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Bitcoin and crypto ETFs explained
An introduction to Bitcoin and crypto exchange-traded funds, and how they impact crypto markets
With Bitcoin gaining massive institutional interest and countries adopting it as legal tender, the demand for regulated financial products for cryptocurrencies is growing. For instance, the bullish sentiment caused by the first Bitcoin futures-backed ETF in the United States — with over $1 billion traded on its first two days — is indicative of the growing market for crypto exchange-traded funds.
An exchange-traded fund, or ETF, is a regulated financial instrument that tracks the price of an underlying asset, a basket of assets or an index. For example, the S&P 500 ETF follows the performance of the corresponding equity index, which tracks the top 500 U.S. stocks. Similarly, a gold ETF tracks the value of its gold reserves and issues shares against it. The shareholders have fractional ownership of the fund’s portfolio.
With at least 10 additional crypto ETF applications currently tabled with the U.S. Securities and Exchange Commission, the crypto market could potentially tap into the global ETF industry — currently worth $9.46 trillion. Moreover, given how easy these funds are to invest in, the approval of these assets could bring additional institutional and retail investors to the crypto market.
In this article, we’ll understand how Bitcoin and crypto ETFs work, the advantages and disadvantages associated with them and how they could impact crypto markets.
What is a Bitcoin ETF and how does it work?
First, let’s understand how a Bitcoin exchange-traded fund works.
There are two types of Bitcoin ETFs — physically-backed and futures-backed. Although the underlying asset — in this case, BTC — might be the same, these two instruments are functionally quite different.
Physically-backed Bitcoin ETF
A physically-backed Bitcoin ETF — or any other crypto ETF — follows the concept of a traditional ETF, such that companies purchase BTC and hold it in their reserves. The company then creates a fund, lists it on a stock exchange and issues shares against it. When you buy a share of the Bitcoin ETF, you get a stake in the BTC held in the company’s reserves.
Futures-backed Bitcoin ETF
On the other hand, futures-backed ETFs are derivative instruments that react to future price movements in their underlying assets. Thus, a futures-backed Bitcoin ETF is not required to hold BTC. It trades on contracts that speculate on the price of BTC in the future, rather than the current spot price of BTC.
These contracts have a finite lifespan, and the fund manager has to sell existing contracts and re-buy the contracts at a later date. Due to this structure, there usually are discrepancies between the actual price of BTC and the price of a futures-backed Bitcoin ETF.
Other crypto instruments
Apart from Bitcoin ETFs, other cryptocurrencies have also garnered institutional attention. For example, VanEck, an asset management firm, has already listed TRON, Solana and Polkadot exchange-traded notes in Germany and other parts of Europe. Additionally, some smaller institutions, such as 21Shares, have gained market share with more than $200 million in assets under management for its Solana exchange-traded product, ASOL.
Crypto ETFs vs. spot crypto investing
Advantages of crypto ETFs for investors
Ease of use
Investing in cryptocurrencies comes with a learning curve — such as setting up different wallets, storing your coins or tokens safely, and transacting with them. Exchange-traded funds help bridge that gap by allowing investors to trade through your registered brokerage accounts directly. This convenience and flexibility make crypto ETFs an attractive choice for new investors.
Exchange-traded funds are tax-efficient. Such tax benefits encourage investment, especially from tax-free advantaged retirement accounts or tax-deferred ones.
An exchange-traded fund provides a safer alternative to directly investing in cryptocurrency markets for more conservative or institutional investors. Having a centralized and regulated product allows investors to diversify their portfolios without additional risk — and contributes to positive market sentiment.
Disadvantages of crypto ETFs for investors
No physical assets
Although you can benefit from a cryptocurrency’s price action through exchange-traded funds, you do not actually hold said coins or tokens. Therefore, you cannot participate in any benefits that their native blockchains offer — such as decentralized finance or staking for passive yield. You also cannot exchange or swap your cryptocurrencies for other coins or tokens.
Fees and international taxes
The ease of use that comes with exchange-traded funds is due to intermediaries handling crypto for you, but which usually carries hefty fees. Additionally, specialized crypto ETF fees are typically much higher than normal ones.
Thus, companies that issue crypto ETFs charge a management fee of 0.4% to 1.5% annually. If you’re investing internationally, you have to be compliant with international taxation laws. In contrast, storing BTC in a private hot wallet or on the crypto exchanges does not incur such fees.
Limited investment options
As crypto exchange-traded funds are still in the nascent phases of adoption — and, in some cases, still struggling to get approved — the cryptocurrencies you can invest in through these ETFs are limited. Currently, the ETF scope is majorly restricted to the top cryptocurrencies, such as BTC, ETH, SOL, etc., depending on the jurisdiction. However, as other crypto markets gain maturity, we might see more potential coin candidates for ETFs in the United States.
Active trading hours
While the cryptocurrency market is open 24 hours, the stock market does not have the same luxury. Thus, the price of BTC may change dramatically when the stock market is closed, and ETF investors will not be able to sell or buy funds during that time.
