What are Bitcoin and crypto ETFs and how can they impact markets?

With Bitcoin gaining massive institutional interest and countries adopting it as a legal tender, the demand for regulated financial products for cryptocurrencies is growing. For instance, the bullish sentiment caused by the first Bitcoin futures-backed ETF in the United States — with over $1 billion traded on its first two days — indicates the growing market for crypto exchange-traded funds.

An exchange-traded fund, or ETF, is a regulated financial instrument that tracks the price of an underlying asset, a basket of assets, or an index. For example, the S&P 500 ETF follows the performance of the corresponding equity index, which tracks the top 500 US stocks. Similarly, a gold ETF tracks the value of its gold reserves and issues shares against it. The shareholders have fractional ownership of the fund’s portfolio.

With at least 10 additional crypto ETF applications currently tabled with the US Securities and Exchange Commission, the crypto market could potentially tap into the global ETF industry — currently worth $9.46 trillion.

Moreover, given how easy these funds are to invest in, the approval of these assets could bring additional institutional and retail investors to the crypto market.

In this article, we’ll understand how Bitcoin and crypto ETFs work, their advantages and disadvantages, and how they could impact crypto markets.

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What is a Bitcoin ETF and how does it work?

First, let’s understand how a Bitcoin exchange-traded fund works. There are two types of Bitcoin ETFs — physically-backed and futures-backed. Although the underlying asset might be the same in this case, BTC, these two instruments are functionally quite different.

Spot Bitcoin ETF

Also known as a physically-backed Bitcoin ETF, spot Bitcoin ETFs follow the concept of a traditional ETF where companies purchase BTC and hold it in their reserves. The company then creates a fund, lists it on a stock exchange, and issues shares against it. When you buy a share of the Bitcoin ETF, you get a stake in the BTC held in the company’s reserves.

Futures-backed Bitcoin ETF

Futures-backed ETFs are derivative instruments that react to future price movements in their underlying assets. Thus, a futures-backed Bitcoin ETF isn't required to hold BTC. It trades on contracts that speculate on the price of BTC in the future, rather than the current spot price of BTC. These contracts have a finite lifespan, and the fund manager has to sell existing contracts and re-buy the contracts at a later date. Due to this structure, there are usually discrepancies between the actual price of BTC and the price of a futures-backed Bitcoin ETF.

Other crypto instruments

Apart from Bitcoin ETFs, other cryptocurrencies have also garnered institutional attention. For example, VanEck, an asset management firm, has already listed TRON, Solana, and Polkadot exchange-traded notes in Germany and other parts of Europe. Additionally, some smaller institutions, such as 21Shares, have gained market share with more than $200 million in assets under management for its Solana exchange-traded product, ASOL.

Crypto ETFs vs spot crypto trading

Advantages of crypto ETFs for traders

Ease of use

For many, diving into cryptocurrency trading can be daunting, from setting up digital wallets to safely managing and transacting coins or tokens. Crypto ETFs simplify this process by offering a direct trading route via registered brokerage accounts, making them a favorable option for newcomers to the crypto scene.

Tax benefits

Crypto ETFs come with tax efficiencies, mainly when traded from tax-free advantaged retirement portfolios or tax-deferred ones.

Trust

ETFs represent a more secure option for those who might be wary of the direct cryptocurrency market's uncertainties. As a centralized and regulated entity, they allow traders to expand their horizons without incurring extra risks, boosting overall confidence in the market.

Disadvantages of crypto ETFs for traders

No physical assets

Crypto ETFs give exposure to cryptocurrency price movements but don't grant actual possession of the underlying coins or tokens. Individuals are excluded from several direct advantages of owning cryptocurrencies or engaging in decentralized finance activities.

Fees and international taxes

While crypto ETFs might seem convenient due to their integration with traditional financial systems, this ease of use can come at a cost. Intermediaries who manage these funds on behalf of individuals charge fees which can be substantial. Crypto ETF management fees can range from 0.4% to 1.5% annually.

