What is an exchange-traded fund (ETF)?
Before venturing into the world of cryptocurrency exchange-traded funds (ETFs), like those for Bitcoin, it is important to understand what ETFs are more generally. ETFs are financial products that trade on stock exchanges like the New York Stock Exchange (NYSE) or Nasdaq. They are issued and managed by financial companies like Blackrock, Vanguard, and Charles Schwab. These institutions typically charge shareholders a fee to compensate them for the costs of fund management.
ETFs can be bought and sold in these markets throughout the day, just like stocks. However, they share features with mutual funds, as well—mainly that, in addition to tracking specific assets like gold, they can also hold a basket of different stocks, bonds, commodities like oil, and derivatives like futures. The largest ETF measured by “assets under management” is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 index by holding the underlying stocks the index is comprised of.
Many people and institutions trade ETFs because these products allow for financial exposure they otherwise could not achieve. For instance, index ETFs permit trading of diversified baskets of assets, commodity ETFs enable trading of gold without individuals having to store gold bars, and leveraged ETFs can magnify profits (and losses) compared with trading individual stocks.
There are many kinds of ETFs, but in recent years a new type has captured the attention of market participants: cryptocurrency ETFs.
What is a Bitcoin ETF?
Background
Just as Bitcoin was the first cryptocurrency, it was also the first coin to gain traction as the subject of an ETF. In the early years of cryptocurrencies, those who wanted to trade and own crypto had to have a significant amount of technological knowledge. The only way to obtain, hold, and trade coins was by setting up a crypto wallet and use complex peer-to-peer protocols.
The rise of centralized exchanges like Bitstamp helped more users gain exposure to cryptocurrencies. It significantly lowered the threshold for onboarding crypto users. However, while using these platforms is relatively easy, it still requires a separate onboarding process (e.g., signing up on a website, completing know-your-customer processes) for traders who already have existing brokerage accounts, including tax-advantaged retirement accounts.
This is the reason many are excited about Bitcoin—and other crypto—ETFs. These give traders exposure to the price of Bitcoin, allowing them to access the crypto market through traditional financial tools and accounts.
How Bitcoin ETFs work
There are two types of Bitcoin ETFs: spot and futures. Both give traders exposure to Bitcoin, but in different ways.
Spot Bitcoin ETFs are products that have direct exposure to the price of bitcoin. Issuers, such as Blackrock and Fidelity, buy and hold bitcoin and holders of the ETF have a claim on the fund’s bitcoin holdings. This design, along with the ability for traders to create and redeem shares of the ETF, ensures that the price movement of the ETF’s shares are well aligned with bitcoin.
Futures ETFs, on the other hand, do not follow the price of bitcoin as directly. Instead of holding bitcoin itself, companies who issue Bitcoin futures ETFs hold derivatives called futures contracts. These are financial tools that represent agreements between traders to trade assets at a certain price at a pre-defined date, and the fund rolls the futures contracts over as they expire. Though the price of Bitcoin affects the value of shares of these ETFs, it often does so more unpredictably, a concept known as “tracking error”.
Implications for the Bitcoin market
Soon after the first Bitcoin futures ETF was approved, the price of Bitcoin peaked and began a precipitous decline. Many believe the anticipation of the event fueled a trading frenzy that drove the price to its top.
The implications of a spot Bitcoin ETF are less clear. One prevailing theory is that spot ETFs have more direct effects on markets than futures ETFs. Unlike with futures ETFs, as traders buy shares the issuers must buy and hold bitcoins. This means that a large pool of new investors—individuals, hedge funds, financial institutions, retirement funds, and more—could have a stronger influence on bitcoin’s price.
A timeline of Bitcoin ETFs in the United States
To bring a Bitcoin ETF to market in the United States, the U.S. Securities and Exchange Commission (SEC) evaluates how an issuer plans to hold coins (known as “custody”), the liquidity of the bitcoin market, how the price of ETF shares will follow that of bitcoin, and a number of other factors. When the SEC approves a Bitcoin ETF based on this process, the product can trade on exchanges.
The first US Bitcoin ETF was proposed by Cameron and Tyler Winklevoss in 2013. Their efforts were rejected—twice—by the SEC. Numerous others tried their hand at petitioning the SEC for their own Bitcoin-based funds in the ensuing years, all with the same result. However, in 2021 the SEC approved the first Bitcoin futures ETFs, setting the stage for other US futures-based crypto ETFs including leveraged products.
Consistent with its prior decisions, the SEC denied crypto asset manager Grayscale’s attempt to convert one of its products into a spot Bitcoin ETF in 2022. However, Grayscale sued the SEC on the grounds that its proposed spot ETF’s design was not significantly different than futures ETFs that were already approved by the SEC.
In August 2023, the U.S. District of Columbia Court of Appeals agreed that the SEC was “arbitrary” in its denial, and ultimately the SEC was ordered to re-review Grayscale’s application. This also prompted review of other similar applications, culminating in the SEC’s approval of eleven spot Bitcoin ETFs on January 10, 2024.
Non-US spot Bitcoin ETFs
Spot Bitcoin ETFs were embraced more quickly outside of the United States. In 2021, three Canadian Bitcoin ETFs began trading: Purpose Bitcoin ETF (BTCC), CI Galaxy Bitcoin ETF (BTCX), and Evolve Bitcoin ETF (EBIT). Canada continued to lead the world in the following two years, with six spot Bitcoin ETFs available for trading in total. Markets with similar products by December 2023—as attention on the SEC was beginning to mount in the US—included countries like Germany, Switzerland, Liechtenstein, and Brazil.
Conclusion
- Exchange-traded funds are financial products that can be traded like shares of stocks on exchanges.
- Bitcoin futures ETFs began trading in the US in 2021, and spot Bitcoin ETFs (which attempt to track the price of Bitcoin more closely) have traded in other countries across the world since that time.
- Though the first spot Bitcoin ETF was proposed in 2013, US regulators rejected their applications until finally approving the first eleven spot Bitcoin ETFs in January 2024.