actual Bitcoin.
- Hedging: Bitcoin futures ETFs protect investors from Bitcoin price fluctuations.
- Liquidity: ETFs trade on stock exchanges, offering high liquidity and flexibility.
- No Ownership:Investors don’t own the actual Bitcoin, which can be beneficial for security and custody.
- Underperformance: Bitcoin futures may underperform spot price due to tracking error.
- Lack of Use: Futures ETFs don’t let investors use cryptocurrencies for staking, voting, or blockchain networks.
- Price Variance: Bitcoin futures prices can deviate from spot prices due to market sentiment, leading to inaccurate tracking.
Bitcoin Spot ETFs
- Ownership: Spot-based ETFs let investors own crypto directly for staking, governance, etc.
- No Price Deviation: ETFs track spot market prices closely, minimizing pricing inaccuracies.
- Simplicity: It is like regular crypto exchanges, which makes it easy to understand
- Market Volatility: Spot-based ETFs are volatile, not suitable for risk-averse investors.
- Custody Challenges: Owning crypto means securing private keys, which can be complex and risky.
This article is published on BitPinas: Beginner’s Guide: What is Bitcoin Exchange-Traded Funds?
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