What Are Bitcoin Exchange-Traded Funds (ETFs)

Since its inception amidst the global financial market crisis, Bitcoin has presented itself as one of the most valuable asset classes. Initially, it was valued at less than a dollar as a cryptocurrency for novel technology — blockchain — it soared to its all-time high of $69,000. This unprecedented growth has been incredibly profitable for early adopters.

Bitcoin’s growth has captured widespread attention and significantly contributed to the overall adoption of cryptocurrencies. However, a particular group of retail traders and investors finds it difficult to navigate the uncharted cryptocurrency space. Several factors contribute to this difficulty, including the market's unregulated nature, the need for technical expertise, and the associated costs.

Bitcoin Exchange-Traded Funds (ETFs) have been developed as a solution to address these issues, providing these individuals with the opportunity to trade Bitcoin without requiring direct exposure. Currently, Bitcoin Futures ETFs remain the most popularized form of Bitcoin ETFs, which we will explain in greater detail.

Understanding All About Bitcoin Futures ETFs

Bitcoin Futures ETFs represent pools of assets managed by specific financial firms, and they are available for trading on traditional exchanges. These funds serve as investment vehicles, offering investors exposure to Bitcoin without requiring the direct investment and storage of the cryptocurrency. Instead of holding Bitcoin directly, these ETFs invest in Bitcoin futures contracts, providing an alternative way to interact with the cryptocurrency market.

Since it is a Bitcoin Futures ETF, investors do not actually hold the Bitcoin futures contracts themselves. This arrangement implies that the contracts are to be bought and sold at a predetermined price on a specified date, aligning with the workings of futures contracts.

Bitcoin futures ETFs operate in a straightforward manner. Investors purchase these ETFs, which are listed on an exchange, from institutions that peg the ETFs’ value to that of Bitcoin. These institutions use a strategy known as rolling contracts. This involves selling futures contracts as they near expiration and acquiring new contracts set to expire at a later date. This strategy ensures continuous exposure to Bitcoin's price movements and helps maintain the investment position.

Historical Record of Bitcoin ETF

The concept of a Bitcoin ETF was first introduced in 2013 when Cameron and Tyler Winklevoss, founders of the cryptocurrency exchange Gemini, filed with the Securities and Exchange Commission.

Currently, there is a limited number of Bitcoin futures ETFs available, and availability varies by jurisdiction. In the United States, the Security and Exchange Commission (SEC) approved the first Bitcoin futures ETF, Proshares Bitcoin Strategy ETF (BITO), in October 2021, and it was subsequently listed on the New York Stock Exchange.

Countries like Canada were ahead of the curve, approving three Bitcoin futures ETFs in the same month. The Purpose Bitcoin ETF (BTCC) came first, followed by the Evolve Bitcoin ETF (EBIT) and the CI Galaxy Bitcoin ETF (BTCX). Unlike the United States, Canada also supports Bitcoin spot ETFs, specifically BTCC and BTCX.

Bitcoin Futures ETFs Vs Bitcoin Spot ETFs

Various types of Bitcoin ETFs exist. Currently, Bitcoin Futures ETFs are the more widely accepted type among investors, distinguishing themselves from Bitcoin Spot ETFs, which take a distinct approach to Bitcoin investment.

The main difference is that a spot Bitcoin ETF lets you have direct exposure to actual Bitcoin, whereas a futures Bitcoin ETF involves dealing with contracts linked to Bitcoin's price. With a futures ETF, you keep buying new contracts when the old ones expire and vice versa. Bitcoin futures ETFs can often trade significantly above or below Bitcoin’s actual price, which is less common with the Bitcoin spot ETFs since they closely track Bitcoin’s actual price.

Bitcoin futures ETFs have become widely accepted due to more lenient regulatory restrictions. In contrast, Bitcoin spot ETFs have faced significant challenges and struggled to gain traction due to ongoing regulatory hurdles and backlash.

However, the recent ruling by the D.C. Circuit Court of Appeals, which ordered the SEC to close its case against Grayscale Investments LLC’s Bitcoin spot ETF filing, opens up the potential for such an ETF in the future. Despite this legal victory, it is still within the capacity of the SEC to reject Grayscale’s proposal on other grounds. If it does not, we might see the launch of the first US Bitcoin spot ETF. The SEC has not yet made a public announcement about its decision on other Bitcoin spot ETF applications filed by major asset management firms, including BlackRock and Fidelity.

