BTC exchange-trade funds explained

• Updated

Regulators are slowly warming up to the idea of Bitcoin ETFs. How do ETFs work and what advantages can they offer investors?

Ask a crypto expert to name one thing they would like to see in the industry, and they’ll probably say a Bitcoin exchange-traded fund (ETF). Despite the cryptocurrency being around for more than a decade, ETFs for bitcoin (BTC) remains an idea that regulators are only coming around to. This, in part, is because of how this asset is incredibly volatile, sparking fears that novice investors could unknowngly end up putting their funds at high risk.

A substantial number of applications for Bitcoin ETFs have been rejected by the US Securities and Exchange Commission in recent years. ProShares was the first to launch a US Bitcoin-linked ETF in October 2021. Now, pressure is growing on the SEC to open the door wide and give BTC ETFs the green light. Here, we’ll look at how they work.

What is a Bitcoin ETF?

An ETF is an exchange-traded fund. They’re incredibly common for things like stocks, commodities and fiat currencies. As an example, someone who invests in an airlines ETF would be able to take advantage of appreciating share prices without physically owning the stock themselves.

So… how does a BTC ETF work in theory? Well, a regulated bank, crypto exchange or asset management company would collect funds from investors and from here, they would buy bitcoin on their behalf (or, in some cases, BTC futures). In return, a buyer would receive shares in the bitcoin ETF, with prices going up or down based on the cryptocurrency’s value.

At this point, you may be wondering what the point of a bitcoin ETF is. Why don’t people just use their money to buy BTC for themselves? Doesn’t this just involve unnecessarily bringing middlemen into the investment?

But here’s the thing: many prospective investors have little interest in physically owning bitcoin. Some are worried about storing their coins securely and have little patience for the technical hurdles related to creating a wallet. If done correctly, ETFs with bitcoin deal with all of these issues on the investor’s behalf – and, better still, the cryptocurrency is often insured against the risk of theft.

There is excitement surrounding the concept of a BTC ETF because of how it could make this cryptocurrency more credible in the eyes of old-fashioned financial institutions, as well as investors who may have only previously dabbled in stocks and bonds. Digital assets have often struggled to enjoy mainstream adoption because they’ve gained a reputation of being difficult to understand or unsafe – and the familiarity of an ETF would make a big difference.

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What does a BTC ETF mean for cryptocurrency sceptics? Well, it could enable them to have a profitable moment, too. Exchange-traded funds mean that someone who believes BTC’s value is going to fall can short sell.

The downsides of a Bitcoin ETF

  • First off, it’s worth remembering that BTC’s maximum supply has been capped at 21 million. As a result of this, locking substantial amounts away could cause instability in its price;
  • In addition, the businesses that hope to provide a BTC ETF will need to prove that they are trustworthy – and right now, regulators such as the SEC are cautious because the risk of fraud and manipulation in this burgeoning sector can’t be ruled out.

However, there are reasons to be optimistic. Several senior figures within the SEC have been part of growing calls for these exchange-traded funds to be accepted. In summer 2020, commissioner Jay Clayton – a well-documented crypto sceptic – announced he was leaving the role. Even he couldn’t resist joining the crypto parade, joining Israel-headquartered digital asset custodian Fireblocks.

What next?

Bitcoin ETFs coming to the market were seen as somewhat inevitable. The case in favour of such exchange-traded funds has grown ever since BTC futures burst onto the scene, as these financial instruments could be included. Those who are itching for exposure in this market might want to start looking at ETFs that track blockchain companies, and others that are involved in this emerging technology.

Alternatively, those who have an interest in bitcoin might have to suck it up and buy some until more exchange-traded funds come along. Although this doesn’t offer all of the advantages associated with an ETF, many crypto-focused platforms have been vying to make it much easier for everyday consumers to purchase BTC for the first time.

Indeed, some of the world’s best-known investors have already announced that they are devoting a small amount of their overall portfolio to BTC. One of them is Paul Tudor Jones, who recently declared that he believes bitcoin is going to be “the fastest horse in the race” over the next 10 years. His rationale was simple: by investing a maximum of 2% in bitcoin, he has enough exposure to enjoy significant benefits if BTC prices go through the roof, but not enough of an interest that it would be a financial disaster if prices tank.

No one knows what the future holds. But pretty soon, a guide that looks at how to trade a bitcoin ETF will become the norm.

Further reading:

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