Bitcoin ETFs: Definition, Pros and Cons

The cryptocurrency market is becoming more and more mature, with its trading instruments also actively developing. Just about 12 years ago, BTC was used by a small community of enthusiasts. In a dozen years, well-established companies like MicroStrategy and Tesla entered the crypto market. In many jurisdictions, Bitcoin is not treated yet as a legitimate investment asset. As the popularity of BTC rises, more institutional and individual investors need a legal framework for crypto assets.

Bitcoin ETFs (exchange-traded funds) solve the problem of regulation by providing traders exposure to BTC via traditional stock exchanges. As early as October 2021, the U.S. Securities and Exchange Commission (SEC) approved the first Bitcoin ETFs for the financial service firms ProShares and Invesco. This event contributed to Bitcoin's growth, with its price reaching a record high of $68,000 in November 2021.

This article will help you to understand BTC ETF as well as learn about the advantages and disadvantages of this type of investment instrument.

Key Takeaways

• Bitcoin ETFs allow traders to gain exposure to Bitcoin without the need to purchase the asset itself
• Currently, there are only futures Bitcoin ETFs on the U.S. market
• Spot ETFs are traded in the UK, Canada, and Australia
• Dealing with ETFs is convenient for investors not familiar with cryptocurrencies
• Bitcoin ETF annual expense ratio fees range from 0.5% to 1.5%

What Is a Bitcoin ETF?

ETF stands for an exchange-traded fund. It usually tracks the value of an index or a collection of assets. Here is how it works: a firm purchases currencies or/and securities. The purchased assets comprise the fund’s investment portfolio. The fund then sells shares that track its value on the exchange. However, the ETFs’ buyers do not directly own the assets, as it would be the case with stock shares.

ETFs are created by financial companies. The largest ETF operators in the world are BlackRock, Invesco, Vanguard, State Street and Charles Schwab.

A Bitcoin ETF is a fund that builds its portfolio with Bitcoin-related assets, such as Bitcoin futures or BTC coins themselves. Thus, investors have exposure to bitcoins without having to buy them directly from cryptocurrency exchanges. Bitcoin ETFs eliminate regulatory risks, as many of them are officially approved by the U.S. Securities and Exchange Commission (SEC).

Understanding Bitcoin ETFs

First, it is worth mentioning that currently there are no ETFs on the U.S. market with portfolios consisting of BTC coins. Such ETFs would be called spot Bitcoin ETFs. Wall Street firms have made several attempts to launch spot bitcoin ETFs in the US. But so far, none of the applications received SEC approval.

However, a BTC futures ETF is available in the U.S. market. ProShares Bitcoin Strategy ETF (BITO) became the first Bitcoin ETF approved by SEC in October 2021 to trade in U.S. market. The underlying asset of BITO is Bitcoin futures contracts, traded on the Chicago Mercantile Exchange. BITO tries to track the Bitcoin price movement as close as possible. Just like any other currently existing Bitcoin ETF, BITO does not own actual Bitcoin. Instead, it owns futures contracts on Bitcoin.

Goals of Bitcoin ETFs

One of the main pitfalls of cryptocurrencies is regulation. At the moment, not all large investors are able to purchase digital assets directly from crypto exchanges due to incomplete legal framework. Another concern is the risk of losing private keys or password from the crypto wallet. Some investors may feel safer investing in ETFs because of the familiar legal structure and easy account recovery.

The fact that ETFs can be traded on major stock exchanges makes ETFs attractive for institutional investors. For retail investors, ETFs are a convenient way to interact with cryptocurrency universe without. There is no need to study the technical aspects of the crypto wallets.

Security

Investors who buy Bitcoin ETFs may use their existing brokerage accounts. That means they don't have to worry about protecting their BTC wallets from hackers or sophisticated phishing attacks. Many crypto wallets, have already been marked by high-profile scandals due to the low level of reliability and periodic theft of funds placed on them.

Traditional financial services platforms a priori provide a standard level of reliability and security of investments. However, it is still important to review the information about the exchange and the fund itself, before making an investment.

High Prices

ETFs themselves are quite affordable. For example, the face value of BITO securities is only $40. However, holding an ETF sometimes may be more expensive than buying a crypto asset on a crypto exchange. Crypto exchanges charge a one-time fee, while ETFs incur annual fees. At the same time, we can not eliminate the deposit and withdrawal fees on crypto exchanges from the calculations. Your final expenses will depend greatly on a particular exchange or broker.

ETFs are Better Understood

For investors who are new to cryptocurrencies, it can be difficult to understand the technical peculiarities of digital assets. Investors simply looking to make money on the growth of the most popular cryptocurrency on the market, may find ETFs very convenient. There is no need to have a deep understanding of digital currencies, wallets, blockchain, mining, decentralisation and validation.

Advantages of Bitcoin ETFs

In addition to mentioned above, Bitcoin ETFs also have the following advantages:

Convenience

Bitcoin ETF gives traditional investors exposure to BTC without the need to create an account on a cryptocurrency exchange. Thus, it is easier for them to start investing in Bitcoin without leaving their conventional trading terminal. Moreover, ETFs help to rid of the additional complications related to bitcoins’ storage.

