What is a Bitcoin ETF?

Meet ETFs, one of the most anticipated financial tools in the world of cryptocurrencies. ETFs will facilitate investors' access to virtual currency markets, a situation that could increase their economic potential to unsuspected limits.

Unot of the events that many enthusiasts Bitcoin, and cryptocurrencies in general, have waited are the so-called Bitcoin ETF.

Bitcoin ETFs are instruments that have both potential benefits and potential risks. But what remains no doubt is that they will be a vehicle that will allow investment in Bitcoin to be brought to millions of new investors. And this includes institutional funds, allowing them to invest in Bitcoin without any complexity and under a reliable regulatory regime.

They are listed in countries such as Germany, Liechtenstein, the Jersey Islands and Brazil, although the true global expansion of this instrument has not stood out until it landed on Wall Street. The United States authorities have allowed the well-known Bitcoin Futures ETFs since October 2021, but currently the community is eagerly awaiting the approval of the Bitcoin Spot ETFs, of which companies such as BlackRock, VanEck and Grayscale are carrying out various efforts to its launch.

This tool could take Bitcoin to a market capitalization never seen before. In fact, institutional markets specialists point to the approval of Bitcoin Spot ETFs and the arrival of the April 2024 halving as sufficient momentum for Bitcoin to break the $100.000 valuation barrier.. However, all this could also have an impact on the bitcoin price negatively, as it would allow many new speculators to agree to determine its price.

In this Bit2Me Academy article we will explain Bitcoin ETFs in detail, as understanding them can help you position yourself strategically.

How do ETFs work?

Before talking about Bitcoin ETFs, with their potential benefits and risks, let's talk roughly about what an ETF is and how it works.

Listed investment funds, or Exchange Trade Funds (ETF, for its acronym in English), It is a useful investment tool that facilitates the process of exchanging securities on the stock market, as if it were ordinary shares. Its main feature is that it is traded on secondary securities markets, being very typical investment vehicles in the traditional financial world.

ETFs track the performance of one or a group of assets. That is, the asset itself is not purchased, but the value that marks the price. For example, a Bitcoin ETF would track the price of Bitcoin, and by buying a part of that vehicle, you would be winning if the price of Bitcoin goes up, or losing if the price of Bitcoin goes down. But you would not have bought bitcoins as such at any time.

Traditional exchange platforms allow trading with this type of vehicle, which enables ETFs to list in multiple markets. But without any of those platforms having to deal with the technical complexity of integrating the Bitcoin protocol, or other cryptocurrencies, or dealing with their management, security, or updates. In other words, the integration of the crypto ecosystem in traditional markets is simplified.

On the other hand, holders of a Bitcoin ETF also have no need to own a wallet to store them, nor worry that they may be hacked or stolen from the wallet. However, the latter is similar to operating with a traditional cryptocurrency exchange, as the cryptocurrency platform manages those things for you.

As for legality, for an ETF to function, it is necessary that the company that issues it is registered with the corresponding authority, which in this case is the Securities and Exchange Commission (SEC) of the United States, or the CNMV in Spain.

Why buy a Bitcoin ETF and not bitcoin outright?

The reasons why a traditional investor may want to buy a Bitcoin ETF instead of the bitcoin itself can be many and varied, we are going to highlight four that we consider to be the most important:

• For a traditional investor, accessing and learning how a cryptocurrency platform works is a very important psychological access barrier. This type of investors uses platforms and tools that they have known for years, oriented to high frequency, being able to connect various trading algorithms, and even roboadvisors with artificial intelligence.
• Cryptocurrency platforms do not usually have the legal backing of the height that a regulated national exchange has, supervised and with the licenses that the government issues to have liability insurance if some type of unforeseen disaster occurs: such as robberies, exit scams, market manipulations, ...
• Adding an ETF to a trading platform simplifies life, well you don't have to deal with complex integrations. This means that, in turn, they have lower operating costs, passing on fewer service commissions, and therefore liking the end user more.
• Currently, Bitcoin has a high level of speculation, not so much of actual use. For this reason and coming from a more traditional mindset, many users do not perceive the advantage of having the ability to withdraw their bitcoins to wallets where they control the keys, so they only need a service to speculate on.

ETF Characteristics

As we have already mentioned, ETFs function as an action and not so much as a fund or that their management is passive and not active. In this sense, we can mention some of the most relevant characteristics of ETFs.

1. Transparency. One of the great characteristics of ETFs is that being a listed asset, it is possible to know their value at all times.
2. Flexibility. An ETF can be purchased at any time and the purchase will be effective based on its current price. This means that there will be no need to wait until the end of the session and there will be no exit windows as with certain funds.
3. management . An ETF can be bought and sold at any time, like a stock. They are 100% liquid.
4. Diversification. An ETF is an already diversified instrument in itself. When investing in a basket of securities there will always be some degree of diversification. And it is that with an ETF you can “buy” an entire index without having to invest in each of its shares.
5. Commissions. ETF management fees are lower than those of a traditional fund. Although as with any action, you will have to add the purchase-sale commissions if you dedicate yourself to make a very active operation with these funds.

