Beginner’s Guide to Bitcoin ETFs

Bitcoin is the most prominent crypto in the world without a doubt. The whole crypto market focuses on Bitcoin to trace its whereabouts and growth. As many investors enter the ecosystem, market expansion is a sure-shot thing. As other virtual assets are spreading their domains and adding more use cases to their work, Bitcoin also developed its ETF segment.

Bitcoin ETFs (exchange-traded funds) are pools of bitcoin-related assets provided by brokerages on standard exchanges for trading as ETFs. The goal of these ETFs is to provide retail investors and investors who are hesitant to participate in cryptocurrencies with access to them without really owning them.

Let’s understand what is Bitcoin ETF and how it works.

What are Bitcoin ETFs?

A Bitcoin ETF is an exchange-traded fund that invests in bitcoin or assets connected to the price of bitcoin. Instead of a crypto exchange, they are exchanged on a regular exchange. In essence, the corporation buys bitcoin, securitizes it, and then sells or trades it on an exchange. 

At the moment, Bitcoin ETFs' underlying assets are tied to Bitcoin futures contracts traded on the Chicago Mercantile Exchange.

Despite its connection to Bitcoin, exchange-traded funds are not a new technology. ETFs have been available in the financial markets as an investment vehicle for more than two decades, pooling around USD 1 trillion in managed assets and being established in hundreds each year.

A Bitcoin ETF (exchange-traded fund) is something like the ProShares Bitcoin Strategy ETF, which trades on the NYSEArca. It is important to note, however, that the Securities and Exchange Commission (SEC) of the United States has already rejected various proposals for Bitcoin ETFs, claiming the crypto market's absence of regulation as the primary reason for their objection.

Developing Years of Bitcoin ETF

The first Bitcoin ETF (exchange-traded fund) in the United States, "BITO," began trading on October 19, 2021. The fund started as one of the most highly traded ETFs in market history, garnering more than $1 billion in assets in its first few days of trading. Following that, the ETF amassed a sizable chunk of all short-term bitcoin futures contracts, accounting for around one-third of the underlying futures market just 10 days after its debut.

As of now, the Securities and Exchange Commission (SEC) has delayed or denied applications to form an ETF that invests directly in bitcoin, mostly owing to concerns that the commodity is mostly traded on unregulated exchanges. The first SEC-approved bitcoin ETF is the BITO, which is based on futures contracts traded on the regulated Chicago Mercantile Exchange (CME).

The ProShares Bitcoin Strategy ETF (BITO) is the first Bitcoin ETF that has been licensed for trading on US exchanges. BITO became one of the most actively traded ETFs in market history upon its introduction in October 2021, garnering about $1 billion in assets in a matter of days.

BITO is an actively managed fund that invests in Bitcoin futures contracts to monitor the price of Bitcoin as closely as possible. It may also have Treasury securities and cash on hand.

How Does Bitcoin ETF Work?

If you invest in Bitcoin ETFs, you commit to buying or selling BTC at a certain price on a particular timeline, regardless of market conditions. The contract settlement date, also known as the expiration date, is the agreed-upon deadline by which both parties must fulfil their commitments. A futures contract is a standardized contract in which two parties agree to exchange a certain amount of assets.

The party agreeing to acquire BTC at the expiration of a Bitcoin futures contract must do so at a discount or premium. When the futures price is trading higher than the spot price, the market is said to be "premium."

However, when the spot price is more than the futures price, there is a "discount" that follows. In the commodities derivative market, the phrase is backwardation, but in the stock derivative market, the term is discount. When the futures price converges with the present price, the situation is considered normal.

The amount due is determined by the spot price and the value of futures contracts purchased by the buyer. Furthermore, if the spread between the ETF and the underlying asset grows too wide, investors may arbitrage away the spread; the price of an ETF will normally retain a high correlation with the price movement of the underlying asset.

The fund issues share values based on the current value of one contract unit and trade them on an exchange. The Proshares Bitcoin Strategy ETF (BITO) was the first official Bitcoin-linked ETF, authorized by the SEC in October 2021 and listed on the New York Stock Exchange.

Related: How to mine Bitcoin

What Solution Does Bitcoin ETF Provide?

