Exploring Bitcoin Exchange-Traded Funds (ETFs): Benefits and Investment Opportunities
On January 10th, 2024, the cryptocurrency saw a landmark moment as the US Securities and Exchange Commission approved 11 spot bitcoin exchange-traded funds (ETFs). These ETFs provide mainstream investors regulated access to an asset that tracks the price of Bitcoin without the need to access a cryptocurrency exchange and buy Bitcoin.
In this article, I will explore spot Bitcoin ETFs and the features and benefits of Bitcoin ETFs as they attract billions in investor spending.
Understanding Bitcoin ETFs
Definition of a Bitcoin ETF
So, what does “Bitcoin ETF” mean? What are these new investment products that leverage an asset still somewhat controversial in mainstream investing?
A spot bitcoin ETF is an exchange-traded fund that tracks the performance of Bitcoin, allowing investors direct exposure to Bitcoin without owning the asset. Each spot Bitcoin ETF is managed by an SEC-approved company that issues shares of its own Bitcoin holdings. The shares are listed on a traditional stock exchange.
Investors in spot Bitcoin ETFs buy shares of a fund that holds Bitcoin, essentially shares in a pool of Bitcoin.
How Bitcoin ETFs Work
Spot Bitcoin ETF providers hold previously purchased Bitcoin in secure crypto custody. The ETF company then issues shares corresponding to its holdings, the share price reflects the market price of Bitcoin, and the shares are listed for public trading on traditional stock exchanges like the New York Stock Exchange and Nasdaq.
ETF providers manage their Bitcoin holdings’ purchase, storage, and safekeeping and charge an annual fund management fee. They will issue new ETF shares to match demand, or when investors sell shares, shares are redeemed, reducing the number of shares in circulation.
The value of spot Bitcoin ETF shares reflects the price and performance of Bitcoin. Market makers keep the ETF price aligned with Bitcoin’s price by buying and selling to balance supply and demand and earn a profit.
Key Features of Bitcoin ETFs
- Spot Bitcoin ETF firms hold actual Bitcoin, providing direct exposure to Bitcoin for investors. They have a creation and redemption mechanism similar to other ETFs.
- They are more straightforward than Bitcoin futures ETFs because they tend to follow Bitcoin prices directly.
- Investors don’t need to access cryptocurrency exchanges, manage direct holdings of Bitcoin in a cryptocurrency wallet, or secure cold storage.
- Spot Bitcoin ETFs have the same volatility as Bitcoin, which means the same significant price movements for investors.
- ETFs can be bought and sold freely during a trading day.
Advantages of Investing in Bitcoin ETFs
Liquidity and Ease of Trading
Access to spot Bitcoin ETFs is far easier for conventional investors with limited experience of direct cryptocurrency investment. They can use familiar platforms, brokerages, and payment methods, particularly if they own shares and other ETFs.
Because Bitcoin ETFs are now listed on major stock exchanges, they are available via traditional investment channels. This allows investors to diversify a more conventional portfolio further into cryptocurrency without navigating the cryptocurrency markets directly.
Regulatory Oversight and Investor Protection
Cryptocurrency markets are widely unregulated and fraught with concern for traditional investors who have historically invested with the regulatory comfort of long-standing financial institutions. Spot Bitcoin ETF providers require approval from the US Securities and Exchange Commission (SEC) after undergoing a stringent assessment process.
Depending on the jurisdiction, spot Bitcoin ETFs could simplify taxation, as the tax rules for ETFs have been in place for some time and may be easier to follow.
Disadvantages of Investing in Bitcoin ETFs
Bitcoin ETFs are very straightforward: the company owns Bitcoin and traders and investors own
shares in the company. However, despite this, the price of a Bitcoin ETF will not display perfect
correlation with the price of spot Bitcoin for several reasons.
If you buy Bitcoin, you take on the risk of the Bitcoins you buy. If you buy a Bitcoin ETF, as well as the
risk of the Bitcoin, you also take on the risk of the company which owns the ETF, such as fraud or
regulatory issues. While trading in Bitcoin is very unlikely to ever be suspended, trading in Bitcoin
ETFs might be for some time. If the company gets into difficulty for any reason, this could also
depress the price of the ETF’s shares, even at a time when the price of Bitcoin is rising.