Compliance with international tax regulations is essential for those venturing into global markets. In contrast, holding Bitcoin in a personal digital wallet or directly on crypto platforms might not involve such costs.

Limited investment options

The emerging nature of crypto ETFs implies that they might not offer as broad a range of opportunities as direct crypto trading. Most ETFs currently focus on leading cryptocurrencies like BTC, ETH, and SOL, influenced by regional regulations. However, with the evolution of the crypto sector, it's anticipated that a wider array of coins might become available for ETF-based investments, especially in mature markets like the US.

Active trading hours

Unlike the always-on nature of the cryptocurrency market, traditional stock markets operate within set hours. This time limitation can pose challenges for crypto ETF traders. For instance, significant price fluctuations in Bitcoin can occur outside of regular stock market hours, leaving ETF holders unable to act on these changes immediately.

US crypto ETF history and regulations

Since 2013, there have been numerous ETF applications by high-profile applicants. Some were rejected because they didn't sufficiently protect users in the face of a volatile crypto market. However, selected Bitcoin ETFs have gained approval worldwide, establishing the market for such products. Even though the demand is higher for a spot ETF, the approval of futures ETFs provides another choice for traders — while companies like Bitwise Invest continue to present their case for a spot ETF option.

Current futures ETFs

ProShares Bitcoin futures ETF

The highly anticipated ProShares Bitcoin Strategy (BITO) ETF became the first Bitcoin-linked futures exchange-traded fund traded on the New York Stock Exchange on Oct. 18, 2021. Its parent company, ProShares, is a Maryland-based ETF provider. BITO provides individuals with a regulated avenue to access returns linked to Bitcoin. It manages assets exceeding $1 billion in CME Bitcoin Futures, as the holdings data indicates. The expense ratio for ProShares is 0.95%.

Valkyrie Bitcoin futures ETF

Valkyrie’s Bitcoin futures ETF, or BTF, launched on Oct. 22, 2021, on the Nasdaq Index. Primarily managed by Valkyrie, a Nashville-based investment firm that specializes in digital assets, BTF invests in Bitcoin futures contracts. The expense ratio for BTF is 0.95% — the same as the ProShares ETF. In an interesting twist, Valkyrie wants to transform its existing BTF into a dual Bitcoin and Ether Exchange-Traded Fund (ETF).

VanEck Bitcoin futures ETF

VanEck has been persistent in its efforts to secure a Bitcoin exchange-traded fund, with applications ranging back to 2018. Those efforts paid off with the wealth manager joining ProShares and Valkyrie on Nov. 16, 2021, with its Bitcoin Futures ETF launch. XBTF leverages cash-settled Bitcoin futures contracts. The expense ratio for VanEck is 0.65% — significantly less than ProShares.

Potential candidates for spot ETFs

Following successful applications from futures-backed Bitcoin exchange-traded funds, companies have also started their filing efforts for a spot ETF. For example, Grayscale, the largest Bitcoin fund, filed an application during August 2023 to convert its current Bitcoin Trust to an ETF. Valkyrie, VanEck, and Bitwise Invest are some of the other notable candidates for Bitcoin spot ETFs.

Crypto ETFs in other countries

Jacobi FT Wilshire Bitcoin ETF

August 2023 saw the launch of Europe’s inaugural spot Bitcoin ETF, the Jacobi FT Wilshire Bitcoin ETF, on Euronext Amsterdam. The ETF is meant to be green-friendly and aligns with the European Union’s sustainable finance guidelines. As such, it uses external data to measure energy usage linked to Bitcoin in the ETF. Jacobi Asset Management, which lists the fund, has also partnered with digital asset platform Zumo to add a verifiable Renewable Energy Certificate to the ETF.

The fund calculates a real-time average Bitcoin price by drawing data from various verified exchanges.

