Bitcoin ETFs are mentioned everywhere in news outlets and cryptocurrency reports. This article is all about Bitcoin ETF and how it works.
What is an ETF?
ETF is short for Exchange Traded Fund. This is an investment vehicle that adopts characteristics from an index fund as well as mutual funds. ETFs are a pool of various investment products in the same way as mutual funds.
However, these funds track the performance of specified underlying assets based on their performance and specified output metrics. ETFs are listed on a regulated stock exchange and investors can purchase its share that track the value of underlying asset.
What is a Bitcoin ETF?
A Bitcoin ETF is an exchange-traded product that tracks the value of Bitcoin in the spot markets. Investors who do not wish to directly invest in Bitcoin can gain exposure into the virtual currency by purchasing the shares of a Bitcoin ETF.
Bitcoin is not a regulated entity but Bitcoin ETFs are regulated and registered with a financial regulatory agency. It is because Bitcoin ETFs is listed on a traditional stock exchange rather than offered by cryptocurrency trading platforms.
How Does a Bitcoin ETF Work?
Investors can purchase shares of a Bitcoin ETF rather than investing in BTC on a crypto exchange. The share represent right of an investor to sell or purchase a given amount of Bitcoin at a later date if it tracks futures contracts.
In case of a spot Bitcoin ETF, investors may be able to track the value of Bitcoin prices from the spot markets and represents ownership over a portion of BTC reserves that the ETF holds. Futures ETF carry greater risk as their prices can fluctuate on account of changing market sentiment unlike spot Bitcoin ETFs.
Types of Bitcoin ETFs
There are three popular types of Bitcoin ETFs:
Spot Bitcoin ETF
Spot Bitcoin ETFs are the investment vehicles that allow investors to track the spot prices of Bitcoin. It has the ability to generate maximum returns for investors in comparison to alternatives such as futures ETFs.
Futures Bitcoin ETF
Futures are derivative contracts that require investors to sell or purchase underlying asset at a predetermined price in future. Bitcoin futures ETFs are backed by futures contract and they are often criticized for underperforming gains since they do not track the market value of Bitcoin directly.
Strategy Bitcoin ETF
Strategy-based Bitcoin ETFs are not actively managed funds. Instead, they depend on a predetermined strategy as a way to manage the share to reserve ratio of the fund.
These are less-complex and easier for beginners on account of streamlined trading strategy. ProShares Bitcoin Strategy Fund (BITO) is a good example of this category.
Advantages of Bitcoin ETFs
Here are some of the most noteworthy advantages of a Bitcoin ETF:
- Investors are saved from the hassle of directly dealing with issues such as Bitcoin storage and security.
- Investors are able to create position in a diversified portfolio by working with ETF that is divided into basket of securities, Bitcoin, and other virtual currency products.
- Bitcoin ETFs are regulated therefore they are grant greater protection to investors.
- Regulated Bitcoin ETFs allow investors to qualify for tax efficiency.
Risks Associated with Bitcoin ETFs
Here are some disadvantages that are associated with Bitcoin ETF investments:
- Bitcoin ETFs lead to considerable management fees for investors since they are managed by professional brokers.
- ETFs may be subjected to contango or backwardations which are inaccuracies in tracking the price of underlying asset class.
- Bitcoin ETFs are not accessible to investors who are using cryptocurrency exchanges.
- Bitcoin ETFs require presence of third-party service providers and does not have decentralization. Both these advantages are two important reasons for investing in Bitcoin.
- Investors may not be able to stake or use their Bitcoin reserves for governance options such as voting when they gain exposure using Bitcoin ETFs.
Bitcoin ETFs have gained massive popularity in the current regulatory context. Bitcoin is decentralized but it can become a regulated investment option when converted into an ETF. Bitcoin ETF can pave the way for the introduction of traditional investors into Bitcoin market.