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Bitcoin ETF: Traditional Gateway into Unconventional Asset

  • Bitcoin ETF is one of the easiest ways for traditional investors to get involved with digital currencies.
  • Bitcoin exchange-traded fund tracks Bitcoin’s price on multiple crypto exchanges.
  • It is sold in shares only on stock exchanges and offers indirect exposure to the dominant crypto.

When Bitcoin first hit its $19K all-time high in early 2018, most traditional investors still weren’t biting. Years later, it shot to $65K and they started to want some for themselves.

This is when the demand for a Bitcoin Exchange-Traded Fund (ETF) simply exploded. Wall Street acknowledged Bitcoin as a legitimate asset, invested billions into it, and decided to offer newbies a gate into crypto. This is how Bitcoin ETFs, a new investment product, were born.

What Is a Bitcoin ETF?

A Bitcoin exchange-traded fund (ETF) is an investment fund that tracks Bitcoin’s price on multiple cryptocurrency exchanges. However, the fund is listed and traded only on stock exchanges.

Investors may buy shares of a Bitcoin ETF. This is like an entry point for those who are new to crypto. They are not required to register on crypto exchanges or deal with cryptocurrency wallets. Their exposure to Bitcoin is indirect.

Bitcoin is an unregulated currency, and financial authorities worldwide are careful about authorizing crypto-related exchange-traded funds. They name crypto volatility, legal uncertainty, and usage for illegal financial operations as the biggest obstacles for official ETF approval.

Bitcoin ETFs are currently available in several jurisdictions, including Canada, France, and Germany. The world’s first crypto ETF, Purpose Bitcoin ETF (BTCC), was only just launched at the beginning of 2021.

What’s the Purpose of an Exchange-Traded Fund?

In general, ETFs are financial products that offer the ability to invest into hundreds of different assets at a single time. Traditionally, they track the index or a basket of assets from a certain industry, geographic location, or asset class.

ETFs are trendy, but not a super new investment product. First launched in the ‘90s for mostly institutional players, exchange-traded funds were eventually adopted by individual investors. They exploded in popularity over time, mainly because of the diversification and the lower risk approach they provide.

With ETFs, investors no longer need to buy 100 different stocks to diversify their portfolios or take on the amount of risk that investing in individual companies carries. ETFs were easy to buy, less risky than single stocks, and cheaper than traditional mutual funds, which just gathered the money and actively invested it into particular assets.

How Does an ETF Work?

An ETF first buys a certain amount of cryptocurrencies on different crypto exchanges. Their holdings then are represented in fund shares. Initially, the price of ETF shares is decided by each fund itself.

After listing on the stock exchange, the ETF share price is dependent on several factors that both depend on the ETF’s working model. ETFs are divided into actively and passively managed funds.

  • A passively managed ETF simply tracks the prices of the underlying assets. For instance, the ETF buys 1,000 BTC on various exchanges and puts them in cold storage for some time. The price of such ETF shares simply tracks and replicates Bitcoin price movements.
  • An actively managed ETF has an active team and applies an active investment strategy. For instance, the fund managers constantly trade their Bitcoins to outperform the market and gain higher returns. Actively managed ETFs might apply higher fees, but it will probably perform better.

When listed on stock exchanges, cryptocurrency ETFs are traded in shares. Not all of these exchanges support the ability to buy small fractions of each share. This means investing in a crypto ETF might require you to buy at least one share to get into.

How Investing in a Bitcoin ETF Is Different than Buying Directly

Bitcoin ETF issuers aim to offer crypto exposure for traditional investors with stock exchange brokerage accounts. It is expected that the ability to buy Bitcoin ETFs on stock exchanges will help a broader audience get involved with digital currencies.

As always, the new investment product has both pros and cons compared to buying Bitcoin directly on cryptocurrency exchanges.

Advantages of Bitcoin ETF

  • Indirect exposure to Bitcoin is a simpler investment process for cryptocurrency newbies. They don’t have to set up digital wallets and move coins in and out of cryptocurrency exchanges.
  • The ETF market is under strict regulation. Only companies that meet high regulatory standards are qualified to issue ETFs. Such an approach lowers the risk of possible financial fraud.
  • An ETF is a regulated investment product, and separate jurisdictions may tax it at a lower rate compared to other investment forms like direct crypto buying.
  • Traditional exchange-traded funds pay dividends for their shareholders. Investors can cash them in or reinvest into shares of the same ETF.

Cons of Bitcoin ETF

  • Limited working hours: Crypto ETF shares are traded like stocks. However, in contrast to crypto exchanges that are open 24/7, stock exchanges execute orders only during their open hours.
  • Expenses: Crypto ETFs charge administrational and operational fees. Typically in the stock market, these fees are called an expense ratio. Sometimes this type of fee might reach up to 2%, which is higher compared to fees traders pay on crypto exchanges.
  • Approval of Bitcoin ETFs strongly depends on national laws: This means crypto ETFs can only be listed on stock exchanges that operate in the same jurisdiction. Not all of them approve buy or sell orders from abroad. This creates limitations for foreign investors.
  • A Bitcoin ETF is Bitcoin-based only: It cannot switch to Ethereum or other digital currencies. In this case, an ETF that is tied to single crypto is different from standard ETFs, which track a basket of stocks from a certain sector.

Compared to direct buying, crypto ETFs seem to be an easy and efficient approach to the world of digital currencies. They could work as a sandbox for crypto-curious investors who are hesitant to buy Bitcoin directly.

However, for existing cryptocurrency holders, ETFs might not be a relevant option as they are already in the crypto market.

On The Flipside

  • A large number of crypto ETF applications from Wall Street players are still pending SEC approval in the US. Regulators are sending mixed signals that they are more likely to approve Bitcoin Futures ETFs instead of Bitcoin ETFs, where coins are physically held in cold wallets.
  • In the meantime, another type of crypto-related ETF is emerging that tracks cryptocurrency-related industries like mining or product development companies.

Why You Should Care?

The growing number of filings for Bitcoin, Ethereum, or other crypto-based ETFs indicates that the demand is huge. If and when these funds are approved, the new flows of indirect money to the crypto sphere will be inevitable. As a result, this will affect the crypto space by increasing its market volumes and liquidity. On the other hand, the whole crypto market might become even more vulnerable to manipulation.

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    This article is for information purposes only and should not be considered trading or investment advice. Nothing herein shall be construed to be financial legal or tax advice. Trading Forex, cryptocurrencies, and CFDs poses a considerable risk of loss

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    Author

    Simona is a fintech journalist and content editor at DailyCoin Academy, which focuses on educating new crypto investors. She entered the crypto space in early 2018, got burned, but discovered a passion for trading, and now it’s her hobby. Simona covers crypto and blockchain-related topics and takes a deeper look at what lies behind the latest industry trends.