Bitcoin ETFs: How They Work and How to Invest
Bitcoin Exchange Traded Funds (ETF) have been in the news lately as an important financial asset form that has finally achieved regulatory compliance. At the time of writing, inflows into spot Bitcoin ETFs had reached more than $4.5 billion.
Bitcoin ETFs allow investors to gain exposure to Bitcoin's price movements without the complexities of directly buying, storing, and managing the cryptocurrency. There are two main types of Bitcoin ETFs, which we will explain in more detail.
Responding to the deluge of news coverage about Bitcoin ETFs, our experts at Arincen set about researching what all the noise was about. In this article, we will explain what Bitcoin ETFs are, from where they originated, and how you can invest in them.
What are Bitcoin ETFs?
Before we talk about the Bitcoin version, let’s talk about what ETFs are. There are many types of ETFs; but at their heart, these financial assets offer you and other investors a way to pool your money in a fund that makes investments in stocks, bonds, and now, cryptocurrencies.
In return, you will receive payouts when you sell your stake in that investment if you sell when the price is higher than when you bought it. ETFs are traded on stock exchanges just like individual stocks. ETFs are as easy to diversify as mutual funds and have the flexibility and ease of trading with stocks.
You can buy and sell ETF shares throughout the trading day at market price, potentially capitalizing on short-term price fluctuations, which makes ETFs an attractive option for a wide range of investment strategies, from conservative to aggressive.
The history of ETFs
The history of ETFs dates back to the early 1990s, with the launch of the first ETF in the United States. Since then, ETFs have evolved significantly, expanding across a broad spectrum of asset classes, including stocks, bonds, commodities, and now cryptocurrencies.
The emergence of Bitcoin ETFs is the most recent development in this evolutionary timeline, representing the point at which digital currencies achieved a major integration with the traditional financial system. Bitcoin ETFs give you exposure to Bitcoin's price movements without the need to directly purchase or hold the cryptocurrency, offering a more convenient and regulated investment vehicle for engaging with the crypto market.
Bitcoin ETFs reflect the growing acceptance of cryptocurrencies as a legitimate asset class among investors and regulators alike. By offering a regulated and accessible means to invest in Bitcoin, these ETFs have already started to attract a broader audience of investors, including those who may have been hesitant to invest directly in cryptocurrencies due to concerns about volatility, security, and regulatory uncertainty.
The introduction of Bitcoin ETFs marks a significant step forward in bridging the gap between the innovative world of cryptocurrencies and the traditional finance sector, opening up new opportunities for investment and diversification.
Bitcoin ETFs offer a regulated, accessible, and potentially less-volatile way to invest in Bitcoin. Through Bitcoin ETFs, both seasoned investors and newcomers can partake in the crypto market's potential gains while mitigating some of its inherent risks, such as security concerns related to the custody of digital assets. Their introduction marks a pivotal moment in the integration of cryptocurrencies into mainstream financial portfolios. This has already led to enhanced liquidity and a wider acceptance of digital currencies in global finance.
Different types of Bitcoin ETFs
Not all Bitcoin ETFs are created the same. Depending on the type of ETF, you could be purchasing very different products. The two main types of Bitcoin ETFs are Bitcoin futures ETFs and spot Bitcoin ETFs.
The history of Bitcoin futures ETFs began to take shape with growing interest in cryptocurrency investments and the demand for regulated financial products that provide exposure to Bitcoin prices. The first significant milestone in this journey was the approval of futures-based Bitcoin ETFs by regulatory authorities in the United States in October 2021, which allowed these financial instruments to be traded on traditional stock exchanges.
This development marked a crucial step in legitimizing Bitcoin as an investable asset. Following the introduction of futures-based ETFs, there has been feverish anticipation around the potential approval of spot Bitcoin ETFs, which would directly track the price of Bitcoin itself, rather than futures contracts. Many institutional and casual investors finally got their wish when the Securities and Exhange Commission (SEC) in January 2024 approved spot Bitcoin ETFs.
It had been a long time coming. By comparison, spot Gold ETFs were first introduced in 2003, more than two decades before! These developments underscore the evolving landscape of cryptocurrency investment products, reflecting both growing investor interest and regulatory evolution.
