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What is a Spot Bitcoin ETF: How Does It Work

Articles
21.05.2024
7min.
471
spot bitcoin

Right now, the US Securities and Exchange Commission is reviewing a BlackRock application and a number of other US companies to create a spot Bitcoin ETF. Perhaps by the time you read this article, the decision will have already been made. For now, this is a hot topic and a good reason to talk about crypto ETFs in general. In this article, we will analyze how they are arranged, why they are needed, and how they affect the cryptocurrency and stock market.

What is a spot Bitcoin ETF

ETF stands for Exchange-Traded Fund. It aggregates various assets: stocks, bonds, commodities, etc., and enables investors to buy a "bunch" of these assets with one click. This is a convenient way to diversify your portfolio without having to buy each asset separately.

How do ETFs work? Investors buy and sell shares of ETFs on an exchange like ordinary stocks. Asset management is the responsibility of the management company, which monitors the compliance of the fund composition with a certain index or strategy. For example, an ETF on the S&P500 index will contain shares of all 500 companies included in that index.

In the 2010s, financial companies began to attempt to create Bitcoin ETFs — ETFs backed by Bitcoin. This would make it possible to bring digital assets to the stock market. Some even succeeded, but more on that later.

What is a Bitcoin ETF for?

What's the point of creating an ETF if Bitcoin can be easily bought anyway? Quite a reasonable question. Yes, indeed, any trader can go to WhiteBIT or WhiteSwap and buy some Bitcoins, or hundreds of altcoins. But when it comes to billions of dollars, Wall Street investors prefer to trade in the stock market. And Bitcoins are not sold there. spot-bitcoin.png

A Bitcoin ETF is essentially a pass-through of cryptocurrencies into the stock market. It cannot get there in the form of cryptocurrency. In the form of an action, too. But the ETF is just a tool that can build a bridge between cryptocurrency and the stock market.

The ten-year struggle

The first application to create a spot Bitcoin ETF in the US was submitted by the famous Winklevoss twins in July 2013. More than ten years have passed since then. The SEC has not approved either the twins application or any of the subsequent applications for spot Bitcoin ETFs.

The reason for rejecting applications is banal: high risks and excessive volatility. The Securities and Exchange Commission fears that the entry of cryptocurrencies into the stock market will create additional risks for investors. "Trade crypto among yourselves, and don't go to Wall Street." — they say.

There is also good news. Bitcoin futures ETFs already exist. The SEC first approved it for Teucrium in April 2022. Futures ETFs contain futures contracts for Bitcoin, not the cryptocurrency itself. Probably, that is why the American regulator was more favorable to futures.

But there are already spot Bitcoin ETFs in Europe. The first European spot Bitcoin ETF was launched in July 2022 on the Dutch exchange Euronext Amsterdam under the ticker BCOIN. The pioneer was the British financial company Jacobi Asset Management.

Also, spot Bitcoin ETFs are registered in:

  • Canada: Purpose Bitcoin ETF (BTCC) — by the way, the first Bitcoin ETF in the world.
  • Brazil: QR CME CF Bitcoin Reference Rate Fundo (QBTC11).
  • Switzerland: WisdomTree Bitcoin ETP (BTCW).
  • Australia: Monochrome Bitcoin ETF (IBTC).
  • And in a number of other countries. But not in the US.

However, right now, in September 2023, the SEC is actively reviewing applications for a spot Bitcoin ETF from BlackRock and ARK 21Shares. The decision is planned to be made in 2024. If the application is approved, a spot cryptocurrency Exchange-Traded Fund will finally appear in the US — for the first time in 10 years of struggle.

How spot Bitcoin ETFs work

A spot Bitcoin ETF is backed by real Bitcoins that determine the value of the ETF. If the value of BTC increases, so does the value of the ETF. The ideal situation is a direct correlation between these two assets.

At the same time, the price does not necessarily have to be equal. For example, a Bitcoin may be worth $20,000, and its exchange-traded fund is worth $20. But when Bitcoin grows to $22,000, its exchange "representative" is supposed to proportionally grow to $22.

However, in reality, using the example of European securities, we see that this is not quite the case. If we look at BCOIN or BITO and compare their dynamics with the dynamics of Bitcoin itself, we will not see a direct correlation. BTC-and-BITO.png

BTC and BITO rate comparison (data by Coinmarketcap and MarketWatch)

The most likely reason is that investors are limited to trading ETFs during traditional market hours for regulated securities exchanges, unlike the 24/7 cryptocurrency markets.

Impact of a spot Bitcoin ETF on the market

A spot Bitcoin ETF is an exchange-traded fund directly investing in real Bitcoin. And given the specifics of such funds, the entry of a cryptocurrency ETF into the stock market essentially means the possibility of buying BTC on the exchange. Spot Bitcoin ETFs already exist in several countries, so we can objectively assess the pros and cons of such funds.

Pros

  • Availability for investors. ETFs allow investors to invest in Bitcoin without directly buying and holding the cryptocurrency. This makes investing in Bitcoin more accessible to those who don't want to learn the blockchain.
  • Legal protection. Institutional investors in developed countries are better protected by law than those who simply buy crypto on a crypto exchange or P2P.
  • Liquidity. Large investors invest in ETFs. This is a plus for both investors and Bitcoin.

Cons

  • Limitations of traditional exchanges. After hours, weekends and holidays, crypto ETFs lag behind the crypto market.
  • Centralization. One of the main principles of cryptocurrencies is decentralization. A layer in the form of a financial company nullifies this principle.
  • Lack of real ownership of cryptocurrency. Those who buy ETFs don’t actually own cryptocurrency. They only own securities.
  • Technological risks. You have to pay for legal protection with technological vulnerability. Centralized exchanges are not as reliable as the blockchain.
  • Capture of the market by whales. By opening the way for big investors to cryptocurrencies, we give them even more power over the market.

Alternative

Exchange-Traded Fund is a crutch of the financial market. Its sole purpose is to bring cryptocurrency to the stock market under the conditions of strict regulation and strict regulations of the latter. Compare-BTC.png

An alternative could be the liberalization of the stock market. If real BTC could be bought on the New York Stock Exchange, there would be no need for BITO and GBTC. And it can be the case. The level of adoption of cryptocurrencies is gradually increasing, and the line between crypto and traditional finance is gradually blurring.

Conclusion

Bitcoin ETF is a link between the cryptocurrency and the stock market. For ten years, financial regulators consistently rejected applications to create such funds. And now cryptocurrency ETFs have started working on all major markets, except for the American one.

Now, traditional investors can invest in Bitcoin directly on the exchange. This creates new opportunities for the cryptocurrency market but also brings its own problems, such as increasing the influence of whales. Also, cryptocurrency ETFs have some disadvantages compared to cryptocurrency exchanges: centralization, technological risks, and delays.

FAQ

What Bitcoin ETFs Are There?

The most popular funds include:

  • Grayscale Bitcoin Trust (GBTC)
  • ProShares Bitcoin Strategy ETF (BITM)
  • ProShares Short Bitcoin ETF (BITI)
  • VanEck Bitcoin Strategy ETF (XBTF)

There are also other options.

Where to buy Bitcoin ETF?

Cryptocurrency ETFs are traded like stocks. For example, on the New York Stock Exchange and Nasdaq.

BTC or Bitcoin ETF: Which is better?

Holding real Bitcoins is safer and more reliable than the securities tied to it. It is comparable to cash. Blockchain code is like cash. It is only yours, and you yourself are the owner of your money. And ETFs are like money on a card. They are also allegedly yours, but in fact the bank disposes of them, and there is always a risk of losing access to your funds.

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