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Oct 31, 2021

Bitcoin ETF: Better Than Buying Bitcoin?

Bitcoin exchange-traded fund (ETF) made its long-awaited debut in the U.S on October 19, 2021, marking a watershed moment for the cryptocurrency industry. Offered by ProShares, the fund trades under the ticker BITO, allowing investors to have exposure to Bitcoin without needing a digital wallet. The fund has already surpassed $1 billion in assets under management, making it the fastest ETF to do so. Both new investors and experienced traders are taking advantage of this opportunity to add to their portfolios. 

In this article, we’ll discuss how Bitcoin ETFs work, their advantages and disadvantages, and the prospects for other current and prospective ETFs. 

What Is a Bitcoin ETF? 

A Bitcoin ETF is an exchange-traded fund which tracks Bitcoin pricing and can be bought or sold similarly to stock throughout the day.

Bitcoin ETFs use the same structure as typical ETFs to allow trading on an exchange. ETFs are investment funds that mimic the price of an underlying asset or index, much as the well-known S&P 500 does. Like other funds, ETFs pool money from investors to invest in assets or securities, including stocks, bonds and alternative investments. Investors own shares of the ETF itself, rather than the underlying assets in which the fund invests.

ETFs are traded on stock exchanges, meaning they’re bought and sold like stocks that incur commissions and other related fees. This is in contrast to traditional mutual funds, which only trade once a day. Investors who prefer ETFs do so because they can invest in a basket of securities or other investments to which they may not otherwise have direct access. ETFs can offer investors diversification and liquid investments.

The history of Bitcoin ETFs is littered with rejections by the U.S. Securities and Exchange Commission (SEC), whose role is to protect investors. The first application for a Bitcoin ETF came from Cameron and Tyler Winklevoss in July 2013, and was officially rejected four years later. A few others filed their ETF proposals and either withdrew, or faced rejection in the coming years, including SolidX, Grayscale, ProShares, Direxion and GraniteShares. The latest applications — still pending — include ETF proposals from WisdomTree, VanEck, Valkyrie, Fidelity, and more.

Across the border, Canadian regulators approved the world’s first Bitcoin ETFs in February of 2021, leading to the Purpose Bitcoin ETF being traded under the ticker symbol BTCC, and the Evolve Bitcoin ETF, traded under symbol EBIT.

Early in August 2021, SEC chairman Gary Gensler signaled that he would be open to ETFs trading on Bitcoin futures if they followed strict rules usually reserved for mutual funds. The goal is for issuers to structure ETFs under the Investment Company Act of 1940, which protects investors from illegal activities. ETF providers rushed to submit applications, which led to the first Bitcoin futures ETF being approved in the U.S. this month.

How Do Bitcoin ETFs Work?

Bitcoin ETFs are exchange-traded funds that try to follow the price of Bitcoin, allowing investors to have exposure to Bitcoin without owning Bitcoin itself. The price of each ETF is meant to fluctuate with the price of Bitcoin. When Bitcoin’s value rises and falls, the ETF’s value should rise and fall accordingly. A net asset value can be calculated for an ETF that represents the value of the fund’s holdings.

However, since ETFs trade freely on an exchange, just like stock, their pricing can actually deviate from net asset value — which in this case is the value of Bitcoin. Trading higher than net asset value means the ETF is trading at a premium, and trading lower than net asset value means the ETF trades at a discount. 

Popular Bitcoin ETFs in the Stock Market

Before we look at Bitcoin ETFs, we’ll briefly note that Bitcoin futures ETFs exist as well, such as ProShares Bitcoin Strategy ETF (BITO) and Valkyrie Bitcoin Strategy (BTFD), although we won’t cover these in-depth. 

A Bitcoin futures ETF tracks Bitcoin futures contracts, offering exposure to futures contracts without direct ownership. However, it doesn’t directly hold Bitcoin and is tied to the pricing of Bitcoin futures, rather than the current price of Bitcoin.

Nevertheless, the launch of Bitcoin futures ETFs did create excitement within the industry, as Bitcoin hit a six-month high, barely off its all-time high (ATH). The first Bitcoin futures ETF fund jumped 4.8%, closing at $41.94 per share on its first trading day. The price of Bitcoin surged to $64,157 after the launch, reaching its highest price point of $66,909.15, which exceeded the previous ATH of $64,899 in April 2021.

ETFs in the Stock Market

Image source: CoinMarketCap

Here are some examples of Bitcoin funds that do invest in spot Bitcoin, not futures.