How To Invest in Bitcoin Futures ETFs

The investment process in Bitcoin futures ETFs varies depending on the investor’s jurisdiction. In the US, investors have the option to directly invest on major exchanges such as the New York Stock Exchange or Nasdaq. Popular ETF choices for those in the US include the ProShares Bitcoin Strategy ETF (BITO) and the Valkyrie Bitcoin Strategy ETF (BTF). Meanwhile, in Canada, which is prominent for approving Bitcoin ETFs in the early days, investors can opt for products like the Purpose Bitcoin ETF (BTCC) or the Evolve Bitcoin ETF (EBIT), available through the Toronto Stock Exchange and other Canadian exchanges.

Benefits of Bitcoin Futures ETFs

• Regulatory Overview: Investors and institutional traders, previously restricted from trading Bitcoin due to its lack of official regulation, can now confidently engage with these assets. This is because Bitcoin ETFs are supervised by governmental bodies, such as the Commodity Futures Trading Commission (CFTC) in the US, which oversees Bitcoin futures ETFs. This supervision ensures a higher level of security and transparency.
• Accessibility and Simplicity: Bitcoin futures ETFs offer investors a way to gain exposure to Bitcoin assets through the purchase of ETFs directly from traditional exchange accounts. This presents a simple method to start trading and become involved in digital currencies, removing the need for technical know-how and understanding the complexities of the cryptocurrency market, such as secure asset storage, and the roles of private and public keys.
• Better Tax Efficiency: Directly trading assets like Bitcoin typically means investors need to manage the tax-related requirements associated with capital gains themselves. However, with Bitcoin ETFs, the impact of capital gain distributions can be significantly reduced, leading to better tax efficiency.

Risks of Investing Bitcoin Futures ETFs

• Tracking Error: A common issue in trading Bitcoin futures ETF is a tracking error, which occurs when the ETF’s price deviates from Bitcoin's actual market price. This discrepancy can arise from a process called “rolling contracts” in Bitcoin futures ETFs, leading to situations like contango or backwardation. Contango happens when futures prices are higher than the spot price, while backwardation occurs when futures prices are lower. Both scenarios can negatively impact the performance of a Bitcoin ETF.
• Associated Costs: Investing in Bitcoin ETFs also involves various associated costs, which is another major issue for traders. These include transaction costs incurred during the purchase and sale of futures contracts and management fees required to operate the Bitcoin ETF. Together, these costs can significantly impact a trader’s overall profitability.

Financial Giants Showing Interest in Bitcoin ETFs

Numerous well-established financial entities are aiming to enter the Bitcoin ETF space, with several presently in the process of having their applications reviewed by the SEC. Some of these financial giants include:

Grayscale: It is well-known for its Bitcoin Trust (GBTC), which, while functioning similarly to an ETF, is not technically classified as one. Despite this, GBTC does offer investors direct exposure to Bitcoin, similar to Bitcoin ETFs. GBTC shares can trade at a premium or discount to the actual price of Bitcoin; these factors played a role in Grayscale's decision to apply to the SEC for a conversion of its GBTC into a Bitcoin spot ETF. Although the SEC initially resisted the application, Grayscale prevailed, receiving court approval for their request.

Fidelity: This is a major financial player with an interest in cryptocurrencies. It created a subsidiary known as Fidelity Digital Assets to manage cryptocurrency investments and services. The firm has submitted a Bitcoin ETF application to the SEC, seeking to offer its clients a regulated means to gain Bitcoin exposure. However, they are still awaiting the SEC's approval.

BlackRock: This is among the world's largest asset managers with trillions of dollars in assets under management (AUM). BlackRock is a pioneer in expressing interest in cryptocurrencies and blockchain technology. The firm took an important step by filing for a Bitcoin spot ETF in June 2023.

The Future of Bitcoin ETFs

Bitcoin ETFs provide a valuable entry point for institutional investors and others previously hesitant to engage with one of the world's leading assets. They address major concerns such as regulatory oversight and the complexities of asset management.

Grayscale's recent victory over the Securities and Exchange Commission (SEC) offers a glimmer of hope for the acceptance of Bitcoin spot ETFs in the US soon.

However, opinions within the Bitcoin and cryptocurrency communities vary, as some believe that this undermines the fundamental principle of decentralization in cryptocurrency. Despite these concerns, it is anticipated that Bitcoin ETFs could encourage more investors to explore cryptocurrency trading, which will impact adoption.