How do you create a Bitcoin ETF?

ETFs associate all investments made by participants in the same fund, to subsequently carry out operations on the stock exchange with said investments, as if they were bonds or stocks. This allows investors to carry out operations in the market and obtain short, medium or long-term remuneration or profits generated from the interests produced from said investments.

For example, if a company wants to issue a Bitcoin ETF, it will divide its ownership of bitcoin into shares. You are subsequently bought and sold by investors in the stock market. The objective of this is to obtain profits derived from said operations, and from the volatility of the bitcoin implicit in the process. Something very similar to managing an investment portfolio, with a much simpler and more comfortable way of handling for investors. So any investor with or without experience can benefit from trading with Bitcoin.

By the time investors obtain a Bitcoin ETF, they are acquiring shares, which make up the index of a specific security. That is, the evolution of the prices and quotes of bitcoin for a certain moment.

Bitcoin ETF on Wall Street

For several years, quite a few actors tried to create a Bitcoin ETF on Wall Street. Some of them were the famous billionaire twins Cameron and Tyler Winklevoss, who were rejected by the SEC in 2017 for the ETF called Winklevoss Bitcoin Trust.

The reason for the denial then was that bitcoin was traded on largely unregulated exchanges, with a high risk "of fraud and manipulation," according to the SEC, the US securities regulator. The Winklevoss brothers did not give up their efforts. On June 19, 2018, they were granted a patent by the United States Patent and Trademark Office for a company called Winklevoss IP LLP for publicly traded products.

The Winklevoss weren't the only enthusiasts to successfully launch a bitcoin ETF. Cboe Global Markets (CBOE), promoted the creation of bitcoin futures, in the hope that the SEC would give them the green light, while also acquiring Bats Global Markets, the entity to which the Winklevoss would have entrusted the trading of their securities.

VanEck and SolidX, a fintech company with bitcoin-related projects, announced plans in early 2018 for the VanEck SolidX Bitcoin Trust ETF. This futures ETF would target institutional investors, according to ETF Trends, as it would open with a share price of $200.000. XBTC is designed to track an index related to a group of bitcoin trading desks.

On October 19, 2021, the ProShares Bitcoin Strategy ETF began trading, which would become the first bitcoin-related futures ETF. The fund, which trades under the ticker BITO, tracked prices of the bitcoin/dollar pair (BTC/USD) through futures contracts traded on the Chicago Futures Exchange. Although the fund allows its investors to short BTC, the ProShares ETF primarily differs from other bitcoin ETFs because its value is not directly tied to the current price, but instead tracks the future price of bitcoin.

This means that the returns of funds like BITO based on bitcoin futures contracts can be very different from the market rate of bitcoin. A situation where long-term futures contracts are priced higher compared to short-term contracts.

The reality is that BITO was the ETF that fastest reached $2021 billion in assets under management, when, after authorization by the SEC in October XNUMX, it achieved that milestone in just two days after its launch. And not only that, but it recorded the second largest debut volume in history, exceeding one billion dollars.

The financial expansion of bitcoin has only just begun. In fact, since early 2023, the possibility of approval of Bitcoin Spot ETFs has only increased with various proposals currently being analyzed by the SEC. Facts that demonstrate the enormous institutional interest in this type of tools and the profound changes that are happening within the global financial market.

Bitcoin Spot ETF

A Bitcoin Spot ETF is an exchange-traded fund that tracks the price of Bitcoin in the spot market. This means that the ETF buys and sells actual Bitcoin, rather than futures or derivatives contracts.

Bitcoin Spot ETFs have the potential to democratize Bitcoin investing, making it more accessible to retail investors. Additionally, they can help increase the liquidity of the Bitcoin market, which could make it easier to buy and sell the cryptocurrency.

A Bitcoin Spot ETF works similarly to any other ETF. Investors buy shares of the ETF, and the ETF uses that money to buy actual Bitcoin. The value of ETF shares is determined by the price of the underlying Bitcoin.

For example, if the price of Bitcoin is $50.000, the value of one share of a Bitcoin Spot ETF that tracks the price of Bitcoin will be $50.000.

Bitcoin Spot ETF Applications

Currently (October 24, 2023), the SEC is considering the following Bitcoin Spot ETF applications:

1. Grayscale Bitcoin Trust (GBTC): Grayscale Investments is a digital asset management company that manages GBTC, the largest Bitcoin investment fund in the world. GBTC has been filing for a Bitcoin Spot ETF since 2017.
2. VanEck Bitcoin Trust (XBTF): VanEck is an asset management company that offers a wide range of investment products, including ETFs. VanEck filed for a Bitcoin Spot ETF in 2019.
3. Invesco Bitcoin Trust (BITO): Invesco is an asset management company that offers a wide range of investment products, including ETFs. Invesco filed for a Bitcoin Spot ETF in 2020.
4. WisdomTree Bitcoin Trust (BTCW): WisdomTree is an asset management company that offers a wide range of investment products, including ETFs. WisdomTree filed for a Bitcoin Spot ETF in 2021.
5. ETFMG Bitcoin Strategy ETF (EBIT): ETFMG is an asset management company that offers a wide range of investment products, including ETFs. ETFMG applied for a Bitcoin Spot ETF in 2021.
6. Fidelity Bitcoin ETF (FBTC): Fidelity Investments is an asset management company that offers a wide range of investment products, including ETFs. Fidelity filed for a Bitcoin Spot ETF in 2022.
7. BlackRock Bitcoin ETF (BBTC): BlackRock is an asset management company that offers a wide range of investment products, including ETFs. BlackRock has filed for a Bitcoin Spot ETF in 2022.
8. ARK Invest Bitcoin ETF (ARKKBTC): ARK Invest is an asset management company that offers a wide range of investment products, including ETFs. ARK Invest has filed for a Bitcoin Spot ETF in 2022.