Bitcoin Futures ETFs
So, what is the difference between the two types of ETFs? Bitcoin futures ETFs are a type of exchange-traded fund designed to track the future prices of Bitcoin, rather than its current spot price. These ETFs invest in futures contracts of Bitcoin, which are agreements to buy or sell the digital currency at a predetermined price on a specific future date. This mechanism allows investors to speculate on the future price of Bitcoin without directly holding the cryptocurrency, providing a way to gain exposure to its price movements through a regulated, stock exchange-traded product.
The structure of Bitcoin futures ETFs offers investors the advantage of trading in a familiar market environment while mitigating some of the risks and technical challenges associated with the direct ownership of cryptocurrencies. Some of these risks and challenges include handling crypto wallets, which could expose you to hacking or loss of the wallet itself.
Spot Bitcoin ETFs
Enter spot Bitcoin ETFs. These financial instruments are designed to track the current market price of Bitcoin directly, providing you with exposure to the actual price movements of Bitcoin rather than through derivatives like futures contracts. This direct exposure means that the performance of a spot Bitcoin ETF closely mirrors the real-time value of Bitcoin, offering a more accurate reflection of the cryptocurrency's market price.
Unlike Bitcoin futures ETFs, which are based on speculative future prices of Bitcoin, spot ETFs allow for investment in the cryptocurrency without the complexities and potential misalignments of futures markets. The advantages of spot Bitcoin ETFs include eliminating the time decay and Contango effects often associated with futures contracts and providing a more straightforward and potentially less costly investment in Bitcoin. We’ll discuss Contango effects in the next section.
Which is better between the two?
Spot Bitcoin ETFs are often considered more attractive than Bitcoin futures ETFs for several reasons:
Direct exposure to Bitcoin prices:
Spot Bitcoin ETFs are based on the current, or "spot," price of Bitcoin, offering investors direct exposure to the actual price movements of the cryptocurrency, rather than through futures contracts that may predict future prices. This way, you are more in tune with what is happening in the moment, rather than speculating about what might happen in the future. It’s a much more engaging way to trade.
Reduced Contango impact:
It’s worth explaining a little about what Contango Impact is. This phenomenon refers to the situation in futures markets where the futures prices are higher than the spot price of the underlying asset. It affects investors by increasing roll costs and eroding the fund's returns over time. There is also performance drag, as the cost of maintaining exposure to the futures contracts can result in returns that lag behind the actual movements of the underlying asset's spot price. This is one of the classic drawbacks of futures markets.
The performance of futures-based ETFs can be negatively impacted by Contango. Spot ETFs do not face this issue since they hold the underlying asset directly, thereby closely tracking the actual price of Bitcoin without the distortion caused by the futures market's structure.
Lower costs:
Spot Bitcoin ETFs can potentially have lower costs compared to futures ETFs. Futures ETFs may incur rollover costs as they buy and sell futures contracts to maintain exposure. These costs can erode returns over time, especially in markets experiencing Contango, where future prices are higher than spot prices.
Simplicity and transparency:
Spot Bitcoin ETFs provide a straightforward and transparent way to invest in Bitcoin, as they directly hold the cryptocurrency. This can be easier for investors to understand compared to the complexities of futures contracts and the strategies involved in managing a futures-based ETF.
Market structure impact:
Contango often reflects the market's expectations of future price increases of the underlying asset. While it can indicate positive sentiment about future price movements, the immediate impact of Contango is typically negative for futures-based investment products due to the costs associated with rolling contracts.
Regulatory clarity:
While both types of ETFs are subject to regulatory oversight, the approval and operation of spot Bitcoin ETFs may offer clearer regulatory implications for investors, given their direct investment in the cryptocurrency. Regulation that governs in events and prices in the present has naturally fewer complexities than regulation discussing a possible future scenario. For more information on the latest regulations around cryptocurrencies, read our article here.
These factors combine to make spot Bitcoin ETFs an appealing option for investors seeking a more direct, cost-effective, and simple way to gain exposure to Bitcoin's price movements.
How to invest in Bitcoin ETFs
To invest in Bitcoin futures ETFs or the more attractive spot Bitcoin ETFs, you can start by researching and selecting from the popular options available in the market through major stock exchanges. Investors should consider factors like:
The ETF's performance history
ETF management fees
The nature of the underlying futures contracts it holds
Opening an account with a brokerage that offers access to the exchange where the ETF is listed is essential. After setting up an account, you can buy and sell shares of the ETF much like you would with traditional stocks. Keep in mind that you should monitor the performance and adjust your investment strategy as needed. It's also advisable to stay informed on the latest market trends and regulatory developments related to Bitcoin and cryptocurrency investments.