Diversification

The Bitcoin ETF portfolio contains an asset not represented on classical exchanges. This gives the investor a way to diversify their existing equity portfolios. Moreover, some Bitcoin ETFs consist of more than just Bitcoin futures. They may also comprise shares of stocks to balance the portfolio.

Tax efficiency

Being non-regulated and decentralized, Bitcoin is not welcomed by the majority of pension funds. On the other hand, a Bitcoin ETF regulated by SEC can become a part of pension scheme and be eligible for tax efficiency.

Also, some ETFs, such as VanEck Bitcoin Strategy ETF (XBTF), are separately taxable entities. XBTF is not required to distribute dividends to the investors, allowing investors to save on taxes.

Disadvantages of Bitcoin ETFs

However, along with the pros, a number of cons come with the investing in Bitcoin ETFs:

Management fees

ETF managers charge a share of the profit for their work. The service fees are included in the ETF price and are listed in the prospectus under the expense ratio category. Usually the fees ranges from 0.5% to 1.5%.

ETF inaccuracy

ETF price movement is also often inaccurate. Fluctuations in the actual BTC market on cryptocurrency exchanges are not immediately reflected in the ETF value.

Limits to cryptocurrency trading

ETF only tracks the price of Bitcoin and can not be traded for other cryptocurrencies. At the same time, crypto exchanges allow conversion of bitcoins into other assets. The ability to quickly trade cryptocurrency may be necessary if there is a sudden change in the trend.

Lack of Bitcoin ownership

One of the most important disadvantages of Bitcoin ETFs is the absence of the bitcoins' ownership. By purchasing an ETF, you own shares in the fund. It defies the main idea of cryptocurrencies: decentralisation. As the famous saying goes, “Your keys, your Bitcoin. Not your keys, not your Bitcoin”.

Investing in Bitcoin ETFs

As it was already mentioned, investing in Bitcoin ETF does not involve the usual hassles related to cryptocurrencies, such as wallet set up, private keys storage etc.

Let's compare the investing in Bitcoin and investing in a Bitcoin ETF in more detail.

Bitcoin vs. Bitcoin ETFs

The original idea behind Bitcoin is a decentralized financial system. Bitcoin is not only “Digital Gold”. It is a decentralized digital currency, an asset not controlled or owned by any single authority. Bitcoin is less susceptible to regulation, especially since it is still not recognized as safe by the SEC. Having your own private keys from a Bitcoin wallet gives you direct ownership of the assets.

Bitcoin ETFs, on the other hand, are just an easy tool to invest in cryptocurrencies. It facilitates the mass adoption of BTC and potentially brings additional liquidity. Therefore, buying this asset is primarily suitable for conservative investors who are not interested in the technology itself and the idea behind it.

What Are the Best Bitcoin ETFs to Invest?

With the popularisation of the new instrument, many variants of Bitcoin ETFs emerged on the market. We will highlight 5 most popular funds to invest in 2022. The Bitcoin ETF symbol for each fund is provided in the brackets next to its name.

Grayscale Bitcoin Trust

Grayscale Bitcoin Trust (GBTC) is not a genuine ETF, but rather an investment trust. It issues a fixed number of shares, which are traded on the over-the-counter market. GBTC was among the first to offer investors exposure to BTC.

GBTC shares track the price of Bitcoin from the CoinDesk Bitcoin Price Index. Currently, each share of Grayscale Bitcoin Trust is 0.00093535 BTC, but that number is not fixed. Unlike ETFs, closed-end trusts like GBTC can trade at a discount or premium to their underlying assets.

The trust charges a 2% management fee. That's quite high compared to the average fee of 0.53% for ETFs. That said, the minimum investment amount is $50,000.

ProShares Bitcoin Strategy ETF

The ProShares Bitcoin Strategy ETF was launched on Oct. 19, was the first ETF in the U.S. to give investors access to Bitcoin futures.

BITO does not invest directly in Bitcoin. Instead, it invests in Bitcoin futures. These futures contracts are regulated by the Commodity Futures Trading Commission. They are traded only on the Chicago Mercantile Exchange and are subject to CME rules.

The annual management fee is 0.95%

Bitwise 10 Crypto Index Fund

The Bitwise 10 Crypto Index Fund (BITW) is an index, not an ETF. They are broadly similar investment vehicles but have different purchasing and selling times.

Launched back in 2017, BITW tracks the performance of the Bitwise 10 Large Cap Crypto Index, representing the 10 largest cryptocurrencies. These 10 cryptocurrencies comprise 70% of the entire cryptocurrency market. Bitcoin makes up 65% of the portfolio. That's more than double Ethereum's 25%. Cardano is in third place with 4%.

Although the Bitwise 10 Crypto Index Fund is constructed differently than the GBTC, it can still sell at a premium or discount to net asset value per share. BITW currently trades at a nice 22% discount to NAV.

So investing in BITW solves a number of problems — eliminating cryptocurrency volatility and participating in the crypto industry.

