What is a Bitcoin ETF?

TL;DR

Bitcoin is solidifying itself as a legitimate investment asset that anyone can invest in. Well, technically not anyone, as some institutions and individuals can only participate in a highly regulated manner. Many think a Bitcoin exchange-traded fund (ETF) could fulfill this purpose.

Bitcoin ETFs are pools of assets related to bitcoin that are offered on traditional exchanges by brokerages to be traded as ETFs. This gives traditional investors access to Bitcoin without actually owning any BTC.     

Bitcoin ETFs already exist in Canada and the US, helping cryptocurrencies increase their mainstream adoption among investors. Let’s look at what an ETF is and what it could mean for Bitcoin.

Introduction

Bitcoin (BTC) and the overall cryptocurrency market have come a long way. Not more than a decade ago, this technology was only used by a small community of enthusiasts, when 10,000 BTC could buy you two pizzas. 

Fast forward a few years, and we’ve seen many entire businesses spring from this industry, countless cryptocurrency projects, the birth of DeFi, and much more. Institutional adoption is also booming — MicroStrategy has converted more than $2 billion of their balance sheet into Bitcoin, and you may soon be able to buy the latest Tesla with your BTC.

But what building blocks are still needed before Bitcoin can become a major asset in the global macroeconomic environment? One of these could be that a regulatory framework would help increase exposure to BTC for institutions and mainstream investors. According to some, the best way to do so could be through a Bitcoin ETF.

What is a Bitcoin ETF?

First, a bit of an overview. An ETF is an exchange-traded fund, i.e., an investment fund that tracks the price of an underlying asset. ETFs exist across many different industries and asset classes. For example, gold ETFs, which have existed for decades, track the price of gold.

A Bitcoin ETF is simply an exchange-traded fund consisting of bitcoin or assets linked to Bitcoin’s price. ETFs are regulated financial products, so Bitcoin and other cryptocurrency ETFs trade on traditional markets like the NASDAQ or New York Stock Exchange (NYSE) and not on a cryptocurrency exchange. This, however, might change in the future as the borders between traditional finance and the cryptocurrency industry continue to blur. 

The aim of Bitcoin ETFs is to give mainstream investors who are not comfortable trading cryptocurrency access to bitcoin via a vehicle with which they are familiar. 

Why is a Bitcoin ETF important?

Bitcoin isn’t the easiest asset to handle. Custody, for example, can cause serious headaches for a large institution. After all, Goldman Sachs won’t just plug a hardware wallet into a laptop and transfer $2 billion worth of Bitcoin to it. Large financial institutions don’t operate the way individual investors do — they need a complex regulatory framework and financial plumbing to be able to participate in this space.

This is why an ETF can be instrumental in increasing adoption and expanding the potential investor base. It can offer price exposure to participants in the traditional markets without them having to worry about the nitty-gritty of physically owning coins.

Apart from Bitcoin, a Bitcoin ETF could hold a basket of assets, including Ethereum, Tesla stock, and gold, thereby providing investors with diversification benefits.

A brief overview of Bitcoin ETFs

When people talk about Bitcoin ETFs, they’re usually referring to ETFs on the US markets. However, ETFs exist on many different markets. For example, the first Bitcoin ETF, the Purpose Bitcoin ETF, was launched on the Canadian stock market  and trades on the Toronto Stock Exchange under the ticker BTCC.

Still, for a long time, most eyes were on US regulators and whether or not they would allow for a US Bitcoin ETF. Finally, in October 2021, the US Securities and Exchange Commission (SEC) accepted an application to list the ProShares Bitcoin Strategy ETF (BITO) on the NYSE. 

Historically, most applications were rejected due to volatility, the unregulated nature of the Bitcoin markets, and their apparent liability to market manipulation. While these are valid concerns to some extent, they are probably also applicable to many other financial markets that already have ETFs.

Much of the financial plumbing required for Bitcoin to be a legitimate macro asset class was built in the last bear market. If MicroStrategy wanted to buy billions of dollars worth of Bitcoin just a few years ago, it might have been exceedingly difficult to do so. Now, however, both the infrastructure and the liquidity are in place to make such sizable investments possible.

This ongoing maturation of the Bitcoin markets likely turned the tides for regulators and eventually gave way to the US Bitcoin ETF we see today.

What is a Bitcoin futures ETF?

Not all Bitcoin ETFs are backed by BTC held in wallets, also known as Bitcoin physical ETFs. Many Bitcoin ETFs, like BITO, use BTC futures contracts as their underlying assets. 

The SEC has so far favored futures ETFs tied to the Chicago Mercantile Exchange’s (CME) Bitcoin futures, a regulated financial security. A Bitcoin futures ETF uses the price of the CME’s Bitcoin Reference Rate (BRR), rather than the spot price. This means the only difference between a Bitcoin physical ETF and a Bitcoin futures ETF is where their prices are derived.

Should I invest in a Bitcoin ETF?

Is a Bitcoin ETF the right financial instrument for you to invest in Bitcoin? If you simply want to protect your savings against the melting value of fiat, you may be better off just buying Bitcoin. 

After all, Bitcoin is about democratizing finance, though it also represents different things to different people. But ultimately, having direct custody of your savings can be powerful. Furthermore, there are countless ways in which you can earn yield or borrow against your Bitcoin. 

With that said, there are advantages to investing in a Bitcoin ETF. If any of those are beneficial to you, an ETF could very well be a good investment option.

Closing thoughts

Bitcoin ETFs let investors in traditional markets gain exposure to Bitcoin in a regulated way and  can lead to greater institutional adoption of cryptocurrency as an asset class. With the building blocks now in place in the US, we can only anticipate how much exposure to BTC investors will allow their portfolios.