On January 10th the U.S. Securities and Exchange Commission approved the first regulated Exchange Traded Products (ETPs) that give investors direct exposure to the price of Bitcoin. Almost immediately 11 Spot Bitcoin ETFs were launched by some of the biggest names in investments including Blackrock, Fidelity, ARK, Invesco, and others.

Did Bitcoin ETFs already exist?

Yes, just in a different form. In 2021 a different type of Bitcoin ETF was approved. These funds do not hold any actual Bitcoin. Instead, they use futures contracts on Bitcoin to gain exposure to changes in price of Bitcoin. For more information on the initial Bitcoin ETFs and how they work, see our blog post Understanding Bitcoin ETFs.

Key Terms:

Exchange Traded Product (ETP): An Exchange-Traded Product (ETP) is a type of financial instrument that is traded on stock exchanges, providing investors with exposure to various assets or investment strategies. ETPs are similar to mutual funds or index funds but are traded on exchanges throughout the trading day, like individual stocks.

Exchange-Traded Fund (ETF): An Exchange Traded Fund (ETF) is a type of ETP. More specifically, a Bitcoin ETF is a financial product that allows investors to gain exposure to Bitcoin without directly owning the cryptocurrency itself. Instead, investors can buy and sell shares of the ETF on traditional stock exchanges, just like they would with any other stock or ETF. This structure enables investors to participate in the potential upside of Bitcoin’s price movements without the complexities of managing private keys or dealing with cryptocurrency exchanges.

Spot price: Also called the market price, this is the value of the asset at a current moment as set by market forces. If you own a direct investment in Bitcoin, that is the price of your investment at that current time. When you hear “bitcoin has crossed about $50,000” that is a reference to the spot price.

Premium/Discount. The price of Bitcoin ETF shares may not always perfectly track the underlying value of Bitcoin. This can lead to premiums or discounts to net asset value (NAV), resulting in potential discrepancies between the ETF’s price and the actual value of its holdings.

How do the new Bitcoin ETFs Work?

The long story short is that these new Spot Price ETFs can own bitcoin as the underlying asset in the fund, not just derivatives designed to mimic the movements in the price of the asset as in the initial Bitcoin ETFs. Investors can buy shares of these ETFs in their brokerage accounts during market hours and gain exposure to the price movements of Bitcoin.

The investment companies bringing these ETFs to market have partnered with cryptocurrency exchanges to hold the Bitcoin the fund has purchased. So far, nearly every spot bitcoin ETF that has come to market has partnered with Coinbase as their cryptocurrency custodian.

Evaluating the Pros and Cons

Pros:

Accessibility: Bitcoin ETFs provide a convenient way for investors to gain exposure to Bitcoin through their existing brokerage accounts. This accessibility lowers the barriers to entry for traditional investors who may be hesitant to open accounts on cryptocurrency exchanges or hold bitcoin on their own. It also makes it easier to invest in bitcoin in tax deferred accounts.

Regulated Investment Vehicle: Unlike investing directly in Bitcoin through an exchange, Bitcoin ETFs are subject to regulatory oversight. This regulatory framework can offer investors a sense of security and protection compared to less regulated cryptocurrency exchanges.

Liquidity: Bitcoin ETFs trade on traditional stock exchanges, offering investors liquidity and the ability to buy or sell shares quickly during standard market hours.

Costs: Bitcoin ETFs charge an annual management fee (generally called an expense ratio) instead of a transaction fee that is charged by most cryptocurrency exchanges. Depending on the investor’s strategy (generally if the investor is more active) this could create lower costs.

Cons:

Market Volatility and Investment Risk: While all investments are subject to investment risk and potential loss of principal, investment in Cryptocurrency carries elevated risk of the loss of an investor’s entire investment. For example, in their approval of Bitcoin ETPs the SEC referred to Bitcoin as “primarily a speculative, volatile asset” (full statement). Investments in Cryptocurrency ETPs may also be subject to additional risk, including but not limited to, market volatility, regulatory risks, security risks, liquidity risks and counterparty risks.

Counterparty Risk: Spot Bitcoin ETFs still use cryptocurrency exchanges to hold the bitcoin owned by the ETF. Although the ETF is a more regulated investment product, there is still exposure to cryptocurrency exchanges.

Premium/Discounts: The price of Bitcoin ETF shares may not always perfectly track the underlying value of Bitcoin. This can lead to premiums or discounts to net asset value (NAV), resulting in potential discrepancies between the ETF’s price and the actual value of the underlying holding.

Costs: Bitcoin ETFs charge an annual management fee (generally called an expense ratio) instead of a transaction fee that is charged by most cryptocurrency exchanges. Depending on the investor’s strategy (generally if the investor is more passive) this could create higher costs. Expense ratios can create a discrepancy between the performance of the ETF and the performance of the asset it is tracking.

Limited Use: If you own a bitcoin ETF, you do not actually have any bitcoin. It is important to know that with an ETF, you have exposure to the price movement of bitcoin, but you can only buy or sell the ETF, you cannot use bitcoin for any other purpose.

Summary

All in all, the approval of Spot Bitcoin ETFs provides another option for investors who would like to gain exposure to bitcoin. As we have outlined, there are pros and cons to this new type of investment, and it is important that investors consider suitability, benefits, risks, costs, and other issues associated with an investment in a Bitcoin ETF before investing.

How We Can Help

As with any investment, it is important to weigh the risk against the potential returns. If you are interested in finding out if investing in a bitcoin ETF or cryptocurrency is right for you, or if you would simply like to learn more, contact us online or at 410-685-9685. For more information on Cryptocurrencies, take a look at our full series: “Understanding the Crypto Craze.”