Bitcoin ETFs have been approved: What you need to know

TL;DR

A Bitcoin exchange-traded fund (ETF) is a financial instrument that represents one’s Bitcoin holdings and which can be traded in the stock market instead of on a cryptocurrency platform. Bitcoin ETFs allow investors to own and trade bitcoin, without needing to store and secure the assets themselves, allowing for greater access, convenience, and adoption within the mainstream financial market. 

Generally, the stock market and the cryptocurrency market have always been worlds apart, and stock traders and crypto traders have very little to talk about on the average day. Whereas the traditional stock market extols regulatory compliance as a virtue, the crypto market, on the other hand, believes in technology-backed decentralization. 

But in the intersection between these two playing fields, a new financial instrument has just been devised to bring together the best features of both worlds––the Bitcoin ETF.

What is a Bitcoin ETF or Bitcoin Spot ETF? 

In the stock market, an ETF is a bundled asset that can be composed of different securities such as stocks, commodities, or bonds and which are conveniently traded as if it were just like any other stock. Using this model, a Bitcoin ETF is simply an asset that tracks the price of bitcoin, but which can be traded on the stock market, instead of in a cryptocurrency exchange. 

As crypto is still viewed with a lot of skepticism by traditional investors (due to lack of regulation, and the difficulty for most people to grasp its complex technology) Bitcoin ETFs are expected to change perceptions as it will allow for participation in the trade of bitcoin within the boundaries of a regulated and more familiar market.

As of writing, 11 financial institutions, namely BlackRock, Bitwise, BZX, Fidelity, Franklin, Grayscale, Hashdex, Invesco, Valkyrie, VanEck, and WisdomTree, have already secured regulatory approval from the U.S. Securities and Exchange Commission (U.S. SEC) to launch their respective Bitcoin ETFs. 

How do Bitcoin ETFs work?

When you buy Bitcoin ETFs from an issuer, you are purchasing the equivalent amount in bitcoin according to the prevailing market rate. But unlike purchasing the bitcoin itself, which you would have to keep in your own crypto wallet, the bitcoins are purchased by the issuing firm who also keeps the actual bitcoins in custody to back up the value of the ETFs you own. 

However, unlike conventional ETFs which are composed of stocks or bonds–and which thus earn you dividends over time–any profit from trading Bitcoin ETFs is derived from the price fluctuations of bitcoin alone. 

This is because the companies behind the stocks earn profit through its business which shareholders are entitled a portion of, whereas bitcoin functions only as an alternative payment system without any registered company operating as a business behind it. 

Advantages and disadvantages of Bitcoin ETFs

For the traditional investor, Bitcoin ETFs have a lot of advantages over trading directly with bitcoin:

• Asset diversification - Bitcoin ETFs provide access to yet another asset class within the same trading platform, without having to set up a separate account elsewhere to build a portfolio for trading with bitcoin and crypto.

• Security and protection - Bitcoin ETF shareholders are assured of the safety and integrity of their assets by a licensed issuing firm, whereas trading with bitcoin often requires having to personally shoulder the burden of securing one’s assets. Even though personal custody can be seen as an advantage, it can also be a drawback if it results in the irreversible loss of assets should one’s private key be stolen or lost. 

• Removal of technology barriers - Bitcoin ETFs allow investors exposure to bitcoin, while removing the difficulty of navigating and familiarizing oneself with the complex world of crypto wallets, centralized and decentralized crypto exchanges and network fees. 

• Ease of filing taxes - as a regulated security, filing taxes for Bitcoin ETF trades are more streamlined and easier to figure out than with trading with bitcoin directly.

Bitcoin ETFs however, do come with certain compromises which may be seen as disadvantageous by crypto traders:

• Limited training hours - Since ETFs are only traded on the stock market, trading is only available during market hours, unlike the cryptocurrency market which is continuously available 24/7.

• ETF management fees - Issuing firms will charge a fee for securing the custody of an investor’’ bitcoins, which may be costlier over time than holding your crypto in your own personal wallet.  

Road to U.S. SEC approval

The idea behind Bitcoin ETFs has been around for a long time, beginning in 2013 when Cameron and Tyler Winklevoss (the founders of the Gemini crypto exchange and co-founders of Facebook) first filed a proposal which was rejected by the U.S. SEC. Many firms have since then filed their own proposals which have also been rejected. 

Bitcoin ETFs in other countries and territories have had earlier success, being granted by their respective regulators more favorably, with Bitcoin ETFs already previously available in Bermuda, Canada and the U.K.

In 2021, the U.S. SEC approved the first Bitcoin Futures ETF, which was seen as paving the way for greater acceptance towards an actual Bitcoin ETF.

[Note: Bitcoin ETFs or Bitcoin ‘Spot’ ETFs (since they are traded on the spot market) are not to be confused with Bitcoin Futures ETFs, which are backed by other Bitcoin-related assets such as derivatives contracts. Derivatives contracts allow investors to speculate on the future price of bitcoin without owning any of the underlying asset.] 

In 2023, the U.S. SEC underwent a renewed stance on ETFs and reviewed at least a dozen applications for Bitcoin ETFs from various firms, following an order by the U.S. Court of Appeals after it ruled that U.S. SEC’s rejection of a Bitcoin ETF proposal by Grayscale filed in 2021 was without sufficient grounds. 

Bitcoin ETFs were finally granted approval by the U.S. SEC on January 10, 2024. However, U.S. SEC Chair Gary Gensler has stated that U.S. SEC remains neutral on the matter over the trade of digital assets, and that cryptocurrencies remain a “primarily a speculative, volatile asset”.

Expected market impact

The U.S. SEC approval of Bitcoin ETFs is expected to usher in more general interest and acceptance for bitcoin. The sudden increased accessibility for traditional institutional and retail investors may mean a surge in trading volume and price volatility for bitcoin once the ETFs become available. 

Trading sentiments may also spill over to other cryptocurrencies, as a Bitcoin ETF will also signal a greater adoption of blockchain technology throughout the broader industry. 

Prior to the approval, the U.S. SEC has reissued a warning urging the public to be cautious with digital assets particularly meme tokens and non-fungible tokens (NFTs).

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