Main Bitcoin ETFs
Although it is not the emphasis of this article, we will share with you just a few of the ETFs out there. We should point out that there are more Bitcoin ETFs than are mentioned in this list. For more options, you can carry out a detailed search.
Bitcoin Futures ETFs
Bitwise Bitcoin Strategy Optimum Roll ETF: Launched in 2023, this fund aims for capital growth by managing its exposure to bitcoin futures contracts. These are standardized, cash-settled futures contracts that are traded on commodity exchanges registered with the CFTC, with bitcoin serving as the underlying asset. Additionally, the Fund invests in short-term debt securities.
ProShares Bitcoin Strategy ETF: This actively managed investment aims to deliver results, prior to fees and expenses, that mirror the performance of Bitcoin. To meet its investment goal, the fund adviser primarily utilizes managed exposure to bitcoin futures contracts. The inception date of this fund was in 2021.
Bitwise Bitcoin and Ether Equal Weight Strategy ETF: The Bitwise BTC/ETH Equal Weight Strategy offers equal-weighted exposure to Bitcoin and Ethereum, rebalanced quarterly.
ProShares Bitcoin & Ether Equal Weight Strategy ETF: The Bitcoin and Ether Equal Weight Strategy ETF targets the equal weighted performance of bitcoin and ether in a single investment. Users can enjoy the familiarity, liquidity and transparency of an ETF, all available through a brokerage account—no need for a cryptocurrency account or wallet.
Spot Bitcoin ETFs
Franklin Templeton Digital Holdings Trust: This fund seeks to reflect generally the performance of the price of bitcoin before payment of the fund's expenses. It is convenient and cost-effective, lowering the barrier of entry into the crypto market. It is offered by Franklin Templeton, custodied by Coinbase, and registered under the Securities Act of 1933.
Fidelity Wise Origin Bitcoin Fund: This is an exchange-traded fund domiciled in the USA. The Fund aims to track the performance of spot bitcoin as measured by the performance of the Fidelity Bitcoin Reference Rate. In seeking to achieve its investment objective, the Trust holds Bitcoin.
Valkyrie Bitcoin Fund: This exchange-traded fund issues common shares whose purpose is to hold Bitcoin. The investment objective of the fund is for the shares to reflect the performance of the value of a Bitcoin as represented by the CME CF Bitcoin Reference Rate - New York Variant, minus the Trust’s liabilities and expenses.
Grayscale Bitcoin Trust: This trust was first launched over a decade ago. Shares were originally offered through a private placement but in mid-2015, shares began trading publicly on OTC Markets under the symbol GBTC. This continued until 2024 when GBTC uplisted to NYSE Arca as a spot Bitcoin ETF.
Pros and cons of trading Bitcoin ETFs
Trading Bitcoin ETFs offers several benefits, enhancing their appeal to a wide range of investors. However, there are also some drawbacks, which we will discuss here. This list applies to both types of ETFs.
Pros:
Accessibility: Bitcoin ETFs provide accessibility, allowing individuals to invest in Bitcoin through traditional brokerage accounts without the need for a cryptocurrency exchange or wallet. This accessibility opens up Bitcoin investment to those unfamiliar with the complexities of crypto markets.
Security: These financial assets offer increased security, as investors don’t directly hold the cryptocurrency, reducing the risk of loss through hacking or mismanagement.
Diversification: Bitcoin ETFs allow for diversification within investment portfolios, offering exposure to the cryptocurrency market while mitigating the volatility typically associated with direct Bitcoin investments.
Cons:
Tracking errors: In some instances, the ETF's performance may not exactly match that of Bitcoin's price, due to the fund's management fees or the mechanics of futures contracts, such as Contango. This is particularly relevant for futures contracts.
Regulatory uncertainty: This is another concern. The cryptocurrency market's evolving regulatory landscape can impact Bitcoin ETFs, affecting their performance and availability. Even though spot Bitcoin ETFs were approved this year, the brokerages that offer them had to go through years of fierce advocacy for them to be approved.
Market volatility: This remains a significant risk, as the price of Bitcoin and, consequently, Bitcoin ETFs can experience rapid and unpredictable swings, affecting investment value. Cryptocurrency has and foreseeably will be characterized by intense volatility.
