Bitcoin ETF has been discussed in the crypto industry since 2013. A significant step forward was taken in autumn 2021 when the first Bitcoin ETF was approved in the United States. How this futures-based ETF differs from a spot ETF? What does ETF mean? This article explains all!
What is an ETF?
An ETF stands for Exchange Traded Fund. Anyone can buy ETF shares the same way as stocks or other investment products.
As ETF is a publicly listed fund, it must meet the criteria of the authorities supervising the market. In the United States, this authority is called the U.S. Securities and Exchange Commission, better known as SEC.
SEC has become familiar for cryptocurrency investors in recent years. Besides the traditional markets, SEC also oversees crypto regulation. Its decisions have also worldwide implications.
Listing a company in a stock exchange is a demanding and time-consuming process. An ETF must also meet similar conditions before it is approved for trading. This obviously applies to crypto ETFs too. SEC has constantly several Bitcoin ETF applications in process.
How do ETFs work?
Most of the ETFs are index funds. An index can follow the performance of several different stocks or other investment instruments. The world’s most famous index is the S&P 500, which follows the prices of the 500 largest companies in the United States. The famous ETF following this index has the ticker SPY.
By purchasing a share of an ETF, you can invest in an entire industry or certain stocks in a particular exchange. For example, the ETF following the OMXH25 index (Helsinki Stock Exchange) invests in the 25 largest companies of the exchange.
Below you can see the development of OMXH25 in the past ten years.
Without an ETF you would have to make dozens of stock purchases and pay fees for all of them. For a small investor, this would be an absurd task. The cost would be far too high.
Also, you would constantly have to re-balance your portfolio. The ETF will take care of all this.
ETF offers an easy and cost-effective way to invest in dozens, hundreds, or even thousands of companies. You can invest in a specific exchange, geographic area, or industry. Without ETFs, this would be impossible for an ordinary investor.
ETF is a liquid option
As described above, ETF is an excellent option for a retail investor. The popularity of ETFs has exploded in the 21st century, as thousands of different index funds have been launched on the market.
For large institutions, stock purchases are not a problem. For what would they need ETFs for? For example investing in oil, copper, gold, or uranium. Gold or silver can perhaps be stored in a safe, but many other raw materials are quite impractical.
ETFs make it possible to invest in an index that follows the price of a commodity. The ETF could own physical gold or invest in dozens of different oil companies.
ETFs are easy to trade. If you would like to sell 10% of the gold bars you own, it isn’t that simple. Instead, you can sell 10 percent of your ETF shares by pushing a single button.
It is also easy to decrease your holdings by a couple of percent in the S&P 500 index but trading 500 different stocks would be a nightmare.
ETFs have good liquidity because there are market makers supporting them. A market maker is an institution separate from the issuer. It is typically a bank or another financial company. Market makers make sure there is liquidity in the market to meet buy & sell orders.
ETFs are way faster to trade than traditional funds. A traditional fund is usually hosted by a bank, and you must be a client in order to invest in the fund. ETF shares can be bought by anyone and transactions are performed immediately with low costs.
Benefits of an ETF for the crypto investor
Every cryptocurrency investor has gone through challenges with Bitcoin wallets. Even if Ledger Nano X is considered an easy-to-use device, institutional investors are not interested in it. Institutions need custody services and insurances. Many retail investors are also afraid of lost PIN codes or mobile devices.
An offline wallet does protect against cyber attacks, but then your holdings are depending on one piece of paper with your backup codes in it. Online options have always a threat of a hack or downtime. There are always risks involved in storing crypto.
Many investors just want to benefit from the price development of cryptocurrency without worrying about storage. There are also millions of day traders speculating on the price. ETFs and futures are perfect for these investors.
You can also invest in Bitcoin with a tracker certificate. They are very similar to ETFs and follow the price of the underlying asset. There are some differences between the certificate and the ETF, but roughly speaking, it is the same type of investment.
Below is a list of Bitcoin tracker certificates from Nordnet.
The downside of ETFs & tracker certificates is trading only during the stock market opening hours, as well as fees. Investors should also find out about the potential risks related to the issuer.
