Bitcoin is an interesting case study. It started as a revolutionary digital currency that would function as an alternative to government-backed fiat currencies. However, it ended up becoming a speculative asset that is traded in a manner very similar to stocks at a brokerage.
Bitcoin ETFs are a reflection of this journey. These are investment funds that follow the prices of Bitcoin or Bitcoin-related products. They emerged at a time Bitcoin had started gaining mainstream visibility and its prices were on an upward trajectory. Bitcoin ETFs were a way to cash in on the rising BTC prices without actually having to take the risk of owning the asset.
Now, the question is- are Bitcoin ETFs worth it? Is it better to invest in ETFs or directly buy cryptocurrency? What even are ETFs? You are in the right place if all these questions are running in your mind. Here, we are going to answer all your queries about ETFs, Bitcoin ETFs, and their advantages and limitations.
What are ETFs?
Exchange-traded funds(ETFs) are similar to mutual funds. They are baskets of securities that track indexes, commodities, bonds, or other assets. However, unlike mutual funds, ETFs are bought and sold like conventional stocks on stock exchanges. While they can be designed to track a particular commodity only, most ETFs have a diverse pool of securities.
Since they track multiple securities, ETFs are a popular choice among investors looking to diversify their portfolios. Also, it is often more cost-effective to invest in an ETF rather than buying individual stocks.
What are Bitcoin ETFs?
As the name suggests, Bitcoin ETFs track the value of Bitcoin or a Bitcoin-related asset. These are generally linked to Bitcoin futures contracts to shield investors from turbulent market conditions as far as possible. Bitcoin ETFs give investors exposure to the cryptocurrency without having to actually buy and own it. These are traded on stock exchanges like the NYSE instead of cryptocurrency exchanges.
Understanding Bitcoin ETFs
In a regular ETF, a company buys the stocks or other assets that constitute the
holdings of that ETF. Fractions of the shares of this ETF are then offered to investors on stock exchanges or brokerages like Robinhood or Fidelity. The prices of ETFs fluctuate as they are bought and sold at pretty much all hours of the day.
Now, in a Bitcoin ETF, a company would buy and hold Bitcoin to make an ETF and then offer fractionalized shares of said ETF to investors on regular stock exchanges. However, at least in the US, the Securities and Exchange Commission has not approved ETFs that directly hold Bitcoin.
So, what happens is that in practice, Bitcoin ETF refers to an exchange fund linked to Bitcoin futures contracts that trade on the Chicago Mercantile Exchange.
In a futures contract, the buyer enters a contract agreeing to buy or sell an asset at a pre-determined price on a specific date regardless of market conditions. Therefore, Bitcoin ETFs are designed to protect investors from unstable market conditions since these ETFs are generally linked to BTC futures contracts.
Since the prices are determined beforehand, the futures contract buyer generally gets BTC either at a premium or a discount. It is called a ‘premium’ when the BTC futures prices are higher than the spot price. Conversely, investors get a ‘discount’ when the futures prices are lower than the spot price.
Pros of Bitcoin ETFs
One of the biggest reasons for the popularity of Bitcoin ETFs is the convenience they provide to investors. You don’t need to learn much about Bitcoin or cryptocurrency, do not need to sign up for a cryptocurrency exchange or actually buy the coin for your investment portfolio. It gives you exposure to the underlying asset without transferring the ownership of the coin.
ETFs generally are a collection of multiple assets. This means that a Bitcoin ETF will not just have Bitcoin but also stocks like Apple or Meta and other assets. This helps you diversify your portfolio and mitigate the risk of investing in Bitcoin by combining it with more stable or predictable assets.
Cryptocurrency is still an emerging industry and cryptocurrency exchanges are unlicensed and unregulated in a lot of places. This often makes investors wary of investing in Bitcoin or cryptocurrencies in general. Bitcoin ETFs, however, are traded on stock exchanges which are heavily regulated and have been trusted by investors for years.