Best practices for trading Bitcoin ETFs
For successful trading of Bitcoin ETFs, you will notice that these tips are the same for any kind of financial investing.
Comprehensive market analysis:
Study the markets and watch the news. This is crucial to understanding the broader market trends and how they might impact Bitcoin's price.
Use effective risk-management strategies:
Set stop-loss orders; this is also available in Bitcoin ETF circles in the same way as it is available in many other types of financial investing. Only invest funds you can afford to lose.
Diversify your investment portfolio:
This advice will never get old. By including Bitcoin ETFs alongside other assets, you can reduce your risk and improve potential returns. This approach balances exposure to the high-reward potential of cryptocurrencies with the stability of traditional investments.
Regulatory landscape
The regulatory landscape for Bitcoin ETFs is complex and continuously evolving. The first Bitcoin futures ETF was approved by the SEC in 2021.
On January 10, 2024, the SEC approved the first-ever spot Bitcoin ETFs, including those from Fidelity, BlackRock, and Invesco. In total, the SEC approved 11 spot Bitcoin ETFs on that first day. Within 48 hours, 10 of the 11 had started trading.
Until that point, the regulators had been reluctant to approve any spot Bitcoin ETF applications, citing concerns over market manipulation, fraud, custody, and investor protection. Now, regulators in various worldwide jurisdictions are scrutinizing Bitcoin ETF proposals closely. The future outlook suggests an ongoing dialogue between industry participants and regulators, potentially leading to clearer guidelines and more approvals as the market matures and regulatory concerns are addressed.
The future of Bitcoin ETFs
Earlier this year, when regulators finally opened the starting gates for spot Bitcoin ETFs to trade, new funds racked up trading volumes and Bitcoin prices bolted higher. Even though there has been a subsequent correction in Bitcoin prices, the overall performance in Bitcoin ETFs marks a clear step forward for the still-young digital currencies.
The new spot Bitcoin ETFs in particular are expected to increase direct demand for Bitcoin and lure institutions and other new investors into cryptocurrencies. Many analysts say we are at the beginning of the first-ever institutional bull market in crypto — and spot ETF momentum is a key part of the momentum
Soon after the SEC approved spot Bitcoin ETFs, the price of Bitcoin spiked to 20-month highs above $45,000 and briefly reached $50,000. Crypto-related stocks have skyrocketed in recent months. It is clear that spot Bitcoin ETFs have streamlined exposure for traditional players who have been slower to enter the ecosystem, allowing billions in institutional capital to come off the sidelines.
The future of Bitcoin ETFs is poised for continued evolution, driven by technological advancements and positive regulatory changes. As blockchain technology continues to mature, we may see improvements in the security and efficiency of Bitcoin ETFs, making them even more attractive to investors.
Regulatory bodies worldwide are gradually recognizing the importance of cryptocurrencies in the financial ecosystem, potentially leading to clearer guidelines and more robust frameworks for Bitcoin ETFs. This regulatory clarity could lead to the approval of ETFs based on other crypto coins, such as Ethereum. In totality, the road thus far has been filled with setbacks, but the crypto industry can look forward to the future with optimism.
Conclusion
Bitcoin ETFs, especially spot Bitcoin ETFs, represent a major leap in the acceptance of crypto assets into the mainstream. Bitcoin ETFs offer both retail and institutional investors a regulated, accessible path to Bitcoin exposure without the complexities of owning Bitcoin itself.
Despite challenges like regulatory uncertainty and market volatility, the potential for diversification and the promise of technological advancements make for a dynamic and positive future for Bitcoin ETFs. As the regulatory landscape evolves, the market for Bitcoin ETFs is expected to expand, further integrating digital currencies into the global financial portfolio. Now that you understand what Bitcoin ETFs are about, you can feel more comfortable if you ever want to partake.
FAQ
What is a Bitcoin ETF?
How do Bitcoin futures ETFs work?
How do spot Bitcoin ETFs work?
What are the differences between a Bitcoin futures ETF and a spot Bitcoin ETF?
What are the benefits of investing in Bitcoin ETFs?
Are there any risks associated with Bitcoin ETFs?
How can I invest in Bitcoin ETFs?
How does the regulatory landscape affect Bitcoin ETFs?
What future developments can we expect in the Bitcoin ETF market?