ETFs charge management fees, which are effectively deducted from the price you pay to buy the
ETFs. If you buy spot Bitcoin, disregarding any cost of storage, you will not pay such a fee.
Restricted Trading Hours
ETFs can usually only be traded during the hours the exchange they are listed on is open. Contrast
this with spot Bitcoin, which can be traded around the clock seven days a week.
How to Invest in Bitcoin ETFs
Spot Bitcoin ETFs can be bought and sold via popular online stock brokerages. Examples are Fidelity, Robinhood, Charles Schwab, and Morgan Stanley’s E-Trade. ETFs are securities, and the unregulated and contested nature of cryptocurrency exchanges means spot Bitcoin ETFs are not yet available on these platforms.
Choosing a Reliable Brokerage or Platform
Although there are newer platforms, generally reputable online stock brokerages have been around for some time and are under the scrutiny of regulators. It’s still essential to conduct due diligence when choosing a brokerage. Here are some things to consider:
- Does the brokerage support ETFs?
- Is the platform registered and regulated?
- Is there any insurance or guarantee?
- Is it reputable and trustworthy?
- What trading tools and technologies are offered?
- Is there a mobile trading app?
- What other products are available?
- What’s the customer service experience?
- What are the fees?
Setting up an Investment Account
Once the choice of online brokerage is made, the next step is to create an account. Usually, this can be done online without an up-front deposit or a fee for opening an account.
Buying and Managing Bitcoin ETF Shares
After opening an account, funds must be added before investing in a Bitcoin ETF or any other product. Linking bank accounts or cards to fund purchases is usually easy, but some brokers may want to verify an initial transaction.
Once an account is fully functional, buying spot Bitcoin ETF shares is as simple as choosing the amount to purchase and confirming and funding the order.
Keeping Track of Your Investments
As with any other investment, especially with cryptocurrencies due to their volatility, it’s critical to closely track an investment product’s performance and the broader market. In the case of a spot Bitcoin ETF, it is vital to watch out for market influences that can quickly spur Bitcoin’s extreme volatility.
Risks and Considerations
Spot Bitcoin ETF shares will track the price of Bitcoin and, as such, demonstrate the same volatility, which is often much more extreme than with traditional assets such as stocks and shares.
A tracking error is a discrepancy between the ETF share price and the value of Bitcoin. Spot Bitcoin ETFs are designed to mirror the price of Bitcoin, but this is not guaranteed. Tracking errors can occur due to liquidity in the market, a delayed rebalancing of the fund’s holdings, or management fees.
Costs and Fees
Spot Bitcoin ETFs charge management fees or expense ratios that can impact returns. The fees can be higher than those of more traditional ETFs because of the charges the ETF provider has to pay for exchanging Bitcoin and securing crypto custody.
As cryptocurrencies are still widely unregulated, there is still the risk of regulatory or taxation changes. Any impact on Bitcoin would be similarly impactful to spot Bitcoin ETFs. These new products are still untested in the market, and there is uncertainty about how risks such as fraud, manipulation, or loss of assets could be treated.
Spot Bitcoin ETFs will hold significant Bitcoin balances, putting them at risk from hackers and cyber attackers. Although they will follow stringent security processes, Bitcoin ETFs must still use digital crypto wallet addresses and security keys to manage their Bitcoin holdings.
Bitcoin ETF vs. Other Bitcoin Investment Options
Contrasting Bitcoin ETFs with Direct Ownership
A spot Bitcoin ETF is a fund that tracks the performance of Bitcoin, allowing investors direct exposure to Bitcoin without owning the asset. Investors in spot Bitcoin ETFs buy shares of a fund holding Bitcoin and have the funds fees to pay but don’t have to worry about using cryptocurrency exchanges, exchange fees, and securely storing Bitcoin.
Bitcoin ETFs protect somewhat against the risks of fraud or theft associated with cryptocurrency and exchange use. However, counterparty and operational risks are still related to the ETF provider as a centralized third party. Because spot Bitcoin ETFs are traded like regular shares, they can only be traded during market hours, meaning that investors can’t respond to out-of-hours market downturns.