When talking about institutions, Bitcoin ETF offers an important advantage over “physical” Bitcoin. For example, pension funds are bound by strict rules and regulations. Many institutions would like to buy Bitcoins but cannot acquire them because of rules. ETF products solve these problems. At the same time, institutions don’t have to worry about storage.
There are no similar restrictions for retail investors. This is why many small investors head to cryptocurrency exchanges. Also, for the time being, ETFs are mainly available for Bitcoin and Ethereum. There are up to hundreds of different coins available in exchanges.
The first Bitcoin ETF in the United States
The long wait ended in October 2021, when the first Bitcoin ETF was approved for the US market. Applications had been systematically rejected by the SEC since 2013.
The first Bitcoin ETF is officially called ProShares Bitcoin Strategy ETF and has the ticker BITO. On its first day, the fund received a historical amount of interest.
My latest: ProShares bitcoin futures ETF sees historic nearly $1 billion trading day
"It absolutely obliterated," said James Seyffart of Bloomberg Intelligence.https://t.co/XayYB03xUe
— Frank Chaparro (@fintechfrank) October 19, 2021
SEC had been under pressure for a long time to approve a Bitcoin ETF. The approval was therefore not a giant surprise for investors. Just a week later, another Bitcoin ETF was also approved: Valkyrie Bitcoin Strategy ETF with the ticker BTF.
Although this was a historic step for Bitcoin, most investors are waiting for something better. These Bitcoin ETFs are futures-based. In other words, these funds don’t buy “real” Bitcoins from the market. They track Bitcoin’s price by using Bitcoin futures.
This causes a couple of problems. First of all, such an ETF does not affect the demand for Bitcoin because it does not buy any bitcoins. Futures-based funds will also have to buy and sell futures due to their expiry dates. This will cause extra costs. Bitcoin ETFs in the United States are not great products for a long-term hold.
Investors expect SEC to follow the example of neighboring Canada and approve spot Bitcoin ETFs soon.
Market development in recent years
This article was first published in the summer of 2018. At that time the crypto market was so different.
Bitcoin futures gained great popularity in 2019 when Binance, the leading cryptocurrency exchange, added them to its offering. Bitcoin futures are available to all investors and allow leverage of up to 100x depending on the exchange. Futures are a way for cryptocurrency exchanges to provide derivatives. ETFs and tracker certificates again are products of traditional trading platforms (such as Nordnet).
In 2021, the first Bitcoin ETF was finally approved in the United States. Canada has been more active in this area. The first Bitcoin ETF products were approved in Canada as early as February. These funds also invest in real bitcoins instead of futures.
— MAGS 🔑 ⛏ 🚒 (@Crypto_Mags) February 11, 2021
Three Ethereum ETF products were also approved in Canada in April. The United States, the world’s economic power, is therefore lagging behind. Bitcoin funds and tracker certificates have been around in Europe for years. The Swedish XBT Provider has been a forerunner in this respect. There are also a lot of different options listed on the German stock exchange.
Grayscale has become a popular choice among institutions. It offers funds not only for Bitcoin but also for well-known altcoins. The Grayscale fund is an ETF-like investment, but it is structured a bit differently. Grayscale’s product has given institutions access to cryptocurrencies. The company aims to converse the fund into a real ETF.
This article is an overview of Bitcoin ETF and other similar investments. Although such funds are not intended for typical retail investors, they have an important role in the industry. Regulated and listed products bring legitimacy to cryptocurrencies. They also allow big money to enter the market.
ETFs and tracker certificates can also be useful for retail investors. For example, if you’re already Nordnet’s customer and your entire portfolio is there, it’s easy to invest in Bitcoin through Nordnet as well. You don’t need new accounts, you don’t need to diversify your portfolio, there are no worries about storing, and so on. However, be sure to read the descriptions of the products carefully and familiarize yourself with the fees.
It’s also worth remembering the third way to invest in cryptocurrencies: direct stock purchases. There are several mining companies on the stock exchange, as well as companies like Microstrategy, which market value mostly consists of its Bitcoin holdings.
The stock price of the cryptocurrency exchange Coinbase also reflects the development of the crypto market. You can find information about the Bitcoin holdings of different companies bitcointreasuries.net.
Even a small investor has a lot of different options when investing in the crypto sector. Everyone can choose products that suit their own technical knowledge and risk profile.