Cryptocurrency investments generally do not get you any tax benefits since they are unregulated. However, Bitcoin ETFs are traded on exchanges regulated by the Securities and Exchange Commission(SEC). Therefore, investments in Bitcoin ETFs instead of BTC directly can be more efficient from a taxation perspective.
Cons of Bitcoin ETFs
Since Bitcoin ETFs are linked to multiple assets, they may not accurately reflect the changes in the value of Bitcoin due to the influence of the value of other underlying assets. Inaccuracy in prices is a big problem with Bitcoin futures ETFs where a situation called ‘contango’ occurs when the BTC futures prices are greater than the spot prices.
Similarly, ‘backwardation’ may occur when the BTC futures prices are lower than the current prices.
Inconsistent with the Principles of Bitcoin
Bitcoin was developed as an alternative form of payment to regular fiat currencies. Further, maintaining the privacy of users while trading is a defining feature of Bitcoin. Bitcoin ETFs, which are regulated by the government and traded on stock exchanges are primarily inconsistent with this principle.
Crypto Trading Not Possible
When you have Bitcoin, you can directly trade it for other cryptocurrencies like Litecoin, Ether, or Dogecoin. However, you cannot do so with Bitcoin ETFs since they are only investment funds that track BTC prices and do not confer ownership rights on the investor.
While Bitcoin ETFs may be convenient, this convenience comes at a price. You have to pay a certain percentage of your holdings as management fees. Sometimes, having higher shares in a Bitcoin ETF can lead to very high expense ratios over time which negates the benefits of the ETF.
Bitcoin ETF vs. Blockchain ETF
Often, confusion between Bitcoin and blockchain arises because these are very interrelated terms. After all, Bitcoin and other cryptocurrencies have been developed using blockchain technology. While cryptocurrencies are its most widely known use case, blockchain technology can actually be used in several sectors- from finance to agriculture to healthcare.
As discussed above, Bitcoin ETFs are linked to BTC futures contracts and provide investors exposure to Bitcoin and Bitcoin-related products without needing to buy the asset. Blockchain ETFs, however, give investors exposure to a bunch of companies that are developing or using blockchain technology in their operations without having to buy individual stocks.
These firms can be cryptocurrency exchanges like Coinbase or any other firm that is utilizing blockchain technology. Any company, be it a technical, financial, or healthcare-related firm, can be included in an ETF basket as long as its operations are related to blockchain technology.
Blockchain ETFs are considered to be more stable and widely accepted because blockchain technology has diverse use cases in multiple industries. Cryptocurrency is only one example of the practical application of this technology.
On the other hand, Bitcoin ETFs have had to face many regulatory hurdles since Bitcoin regulation itself is not uniform across territories. Cryptocurrencies, including Bitcoin, are outright banned in some countries and remain unregulated in several others.
There are no ETFs actually linked to Bitcoin because of regulatory concerns surrounding fraud, manipulation, and valuation methodology.
Bitcoin ETF Frequently Asked Questions(FAQs)
What is the first BTC ETF?
The first Bitcoin-based ETF in the USA was BITO. It was launched by specialized exchange-traded products provider ProShares and started trading on October 19, 2021. BITO followed the Bitcoin reference rate of the Chicago Mercantile Exchange(CME).
Is Bitcoin ETF Risky?
Yes, Bitcoin ETFs can be risky. Simply because Bitcoin itself is a volatile asset whose prices can dramatically fluctuate. Plus, the average retail investor is not very informed about the technicalities of futures and ETFs which makes BTC-based ETFs a particularly risky investment for retail investors.
How Can I Buy Bitcoin ETF?
You need to have a brokerage account to invest in Bitcoin ETFs. Once you open an account, you can buy it like conventional stocks and ETFs by choosing the amount you want to buy at the brokerage platform. However, note that Bitcoin ETFs are high-risk investments so you should only put in money that you can afford to lose.