What is a Bitcoin Exchange-Traded Fund (ETF) and How Do They Work?

Bitcoin ETF spot futures

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Bitcoin Exchange-Traded Funds (ETFs) rose to the top of the news agenda in 2021 when the Securities and Exchange Commission (SEC) approved the first Bitcoin ETF to trade in the United States.

Although not a pure Bitcoin ETF as such (it’s a futures one, ie based on contracts representing predictions on the future price of BTC rather than a ‘spot’ ETF), the ProShares Bitcoin Strategy Fund began trading on the New York Stock Exchange under the ticker BITO on October 19, 2021.

The ProShares product still marked an important step for Bitcoin and cryptocurrency in general as it signaled further acceptance of digital currency among the traditional financial sector.

The launch also caused a dramatic spike in the price of Bitcoin (BTC), although this had cooled slightly at the time of writing.

Additionally, a raft of applications are in the pipeline for both a ‘pure’ Bitcoin spot ETF and more futures ETFs, and it remains to be seen if any of these are approved.

If a Bitcoin spot-price ETF were to be given the green light, this would mark a seminal moment in Bitcoin’s history and likely encourage adoption even further.

It would likely to lead to a surge in demand for the product for a number of reasons, including:

  • An ETF removes the need for investors to get bogged down in dealing with the often complex world of crypto wallets and transfers – they simply buy shares in the ETF rather than the coins directly.
  • ETFs are hugely popular, mainstream financial products. A Bitcoin spot ETF would further legitimise crypto as a serious asset class.
  • Those who have been dogged by a sense of FOMO (Fear Of Missing Out) when it comes to crypto would gain easy access to Bitcoin and would be increasingly likely to add it to their portfolios.

For those of you who are unfamiliar with ETFs, let’s look at the general definition of what an Exchange-Traded Fund is before we examine Bitcoin ETFs.

Bitcoin ETF security storage
An ETF removes the need for investors to worry about Bitcoin wallets and secure storage, but this comes at a price.

What is an Exchange-Traded Fund (ETF)?

An ETF is a security that can track the price of pretty much any financial instrument, include indexes, bonds, shares, commodities or even a single asset.

The beauty of ETFs is that they’re a perfect way for novice investors to gain exposure to a wide range of asset classes without having to buy the underlying assets individually.

The individual assets are bought by the ETF provider and bundled into various products which you, the investor, buy shares in.

Because ETFs are traded throughout the day in the same way that individual shares are it means they can be bought and sold at any point making them a highly liquid asset.

Advantages of an ETF for investors

The number of ETFs on the market today mean that there’s a huge amount of choice for investors who want to diversify their portfolio.

For example, if you’re looking at ethical investment products you can choose an ETF that features stocks in companies working in the green energy sector.

Another advantage of ETFs is that they’re a cheap way to spread your investment portfolio across a wide range of sectors and assets because they require little active management which keeps fees low.

You can also start investing in ETFs with a very small capital outlay and gradually build up your holdings. This low barrier to entry makes them appealing to first-time investors.

Some of the biggest players in the ETF world are BlackRock, Vanguard and Invesco.

What is a Bitcoin spot price ETF?

While traditional ETFs are usually made up of a basket of stocks or other assets, a Bitcoin spot ETF is based directly on the crypto asset.

Buying shares in a Bitcoin spot ETF means you are by all intents and purposes buying the underlying cryptocurrency without the hassle of wallets, dedicated crypto exchanges and secure storage solutions.

The fund itself takes care of the buying and storing of the Bitcoin securely on your behalf.

The price of the ETF mimics the underlying price of Bitcoin, which is the largest digital currency by market cap at the time of writing ($1.2trillion).

What is a Bitcoin futures ETF?

A Bitcoin futures ETF is a form of derivatives trading which allows investors to gain indirect exposure to Bitcoin.

Instead of buying BTC itself, the ETF consists of bitcoin futures contracts where traders have agreed to buy or sell an asset, in this case Bitcoin, at an agreed price at some point in the future.

The fund itself technically doesn’t own any Bitcoin but rather invests in the contracts to trade the crypto as described above.

You, the investor, can still buy and sell shares in the futures ETF in the same way as other ETFs.

What are the pros and cons of a Bitcoin ETF?

Although cryptocurrency ownership has soared in recent years, the majority of people do not own any.

They are myriad reasons for this, including being wary of investing due to wild price fluctuations, cryptos association with crime and money laundering, believing it’s a fad and that Bitcoin is ‘magic money’, or being technically unable to plug into the market.

ETFs make owning crypto as simple as buying shares in a company you like which itself has never been easier.

You no longer need to employ the expensive services of a stockbroker to buy stocks and shares – platforms like eToro, Trading 212 and many others have brought the markets to the masses.

Bitcoin ETFs apply the same principle – they allow easy access to what is still considered by the less tech-savvy as an esoteric and unattainable asset.

The pros and cons of a Bitcoin ETF

Pros

  • Easy of access. You can gain exposure to Bitcoin through your regular trading platform.
  • Security. You don’t have to worry about storing your Bitcoin or it being stolen by hackers – the ETF management company takes care of this.
  • Liquidity. ETFs can be traded throughout the day in a similar way to stocks and shares.
  • Technical know-how. You don’t need to understand Bitcoin wallets, private keys, or any of the technical side of cryto to add the asset class to your portfolio.
  • Market stability. ETFs and the increased regulation they bring is likely to impart greater stability to the crypto market. People may feel more comfortable in investing if this happens.

Cons

  • Cost. It’s cheaper to buy Bitcoin directly from exchanges such as Coinbase. Fees are levied on transactions but there are no annual management charges. ETF fees can add up in the long term, and futures ETFs are even more expensive.
  • Purism. The ethos of Bitcoin was always as a Libertarian alternative to state regulated financial institutions. ETFs, which are regulated financial products often involving vast sums of cash from institutional investors, conflict with the original idea behind crypto.
  • Stability. For traders, the volatility in the crypto market has been its main appeal. Removing this could see them move their money elsewhere as they chase profits.

Related link: Top 5 exchanges to buy, trade and invest in Bitcoin

Should I invest in a Bitcoin ETF?

Firstly, here’s the standard warning – cryptocurrency is a highly volatile asset class and you could end up losing most, if not all of your original investment. Cryptocurrency is still largely unregulated and none of your investments are protected by schemes such as the Financial Services Compensation Scheme in the UK. None of the information contained in this article constitutes financial advice.

Now that’s out the way… if you’re looking to buy Bitcoin and are considering an ETF, there’s really only one question you need to ask yourself: “Am I technically savvy enough to buy Bitcoin directly and store it myself, or do I want someone to take care of all this for me for an additional fee?”.

In other words, how you choose to enter the crypto market is really down to your own technical ability as it’s cheaper to buy coins directly then go through an ETF provider.

Exchanges such as Coinbase make buying cryptocurrency yourself extremely straight forward. However, there are still some risks attached with keeping your crypto on platforms such as this, however small.

Coinbase recently launched a Bitcoin guarantee scheme which protects your holding up to £150,000 in the event that it’s stolen by a hacker.

Related link: Coinbase review

You can even buy and store Bitcoin through a PayPal account, although at present there are some limitations to the services.

This should give most investors peace of mind, but some still choose to store their coins on a hardware wallet, such as a Trezor, or by using some other offline method, as an added level of security.

If you’re happy buying your own crypto directly from an exchange you’ll save money by doing so, but if you want the comfort of knowing a large institution is looking after everything for you then this is probably the best solution.

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Disclaimer: This article is for informational purposes only and does not constitute financial or investment advice.

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