Bitcoin ETFs, in their present form—and the one requested by many investors—are intended to allow more individuals to participate in Bitcoin without incurring the requisite fees and inconveniences of purchasing them. They reduce the need for extra security and cash while giving a familiar investment form.

Security

To store bitcoin, a cryptocurrency wallet is required, but not everyone has one. As an example, one may have security keys that must be protected. When you purchase your cryptocurrency through an exchange, you can have your keys kept on that exchange if it provides that option.

However, wallets and exchanges may be hacked and keys taken, resulting in the theft of your bitcoin. There are various techniques for storing your keys offline, but none of them is 100% safe or guaranteed. An ETF does not require you to hold any cryptocurrencies, keep keys safely, or shift keys between different forms of storage—you purchase shares of the fund, which assumes the risks of storing keys on your behalf.

ETFs are Easy to Understand

Often most significantly, ETFs are far more well-known in the investing community than cryptocurrency. Even as digital money and tokens gain popularity, they get more sophisticated. If a person is simply interested in investing in digital currencies, an ETF focuses on trading an asset that is already understood rather than learning about blockchain, mining, decentralized exchanges, distributed ledgers, key storage, and cryptocurrencies.

Price Fluctuations

Price is one of the major barriers for typical investors. Bitcoin (BTC) reached a new high of around $69,000 per BTC shortly after the Proshares Bitcoin ETF debuted on the NYSE. Its price began to fall over the next few months, eventually reaching close to $35,000. As a result, even at low prices, individual investors may not be able to acquire 1 BTC. An ETF allows you to obtain exposure to Bitcoin while staying within your budget, risk tolerance, and investment objectives.

What Are Bitcoin Futures ETF

Bitcoin futures ETFs are financial instruments that follow the price of Bitcoin futures contracts. These ETFs invest in Bitcoin futures contracts rather than genuine Bitcoin, allowing investors to obtain exposure to Bitcoin without owning it directly.

Bitcoin futures ETFs generally operate by investing in a basket of Bitcoin futures contracts, which are contracts to purchase or sell Bitcoin at a specified price and time in the future. These contracts enable investors to speculate on the price of Bitcoin without really owning it, which might be beneficial for people who wish to avoid the hazards involved with directly possessing Bitcoin, such as theft or hacking.

Bitcoin future ETFs, like other forms of ETFs, may be purchased and traded on stock exchanges and their prices are decided by market demand. They also have the potential to give diversification benefits to investors as well as the option to invest in Bitcoin in a more regulated and transparent manner. It is crucial to note, however, that Bitcoin future ETFs are still a relatively new financial product, and there may be dangers and limits that investors should be aware of.

Advantages of Bitcoin ETFs

Bitcoin ETF advocates value the fact that they would provide investors with exposure to the complex and volatile cryptocurrency market without requiring them to possess actual bitcoin. Here are a few advantages of Bitcoin ETFs.

Secured Storage

Holding coins on an exchange is one way to directly own Bitcoin. Some cryptocurrency exchanges may be reliable, while others have a shady history of being hacked, stolen from, or deceived. Even reputable exchanges expose investors to danger.

Securely storing cryptocurrencies, such as the private keys to a Bitcoin wallet, is typically accomplished by using either a paper wallet with the keys written in the form of a QR code and a long string of random characters or an external piece of hardware known as a hardware wallet, such as a Ledger wallet.

Social media and cryptocurrency forums are filled with terrible stories about users who sent funds to the wrong location, misplaced their backup pass, forgot their PIN password, or encountered other tragic circumstances that caused investors great harm.

Convenient

Aside from understanding how to use a computer, create a brokerage account, and submit a purchase order, purchasing a Bitcoin ETF needs no technical knowledge.

ETFs appear to be a simple method to profit from growing asset prices without actually owning those assets. Holding genuine Bitcoin, on the other hand, necessitates a relatively high degree of technological competence.

Bitcoin might be perplexing for less tech-savvy people. The process frequently entails opening an account on a cryptocurrency exchange, the majority of which are mostly unregulated. Purchasing an ETF eliminates the need for this step.

Minimum Third-Party Risk

Counterparty risk emerges when a third party holds something for the benefit of another. In some cases, the third party's interests may conflict with the interests of the investor's assets.