Evolve Bitcoin ETF (EBIT)

EBIT is a Canadian ETF that was launched in February 2021. Investors can gain exposure to the actual Bitcoin in which EBIT invests, trade easily with a brokerage account, and be eligible for Canadian tax-advantaged retirement savings accounts like the TFSA and RRSP. Part of the first wave of ETFs ever approved by a regulator worldwide, EBIT had first-mover advantage, at least in Canada.

Purpose Bitcoin ETF (BTCC)

Purpose Bitcoin is the other Canadian-based ETF which also gives investors exposure to Bitcoin in their portfolios. It’s also TFSA/RRSP eligible and easy to trade, with no need for digital wallets. One of the first ETFs approved worldwide, BTCC gathered significant media attention for its launch.

Grayscale Bitcoin Trust (GBTC)

After initially filing and withdrawing their ETF application, Grayscale Investments created the Grayscale Bitcoin Trust (ticker symbol: GBTC) in 2013. This is a non-exchange-traded trust, and has become the largest and most popular Bitcoin fund. Simply put, GBTC is a financial instrument that allows investors to put their money into a trust which holds Bitcoin. As the price of Bitcoin rises or falls, the trust’s shares should increase or decrease accordingly. However, the fund has been trading at a significant discount to net asset value, that is, the value of its holdings.

Grayscale announced in October 2021 that they’ve filed to convert GBTC into an ETF, which would be traded on an exchange. Based on the approval of the first Bitcoin futures ETF in the U.S., Grayscale is hopeful that the SEC will approve GBTC’s conversion to a spot Bitcoin ETF by July 2022.

Why Buy Bitcoin ETFs?

1. Convenience

A Bitcoin ETF’s advantage is that it provides traditional investors accessibility to Bitcoin holdings without having to create an account on a cryptocurrency exchange. Some traditional investors have yet to foray into the cryptocurrency market, though they may have brokerage accounts at financial institutions which trade securities. For these investors, it may be more convenient to continue to use the same brokerage account but still have an investment with exposure to Bitcoin.

Investing in a Bitcoin ETF provides exposure to BTC prices without setting up direct ownership of Bitcoin, with which some investors may not be comfortable or familiar. Storing your own Bitcoin comes with additional responsibility, which an exchange-traded ETF removes. In other words, Bitcoin ETFs make investing in Bitcoin simpler than purchasing it on your own.

2. Regulation

Institutional investors like pension funds or asset managers may have specific mandates and rules that prohibit them from investing in Bitcoin directly. However, they have a better chance of being allowed to invest in an SEC-approved vehicle — such as a Bitcoin ETF. Many institutions that have wider mandates could start investing in the Grayscale Bitcoin Trust, even though they can’t hold Bitcoin directly. An exchange-traded ETF makes investing in Bitcoin even more accessible from a regulatory perspective.

3. Diversification

A Bitcoin ETF invests in the alternative asset Bitcoin, which is a good way for investors to diversify their portfolios. This strategy also helps investors to hedge risks associated with investing in only a single asset, or in a narrow set of assets. An investor who might not know how to buy Bitcoin directly can still diversify their portfolio using a Bitcoin ETF.

4. Liquidity

Being able to invest in a Bitcoin-related asset on a stock exchange can bring a whole new set of investors (for example, institutional investors) into the market. This adds liquidity to cryptocurrency markets as more participants join in, effectively buying and selling Bitcoin. Having ETFs with underlying investments in Bitcoin creates another forum to further increase the size of order books.

5. Shorting

Some institutional investors without previous access to shorting Bitcoin futures can now effectively short Bitcoin using an ETF. This provides another tool for investors to trade Bitcoin.

6. Fear

Since the cryptocurrency market is barely a decade old, it has been subject to sensational news media reports as well as its fair share of scams. Not only do scams keep new investors at bay, but there’s also a learning curve associated with storing your own cryptocurrency. 

Without knowledge of how to properly store cryptocurrency, user error also results in losses. According to Markets Insider, around 20% of the existing 18.5 million bitcoins are lost or stuck in inaccessible wallets. Anyone who is especially concerned about the negative news flow and storing their own cryptocurrency may feel a bit more comfortable investing in an ETF, even though it doesn’t necessarily insulate them completely from risk. After all, ETFs are directly investing in Bitcoin themselves. 

Fear of the unknown is sometimes enough to keep people from pulling the trigger, and ETFs may feel like more of a known vehicle to traditional investors.

Why Not Just Buy Bitcoin Instead?

Bitcoin ETFs may offer features that are useful for investors, but the reality is that owning a Bitcoin ETF differs from owning Bitcoin directly. That raises the question: Why not just buy Bitcoin itself instead? 