U.S. crypto ETF history and regulations
Crypto exchange-traded funds and the U.S. SEC have had a long history. Since 2013, there have been numerous ETF applications by high-profile applicants, such as Bitwise and VanEck. Despite the growing cryptocurrency market, the SEC rejected all of them on the grounds of investor protection — stating that the BTC market was prone to market manipulation.
With Bitcoin ETFs getting approved worldwide and establishing the market for such products, the SEC finally approved two Bitcoin futures-backed ETFs in October 2020. Even though the demand is higher for a spot ETF, the approval of futures ETFs provides another choice for investors — while companies like Bitwise Invest continue to present their case for a spot EFT option.
Current futures ETFs
ProShares Bitcoin futures ETF
The highly anticipated ProShares Bitcoin Strategy ETF became the first Bitcoin-linked futures exchange-traded fund traded on the New York Stock Exchange on Oct. 18, 2021. Its parent company, ProShares, a Maryland-based ETF provider, had over $53 billion in assets under management in 2020. The expense ratio for ProShares is 0.95%.
Valkyrie Bitcoin futures ETF
Valkyrie’s Bitcoin futures ETF, or BTF, launched on Oct. 22, 2021, on the Nasdaq Index. Primarily managed by Valkyrie, a Nashville-based investment firm that specializes in digital assets, BTF invests in Bitcoin futures contracts. The expense ratio for BTF is 0.95% — the same as the ProShares ETF.
VanEck Bitcoin futures ETF
VanEck has been persistent in its efforts to secure a Bitcoin exchange-traded fund, with applications ranging back to 2018. Finally, those efforts have paid off with the wealth manager joining ProShares and Valkyrie on Nov. 16, 2021, with its Bitcoin Futures ETF launch. XBTF leverages cash-settled Bitcoin futures contracts. The expense ratio for VanEck is 0.65% — significantly less than ProShares.
Cathie Wood of wealth management firm Ark Investment also recently submitted its Bitcoin Futures ETF application in conjunction with 21Shares.
Potential candidates for spot ETFs
Following successful applications from futures-backed Bitcoin exchange-traded funds, companies have also started their filing efforts for a spot ETF. For example, Grayscale, the largest Bitcoin fund, filed an application last week to convert its current Bitcoin Trust to an ETF. Valkyrie, VanEck and Bitwise Invest are some of the other notable candidates for Bitcoin spot ETFs.
However, the chances of a spot Bitcoin ETF approval seem slim this year, given SEC Chair Gary Genser’s stated preference for futures and CME-regulated crypto products.
Crypto ETFs in other countries
Purpose Bitcoin ETF
Known widely as the first physically-backed Bitcoin exchange-traded fund, the Purpose ETF is managed by Canadian asset manager Purpose Instruments and is listed on the Toronto Stock Exchange. This ETF uses institutional-grade liquidity providers, such as Genesis, to ensure secure transactions. The Gemini Trust company secures the funds.
Purpose ETF has close to $1.4 billion in assets under management as of Nov. 22, 2021, and holds over 22,000 BTC. The asset management fee for the Purpose Bitcoin ETF is 1%.
Hashdex Nasdaq Crypto Index ETF
Hashdex Nasdaq Crypto Index ETF was the first-ever crypto exchange-traded fund and was listed in February 2021 on the Bermuda stock exchange by the Brazilian-based asset management company Hashdex. Hashdex’s portfolio is distributed across a portfolio of coins, including BTC, ETH, LINK, UNI and others. This ETF uses the Nasdaq Crypto Index as a benchmark for its portfolio, and its asset management fee is 1%.
Apart from these two exchange-traded funds, there are multiple other ETFs worldwide — such as the 21Shares Bitcoin ETP in Switzerland and Germany, QR Capital Bitcoin ETF in Brazil, 3iQ CoinShares in Canada and others.
How to invest in cryptocurrency ETFs?
Cryptocurrency exchange-traded funds can be bought, sold and exchanged like regular stocks through your brokerage account. If you’re investing in an international ETF, you’ll need to have an equivalent account in that country.
What do crypto ETFs mean for the market?
While some investors speculated that a crypto futures-backed exchange-traded fund could bring about a buy-the-rumor-sell-the-news situation, the current bullish market conditions seem to suggest otherwise. However, it is still too soon to tell.
If a Bitcoin spot ETF is approved, fund managers and institutional investments would need to buy actual cryptocurrency for their reserves in a spot ETF. This demand would typically result in positive price action. We saw this happen with GTBC as it became a significant contributor to the BTC bull market in 2020 due to increased institutional demand.
While there are some concerns with ETF approvals, such as futures contract manipulations or institutional holders influencing Bitcoin forks, the launch of the three Bitcoin ETFs marks a milestone for crypto investments and brings additional mainstream legitimacy to the foremost distributed public ledger.
If you’re thinking of investing in a Bitcoin ETF, it is important to understand the risks associated with the crypto market still apply — and might even be higher in the futures market. Therefore, whether you’re directly buying BTC through OKEx or an ETF, you need to have a long-term trading strategy with exit plans based on those risks. If you’re a beginner, you can use the OKEx demo trading platform to practice and develop your strategies before implementing them in the real market.
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