Bitcoin ETF: How does it work?

An exchange-traded fund (ETF) is a financial product that is designed to track the price or performance of a specific asset or commodity, in this case, bitcoin. ETFs are bought and sold on stock exchanges and brokerage accounts Generally, ETFs can be spot or futures. Futures ETFs have had most success in being approved by the Securities and Exchange Commission (SEC). The first bitcoin futures was approved in October 2021 by SEC and contributed to the driving of bitcoin price to about $69,000 in November 2021. These contracts do not convey ownership rights and is settled or traded for new contracts as they approach expiration.

Bitcoin ETFs can take on different forms, namely: bitcoin spot ETFs, bitcoin futures ETFs, bitcoin long ETFs, bitcoin short ETFs, bitcoin mining ETFs. The most common ones are the Bitcoin spot ETF and bitcoin Futures ETF.

Why is Spot ETF not received approval in the US?

Proposals for approval of spot etf have received rejections from SEC with the reason that they do not meet anti-fraud and investor protection standards. Grayscale investments appealed its ETF application rejection by the SEC at the U.S District Court of Columbia.

Court ruling on BTC ETF

The court's panel of judges said Grayscale showed that its proposed bitcoin ETF is "materially similar" to the approved bitcoin futures ETF by the SEC. Thus the underlying assets, bitcoin and bitcoin futures were "closely correlated," and since the surveillance sharing agreements with the Chicago Mercantile Exchange are "identical and should have the same likelihood of detecting fraudulent or manipulative conduct in the market for bitcoin." It was ruled that the SEC acted "arbitrary and capricious" to reject the filing because it "never explained why Grayscale owning bitcoins rather than bitcoin futures affects the CME’s ability to detect fraud." A spot bitcoin ETF approval is likely give investors in the US confidence in investing in bitcoin

Difference: Spot ETF vs Futures ETF

ETFs are investment contracts, with spot ETFs, they allow participants to buy and sell the product on demand as they directly track the price of bitcoin while futures ETFs follow the price of bitcoin futures contract, the futures contract track the expected price of bitcoin at a later date. The futures price is often higher than the spot price. If the price of the ETF diverges from the underlying asset's value, an arbitrage opportunity is presented and participants can take advantage of the price discrepancy.

The intent behind these ETFs is to give retail and other investors exposure to cryptocurrencies without needing to own them and they operate much like a mutual fund

The underlying assets within Bitcoin ETFs are Bitcoin futures contract and these contracts are purchased on the Chicago Mercantile Exchange. A futures contract is simply a standardized contract between two parties who agree to exchange a specified number of assets on a specified date in the futures and at a specific price.

Generally, with ETF funds, the portfolio can hold multiple underlying assets, rather than only one like a stock does. Because there are multiple assets within an ETF, they can be a popular choice for diversification. ETFs can thus contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types.

An ETF can own hundreds or thousands of stocks across various industries, or it could be isolated to one particular industry or sector.

Difference: ETFs and Mutual Funds

ETFs just like a mutual fund, but with ETFs, they can be traded frequently on an exchange unlike mutual funds, which are not traded on an exchange, and which trade only once per day after the markets close. Also, ETFs are known to be more less costly and more liquid compared to mutual funds. These contracts allows investors to take positions without holding the underlying asset.

ETFs work by selling shares to investors on the open market, the proceeds are then used to build a portfolio of assets based on a market index, a stock market sector or another asset class like crypto.

What are the Benefits of Bitcoin ETFs

Below are some of the reasons that investors purchase BTC ETF:

Well Managed portfolio: Some investors may feel safer getting exposure to Bitcoin in their portfolios by purchasing a professionally managed ETF rather others may prefer buying bitcoin via a crypto exchange which gives them ownership of BTC.

Security: Hot wallets on exchanges can be hacked and keys stored on these exchanges can be stolen. Having your private keys compromised is like giving access to your bank account to a stranger. With an ETFs, you don’t own any crypto currency, so you don’t have to worry about stolen keys. You rather own shares of the fund.
High Prices: The high price and volatility of bitcoin makes them very unattractive for average investors. Shortly after the Proshares Bitcoin ETF was listed on NYSE, the price rose to $69,000 per unit, since then, price keep dropping and rising, prices have even seen a drop to under $17,000. Even at its lowest price, retail investors may not have the resources to purchase 1 BTC. With an ETF, one can gain exposure to BTC using available resources, risk tolerance, and investing goals.
ETFs are easy to Understand: Investment professionals easily understand the workings of than cryptocurrencies. An ETF lets you focus on trading an asset you already understand rather than learning about blockchain, mining, decentralized exchanges, oracles, distributed ledgers, private and public keys etc.

How BTC Futures ETF make money

To get exposure to bitcoin, the ETF enters a long position (buy) in the near future, say a month through bitcoin futures contract. When the expiration of the contract draws near, the fund sells them and buys longer dated contracts. This process is called roll. Depending on the strategy, the fund will buy and sell different lots of BTC ETF to profit from the price differences or it may decide to hold cash equivalents such as in Treasury bills in addition.

Generally, when the bitcoin price goes up, above the long position price, a gain is realized, gains from the futures contract multiplies the fund. Conversely, when the bitcoin price goes down, the stored by liquidity in the fund is used to pay for the losses on the futures contract.

Best BTC Futures ETFs

If you're looking to invest in Bitcoin ETFs, you can purchase them through your broker or advisor if they offer them. There are several Bitcoin ETFs that trade on exchanges such as the New York Stock Exchange ARCA and Nasdaq:

Proshares Bitcoin Strategy ETF (BITO)
Valkyrie Bitcoin Strategy ETF (BTF)
VanEck Bitcoin Strategy ETF (XBTF)
Global X Blockchain & Bitcoin Strategy ETF (BITS)

Prospective buyers should consult professional advisors on the best ETF available

Should You Buy Bitcoin ETF?

Bitcoin is a volatile currency, as a result, bitcoin ETF will also have such inherent volatility, it is a risky investment and one should only buy or trade it if they understand the mechanics of the product

How to Invest in Bitcoin ETFs

Bitcoin ETFs are available through purchase from a broker, investors get access to open a brokerage account and then purchase these Bitcoin ETFs the same way they purchase other stocks.

Unlike traditional stocks, ETFs charge an annual expense ratio, which is a fee deducted from the investor’s account.

Investors should also keep in mind that cryptocurrencies such as Bitcoin are a relatively new and volatile asset class. Nobody should invest more than they can afford to lose, and it’s always a good idea to consult a financial advisor prior to any investment decision.

The Bottom Line

It is expected that that bitcoin prices might sky rocket with the approval of BTC Spot ETF, the compound effect is expected to bring in more investments into the financial system. Bitcoin ETFs provides a safe way to invest directly in crypto currency without owning them, by so doing, they gain exposure to these volatile. Bitcoin ETFs are available for purchase on official exchanges.

One should only trade in these financial products if there understand the risks and rewards.