In considering your options, it’s important to understand that Bitcoin was born out of the revolutionary goal of creating a new financial system. While a Bitcoin ETF helps with popularization, mainstream adoption and potentially liquidity, it also comes with a few disadvantages. 

1. Tracking Error

ETFs represent their underlying assets. While the exchange-traded funds invest in the underlying asset, the performance of the ETF doesn’t always match the performance of the asset itself. As previously discussed, there is no rule that the ETF price has to directly correlate with the net asset value of the fund. This introduces a tracking error because the price performance of a Bitcoin ETF won’t always mirror the price performance of Bitcoin itself. 

For example, between October 19–27, 2021, ProShares ETF’s BITO was down by 2.45%, GBTC was up 7.5%, and BTC was down 1%. Performance can vary widely between instruments.

For Bitcoin ETFs that use Bitcoin futures as their underlying asset, the performance is tracking BTC futures pricing instead of spot pricing. 

2. Transaction and Management Fees

The ProShares Bitcoin ETF which started trading in the U.S. has an expense ratio of 0.95%, which is relatively high compared to most ETFs and mutual funds. This is an annualized fee that compounds over the holding period of the investment, reducing its profitability. Other costs may also apply if your brokerage charges transaction fees.

3. Ownership

Bitcoin was created out of frustration with the traditional financial system and fiat currencies that central bankers could inflate away. As a decentralized currency, Bitcoin is a global asset that’s not controlled or owned by any single entity. It’s also less likely to be subject to currency manipulation by a central bank or government. 

Part of this ethos involves holding your own Bitcoin, without involving a financial intermediary — such as a bank — that can charge high fees. At least on a theoretical level, Bitcoin purists want to hold their own private keys and have direct ownership of their assets. Doing so is less subject to regulation, especially since Bitcoin hasn’t yet been deemed a security by the SEC.

4. Trading Hours 

Bitcoin trades 24 hours a day, seven days a week, which lets its holders participate in the market at any time. On the other hand, Bitcoin ETFs do not trade around the clock, and are subject to typical stock market opening and closing times. Traders could potentially miss out on trading opportunities during times when ETF markets are closed.

5. Settlement

One of the reasons Bitcoin enthusiasts see high potential for Bitcoin is because of its convenience for payment transactions. Instead of waiting a few business days for an international wire transfer to arrive, transferring Bitcoin between wallets can be virtually instantaneous. In addition, fees aren’t dependent on a financial intermediary, and costs to transfer payments are relatively low. 

In contrast, settling a Bitcoin ETF transaction will take the same amount of time as other stocks do: two days. The settlement date is the day funds are actually required for an ETF transaction, and when you actually have ownership of the ETF. Trading a Bitcoin ETF puts investors right back into the traditional financial system that requires a couple of business days to settle payments.

6. No Payment Value

Not only do you lose the instantaneous settlement that comes with cryptocurrencies with an ETF, but you miss out on a key benefit of owning Bitcoin: using it as payment. Bitcoin is accepted as a means of payment with retailers ranging from Home Depot to Overstock. On the other hand, ETF units cannot be used as payment, and instead must be sold and converted to fiat in order to have any use in making payments.

To actually take advantage of all the benefits of owning Bitcoin, buying it on exchanges like Bybit is a better long-term solution. Not only do you get to hold the actual Bitcoin, but you have control over your own assets without interference from financial institutions.

Future of Bitcoin ETFs

With the U.S. approval of the first Bitcoin-based ETF, investors are feeling more optimistic about other ETF applications which the SEC is considering. 

Many existing providers are lined up awaiting approval for their own ETFs, including VanEck, WisdomTree, Amplify and Global X. Bitcoin futures ETFs may stand a better chance at the moment, given that there now exists approval precedence. Those ETFs are based on Chicago Mercantile Exchange traded futures, and the SEC has greater regulatory oversight over the CME. The SEC still needs to shift its stance on the Bitcoin spot market before approving a Bitcoin spot ETF.

A few other firms, such as Invesco, are also trying to introduce ETFs that invest in a diversified group of Bitcoin-related assets. Other competing products will likely be created to satisfy the demand for Bitcoin exposure.

The Bottom Line

The Bitcoin ETF is a big leap toward mainstream crypto adoption, though it’s not preferable for all investors. While it seems promising as an investment option, the Bitcoin ETF market is still in its early stages and is bound to see further development. Investing in Bitcoin ETFs also comes with its own risks and disadvantages, including tracking error, less individual control of assets, reduced trading availability and higher fees. On the other hand, owning Bitcoin directly is easy when using cryptocurrency exchanges like Bybit, which affords investors all of the current benefits that owning cryptocurrencies can offer.