The annual management fee is 2.5%

Bitwise Crypto Industry Innovators ETF

Bitwise Crypto Industry Innovators ETF (BITQ) is another equity-focused cryptocurrency ETF. This index fund tracks the performance of the Bitwise Crypto Innovators 30 Index, created by Bitwise Index Services LLC, a subsidiary of Bitwise Asset Management, the world's largest crypto index fund manager.

To qualify for the index, a company must generate at least 75% of its revenue from the cryptocurrency ecosystem or have 75% of its net assets in bitcoin or some other liquid cryptocurrency asset. BITQ holds shares in companies such as MicroStrategy, Galaxy Digital (BRPHF) and Silvergate.

The annual management fee is 0.85%.

Valkyrie Bitcoin Strategy ETF

The Valkyrie Bitcoin Strategy was launched three days after the ProShares ETF went public. The BTF itself is very similar to BITO in that it invests not directly in Bitcoin, but in Bitcoin futures on the Chicago Mercantile Exchange through a subsidiary in the Cayman Islands.

Valkyrie is a Tennessee-based alternative asset manager with years of experience managing traditional and digital assets. It offers trusts for various cryptocurrencies, including Bitcoin, Polkadot, Algorand and others, but BTF is its first cryptocurrency ETF.

The annual management fee is 0.95%

Bitcoin ETF Fees

ETF investors usually incur 2 types of commissions:

• Securities transaction fees: commissions paid per transaction (for buying or selling). The amount of the commission depends on the broker;
• Manager’s fee: the commission paid to the provider for the ETF’s management. The commission is called the Total Expense Ratio (TER). TER is the costs incurred by the provider in the course of his work. The expense items include listing and provision of high liquidity, administrator's services, custodian, auditor, independent control, investment manager, and others.

Why Should I Buy a Bitcoin ETF Instead of Bitcoin?

The main reason to buy Bitcoin ETF instead of Bitcoin is security and convenience. Some investors may be uncomfortable or unaccustomed to dealing with BTC. They may find it easier to invest in Bitcoin ETFs. Moreover, the cryptocurrency market attracts swindlers and there is a risk to lose BTC due to fraud or technical errors.

Why Don't Bitcoin ETFs Own Bitcoin?

Requests to launch a spot Bitcoin ETF, which involves having BTC coins directly in the fund's portfolio, have been repeatedly rejected by SEC. The first application for a spot in Bitcoin ETF came from Cameron and Tyler Winklevoss in July 2013 and was officially rejected four years later.

SEC head Gary Gensler responded to a petition from Congressman Tom Emmer explaining why the agency has yet to approve the launch of a bitcoin-based spot ETF. According to the head of the regulator, applications for such funds do not meet the Securities Act's standards for cracking down on fraudulent or manipulative practices.

However, regulators in other countries have already shown their loyalty to the spot Bitcoin ETFs. A spot bitcoin ETF was launched in Canada in February 2021. It is called the Purpose Bitcoin ETF and is traded on the Toronto Stock Exchange.

Europe's first spot bitcoin ETF will be launched by London-based digital asset management platform Jacobi Asset Management in July 2022 on Euronext Amsterdam under the ticker BCOIN.

In addition to Canada and the Netherlands, spot bitcoin ETFs have also launched in Brazil and Australia.

The Future of Bitcoin ETFs

With the U.S. approval of the first Bitcoin ETF, investors have begun to feel more optimistic about other ETF offerings now being considered by the SEC.

The ETFs approved so far are based on futures traded on the Chicago Mercantile Exchange or stocks of companies in the crypto industry. However, the situation with spot ETFs will remain unclear until the SEC changes its attitude toward the BTC spot market.

FAQ

What is Bitcoin ETF?

Bitcoin ETF is an exchange-based fund that tracks the price movement of Bitcoin. It gives the investors exposure, but not the ownership of the asset.

Where to buy Bitcoin ETF?

Bitcoin ETFs can be purchased through traditional exchanges, just like any other ETFs or traditional financial instruments.

How to buy Bitcoin ETF?

You'll need to open an account with an exchange platform if you don't have one yet. Determine the number of shares of an ETF you want to purchase. Develop your own Bitcoin ETF strategy for trading. You can either purchase the fund at the current market price or place a limit order at a specific price you are ready to pay.

Should You Buy a Bitcoin ETF?

It depends on your interests. An ETF will be particularly useful for you if you want to make money from Bitcoin price movements, but do not want to take on the risks associated with holding cryptocurrency.

Is Buying a Bitcoin ETF the same as Bitcoin?

No. When you invest in an ETF, you don't buy Bitcoin directly. You are buying shares in an exchange-traded fund that tracks the value of Bitcoin.

What is Bitcoin Futures ETF?

Many crypto futures ETFs use futures contracts on cryptocurrency as the underlying asset. Bitcoin futures ETF is based on the Bitcoin Reference Rate (BRR) from the CME, not the spot price.

Is a Bitcoin ETF worth it?

For those interested in Bitcoin, the ETFs available on the market can be a handy investment tool. Some ETFs contain other assets besides Bitcoin, like Facebook or Apple stock. However, it may be as well worth waiting for the SEC to approve a spot Bitcoin ETF.

*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.