The SEC has repeatedly delayed the approval of Bitcoin Spot ETFs. In August 2023, a US appeals court ruled that the SEC had acted arbitrarily in rejecting Grayscale's application. This could increase the chances of the SEC approving a Bitcoin Spot ETF in the future.

There is no expected date for approval of the pending Bitcoin Spot ETFs. The SEC has said it is carefully evaluating the requests and will make a decision "in due course."

Bitcoin Futures ETF

A Bitcoin Futures ETF is an exchange-traded fund that tracks the price of Bitcoin futures. This means that the ETF does not buy or sell actual Bitcoin, but rather invests in Bitcoin futures contracts.

To understand how a Bitcoin Futures ETF works, we must first understand how Bitcoin futures contracts work. A Bitcoin futures contract is an agreement between two parties to buy or sell Bitcoin at a future date at a certain price.

A Bitcoin Futures ETF works similarly to any other ETF. Investors buy shares of the ETF, and the ETF uses that money to buy Bitcoin futures contracts. The value of the ETF shares is determined by the price of the underlying Bitcoin futures.

For example, if the price of Bitcoin futures is $50.000, the value of one share of a Bitcoin Futures ETF that tracks the price of Bitcoin futures will be $50.000.

It is clear that Bitcoin Futures ETFs are a relatively new way to invest in Bitcoin. They offer several advantages over other ways of investing in cryptocurrency, such as accessibility, liquidity, and transparency. However, they also have some risks associated with them, such as market volatility and default risk.

Advantages and risks of investing in ETFs

All types of investments that are made have their pros and cons, and ETFs are no exception. Although it can be highlighted that this type of investment is low risk.

Pros

1. Without a doubt, the main advantage of a Bitcoin ETF would be, the possibility of capitalizing investment in highly liquid markets, for example the New York markets.
2. Any market that wants to implement a Bitcoin ETF is not going to have to do any technical implementation, or worry about the security of managing cryptocurrencies.
3. ETFs allow novice or expert investors to trade cryptocurrencies easily, simply and without complications. Furthermore, they avoid the risks that funds can be withdrawn or hacked from accounts or wallets. Because to manage an ETF it is not necessary to have or store cryptocurrencies.
4. By managing cryptocurrencies and tokens from an ETF, the need to control multiple wallets, wallets or exchange platforms, which require administration and time, is avoided. Since ETFs allow you to trade multiple crypto assets at the same time in a simple and secure way.
5. Being passive tools, ETFs significantly reduce operating costs for investors. So they will not have to make payments to cover administration or management fees.
6. Listed investment funds allow buying and selling operations throughout the stock market. That is, as long as the market remains open. Furthermore, these operations are carried out in real time, and help to diversify investment portfolios.

Cons

1. Bitcoin ETFs and other cryptocurrencies have not been approved by the SEC or the CNMV, so at the moment they have a very limited offer.
2. Due to the volatility that cryptocurrencies still suffer, sudden value changes could play an unfavorable role for ETF investors.
3. The offer in currently existing cryptocurrency ETFs does not diversify risk levels as traditional ETFs do. This is because ETFs currently only provide access to a limited number of cryptocurrencies.
4. Depending on the regulations in each country, ETFs could generate the application of foreign taxes if purchased in another country. In addition, that commission rates may apply for the purchase and sale of these funds.

Differences between ETFs and index funds

The objective of ETFs and index funds are very similar tools in terms of their purpose: to create a representation of some index. However, the way ETFs and index funds do this is different. In that case we can mention the following differences:

1. An ETF works like a stock and can therefore be bought and sold at any time. An index fund on the other hand, works like a traditional investment fund, which can be subscribed and redeemed once a day.
2. The funds within an ETF must be invested 100% within a market. While on the other hand, an index fund must keep a percentage of its funds as a mandatory liquidity section.
3. ETF replication is usually more accurate than that of an index fund.
4. ETF management fees are usually lower, although purchase and sale fees will also have to be paid later. This is because ETFs are a passive management tool.
5. Taxation is different. An index fund is subject to the taxation of investment funds, while the taxation of Spanish ETFs will be that of shares (another different issue is foreign ETFs).
6. Monthly purchases versus monthly contributions. To invest in a listed fund you will have to buy that fund month by month, thus increasing your position in it. With an index fund you can also make regular contributions, which will be used to buy units.