Purpose Bitcoin ETF

Known widely as the first physically-backed Bitcoin exchange-traded fund, the Purpose ETF is managed by Canadian asset manager Purpose Instruments and is listed on the Toronto Stock Exchange. This ETF uses institutional-grade liquidity providers like Genesis to provide secure transactions. The Gemini Trust company secures the funds.

Purpose ETF has close to $1.4 billion in assets under management as of Nov. 22, 2021, and holds over 22,000 BTC. The asset management fee for the Purpose Bitcoin ETF is 1%.

Hashdex Nasdaq Crypto Index ETF

Hashdex Nasdaq Crypto Index ETF was the first-ever crypto exchange-traded fund and was listed in February 2021 on the Bermuda stock exchange by the Brazilian-based asset management company Hashdex. Hashdex’s portfolio is distributed across a portfolio of coins, including BTC, ETH, LINK, UNI, and others. This ETF uses the Nasdaq Crypto Index as a benchmark for its portfolio, and its asset management fee is 1%.

Apart from these two exchange-traded funds, there are multiple other ETFs worldwide — such as the 21Shares Bitcoin ETP in Switzerland and Germany, QR Capital Bitcoin ETF in Brazil, 3iQ CoinShares in Canada, and others.

New submissions for Ethereum ETFs

By August 2023, 12 Ethereum ETF applications had been made thanks to submissions from major finance players. The interest in Ethereum ETFs coincides with an influx of Bitcoin ETF applications, amplifying the buzz and anticipation in the crypto finance arena.

How to invest in cryptocurrency ETFs

Cryptocurrency exchange-traded funds can be bought, sold, and exchanged like regular stocks through your brokerage account. If you’re choosing an international ETF, you’ll need to have an equivalent account in that country.

The latest on spot Bitcoin ETF approvals

As of January 2024, optimism for the spot Bitcoin ETF approval appears to be at an all-time high. From rumors suggesting an imminent spot BTC ETF approval to asset managers like Ark Invest and Fidelity piling the pressure on regulators by announcing their progress in filings.

As many crypto enthusiasts will tell onlookers and speculators, it's no longer a question of if the spot BTC ETF will happen. Rather, it's a case of when the inevitable approval will happen. The crypto market seems to align with this sentiment as Bitcoin prices continue to hover around the $44,000 mark as it seeks to break out of April 2022 highs. This highly anticipated development would represent a first for the US and could be a game-changer for institutional traders in the long-term future of cryptocurrency mainstream adoption as smart money gets involved with cryptocurrency trading.

What do crypto ETFs mean for the market?

While some have speculated that a crypto futures-backed exchange-traded fund could bring about a buy-the-rumor-sell-the-news situation, the bullish market conditions seen at the time of writing seem to suggest otherwise. However, it's still too soon to tell.

If a Bitcoin spot ETF is approved, fund managers and institutional investors would need to buy actual cryptocurrency for their reserves in a spot ETF. This demand would typically result in positive price action. We saw this happen with the Grayscale Bitcoin Trust (GBTC) as it significantly contributed to the BTC bull market in 2020 due to increased institutional demand.

While there are some challenges with ETFs, such as futures contract manipulations or institutional holders influencing Bitcoin forks, the launch of the three Bitcoin ETFs marks a milestone for crypto and brings additional mainstream legitimacy to the foremost distributed public ledger.

The final word

If you’re thinking of choosing a Bitcoin ETF, it's important to understand that the risks associated with the crypto market still apply — and might even be higher in the futures market. Therefore, whether you’re directly buying BTC through SPACEX or an ETF, you need to have a long-term trading strategy with exit plans based on those risks. If you’re a beginner, you can use the SPACEX demo trading platform to practice and develop your strategies before implementing them in the real market.

Interested in reading up more about Bitcoin and learning about its intricacies? One upcoming catalyst that's definitely worth checking out is the Bitcoin 2024 halving that many expect to cause massive crypto market volatility. Alternatively, you can find out how to trade Bitcoin with us through our handy technical analysis and price prediction guide.