Some service providers have sprouted up throughout the years, promising to safely store money for consumers. This may or may not be a desired or hopeful approach, but even if it were appropriate in every circumstance, there would be a danger.

At best, an unforeseeable incident such as bankruptcy or a market disruption might lead a company to withhold client cash for some time, rendering them inaccessible when consumers need those assets the most.

Disadvantages of Bitcoin ETFs

A Bitcoin ETF's risks stem from both the regular financial sector and the realm of cryptocurrency exchanges. Many investigators take into account a few factors.

Extreme Volatility

The volatility stems from the periodic dramatic changes in the price of Bitcoin relative to most other currencies. A Bitcoin ETF, which is designed to imitate Bitcoin's market activity, should see comparable price fluctuations. This might frighten investors with limited risk tolerance, causing them to panic sell.

Fund Charges

One of the concerns associated with holding any type of ETF is its expense ratio. This figure denotes the amount of money that a fund's management charges in exchange for allowing investors to invest in their fund.

If a fund had a 2% cost ratio, for example, the fund manager would deduct $2 from a $100 investment each year. This value is often determined after profits have been deducted, reducing investors' gains. In other words, holding Bitcoin ETFs may be costly for investors.

Scam

Regulators are wary of allowing a spot market Bitcoin ETF due to concerns about fraud and market manipulation. A Bitcoin ETF would provide investors with exposure to the digital coin while without really holding the asset, exposing them to the risk of fraud.

How to Invest in Bitcoin ETFs

To invest in Bitcoin ETFs such as Proshares Bitcoin Strategy ETF (BITO), Valkyrie Bitcoin Strategy ETF (BTF), VanEck Bitcoin Strategy ETF (XBTF), and Global X Blockchain & Bitcoin Strategy ETF (BITS), you can follow the steps below:

• Open a brokerage account: You will need a brokerage account that allows you to buy and sell ETFs. Some popular options include Robinhood, TD Ameritrade, Fidelity, and E-Trade.

• Fund your account: You will need to deposit funds into your brokerage account to invest in Bitcoin ETFs. This can be done through a bank transfer or by linking a credit or debit card.

• Search for the desired ETF: Once you have funded your account, search for the desired ETF by its ticker symbol (BITO, BTF, XBTF, BITS) on your brokerage platform.

• Review the ETF's prospectus: Before investing in any ETF, it is important to review the ETF's prospectus. The prospectus provides information on the ETF's investment objectives, fees, risks, and other important details.

• Place your order: Once you have reviewed the prospectus and have decided to invest in the Bitcoin ETF, place your order through your brokerage platform. You can choose to buy a specific number of shares or invest a specific amount of money.

• Monitor your investment: Once you have invested in the Bitcoin ETF, monitor your investment regularly to ensure that it aligns with your investment goals and risk tolerance.

Bitcoin ETFs FAQs

Are there any Bitcoin ETFs?

Many Bitcoin ETFs hold futures contracts, which are derivative contracts that allow you to purchase or sell an asset — in this case, Bitcoin — at a future date and a predetermined price. ProShares Bitcoin Strategy ETF (BITO), for example, was the first of its type when it debuted in October 2021.

Can I buy a Bitcoin ETF?

There are a few options for purchasing a Bitcoin ETF. The only Bitcoin ETF available in the United States is the ProShares Bitcoin Strategy ETF ($BITO). Aside from that, the Bitcoin ETF BTCE is listed on the Frankfurt Stock Exchange, requiring a foreign securities account.

Are BTC ETFs safe?

They're secure: Because these ETFs are traded on standard stock exchanges, they're heavily regulated. The prices of ETFs cannot be influenced within the markets. They're practical. Even if you have no prior experience with cryptocurrency, you can easily buy, sell, and hold shares of a Bitcoin ETF.

Why is bitcoin ETFs rejected?

Concerns about market manipulation and the lack of a surveillance-sharing agreement between a "controlled market of considerable size" and a regulated exchange were cited as reasons for the SEC's denial.

What is the first US bitcoin-linked ETF?

The ProShares Bitcoin Strategy ETF (BITO) is the first bitcoin-linked ETF in the United States, offering investors a simple option to add bitcoin exposure to their portfolios.

Related:

• What is Bitcoin
• Bitcoin Price Prediction