In contrast, direct ownership means an investor owns the Bitcoin and fully controls the investment. An investor can capture the full reward of an upswing in Bitcoin price without the management fees of an ETF.
Direct ownership means investing in a far less regulated space and carrying the full security risks of Bitcoin, including exchange, wallet hacks, and other illicit activity. There are also differences in taxation rules to consider.
Bitcoin Mutual Funds vs. Bitcoin ETFs
Mutual funds are usually actively managed by fund managers and can only be bought and sold once daily, with all investors receiving the same price on the same day. ETFs are purchased as whole shares, whereas mutual funds can be purchased in fractional shares or fixed amounts. Both have differing implications for fees and taxes, which broker and jurisdiction should compare.
In contrast to directly owning Bitcoin, Bitcoin ETFs and mutual funds offer the comfort of regulatory oversight and third-party asset management, providing exposure to an asset without actual ownership.
Bitcoin ETFs vs. Bitcoin Futures
Whereas Spot Bitcoin ETFs were approved for the first time in January 2023, Bitcoin futures ETFs have been available since 2021.
Bitcoin futures ETFs invest in Bitcoin futures contracts rather than having Bitcoin itself as an underlying asset. Futures contracts allow for speculation on future price movements. They are an agreement to buy or sell Bitcoin at a future date but at a price agreed on during the transaction. Futures contracts expire, so ETF managers sell expiring contracts and buy new ones. Some Bitcoin futures use leverage, a method that can amplify gains and losses.
Bitcoin futures ETFs can have a greater risk of tracking errors and potential basis risk, which is the difference between futures and spot prices. They are more complex and can have greater volatility than spot Bitcoin ETFs because of basis risk and the use of leverage; however, the expense ratios and fees may be less.
Both spot Bitcoin ETFs and Bitcoin futures ETFs negate the need for a cryptocurrency exchange, wallet, or safe storage and have the same regulatory comfort.
Brokers Offering Bitcoin ETFs
Spot Bitcoin ETFs make it easier for conventional investors with no cryptocurrency experience to access cryptocurrency investing and diversify their portfolios via the more familiar investment approach of stock brokerages. Investors can also benefit from the regulatory oversight of an exchange-traded product.
Cryptocurrency proponents hope the SEC’s approval of spot Bitcoin ETFs will extend some of the positive investor and regulatory sentiment to the cryptocurrency markets, encouraging further positive regulation and regulatory clarity.
Mainstream interest in cryptocurrencies and regulatory clarity is much anticipated in cryptocurrency to drive further adoption of these digital assets.
- What is the difference between a Bitcoin ETF and Bitcoin itself?The most critical difference between a spot Bitcoin ETF and direct investment in Bitcoin is that Bitcoin ETF shares are not ownership of Bitcoin but instead are shares in a fund that holds Bitcoin and allows investors to speculate on price movements.
- Are Bitcoin ETFs available to all investors?Yes, spot Bitcoin ETFs are listed on traditional stock exchanges like the New York Stock Exchange and Nasdaq and can be bought at conventional online stock brokerages.
- How do Bitcoin ETFs handle custody of assets?Spot Bitcoin ETF providers hold Bitcoin in a secure digital vault or cold crypto storage managed by registered custodians and, in some cases, managed directly. It varies between the ETFs available.
- What factors can affect the price of a Bitcoin ETF?Spot Bitcoin ETF share prices follow the price of Bitcoin. They are affected by the same factors and any impact on the regulation, security, or taxation of the ETFs, as this will also correspondingly impact Bitcoin price.
- How do authorities regulate Bitcoin ETFs?The cryptocurrency markets and participants have waited for the US Securities and Exchange Commission (SEC) to approve the first spot Bitcoin ETFs for years. In January 2024, the first eleven ETFs were finally approved.
- Are there any minimum investment requirements for Bitcoin ETFs?Spot Bitcoin ETF shares can be purchased in single-share quantities.
- Are there any tax implications when buying or selling Bitcoin ETFs?Yes, tax implications for Bitcoin ETFs will vary for each tax jurisdiction.