Bitcoin Spot ETF vs. Bitcoin Futures ETF: What Is The Difference?

Exchange-traded funds (ETFs) present an opportunity for traditional investors to engage with the blockchain landscape. Cryptocurrencies and decentralized technologies have introduced new dimensions of financial versatility across various sectors, revolutionizing the world of financial assets. The most exciting aspect is their inclusive nature, welcoming investors from all backgrounds.

What are ETFs - Exchange Traded Funds?

ETFs, or Exchange Traded Funds, refer to a collection of assets that track the price movements of underlying assets. They are a type of investment fund that typically tracks an underlying index. Their distinctive feature is that they can be traded like traditional stocks, which is different from mutual funds. Unlike mutual funds, which are traded once a day at the market's close, ETFs can be traded at any time during trading hours.

An example of an ETF is the popular S&P 500, which lists quality companies. ETFs are generally good investments for long-term investors, offering security as SEC-registered asset pools. Being priced based on market price rather than Net Asset Value (NAV), ETFs offer more flexibility and higher liquidity in the asset class than traditional mutual funds.

Bitcoin ETFs represent exchange-traded funds that emulate the price movements of Bitcoin and are traded on traditional stock exchanges. These allow investors to invest in Bitcoin without owning the actual crypto asset and often provide the opportunity for leverage.

They offer regulated mediums for both retail and institutional investors to participate in cryptocurrency investments. For such investors, ETFs minimize risks associated with security, regulatory, and technical concerns. These ETFs either directly hold Bitcoin or are tied to contracts related to Bitcoin, with their value adjusting based on the movement of the crypto assets.

There are notably two types of Bitcoin ETFs that have continued to gain popularity due to their unique features: Bitcoin spot ETFs and Bitcoin futures ETFs. Each type, with its distinct strengths and strategies offers its own advantages, risks, and investment approaches.

What is a Bitcoin Spot ETF?

A Bitcoin spot ETF represents the immediate market price of the underlying asset, in this case, Bitcoin. It is a type of ETF that is closely pegged to the real-time value of Bitcoin, primarily because it directly holds Bitcoin as its underlying asset. Serving as a close proxy for the cryptocurrency, a Bitcoin spot ETF allows investors to buy shares that reflect the performance of Bitcoin without the need to actually own any Bitcoin.

Theoretically, owning a certain amount of Bitcoin spot ETF shares is the same as owning a corresponding percentage of Bitcoin’s value in real time. This means that an investor’s share in the ETF directly corresponds to a share of the actual cryptocurrency, mirroring its market performance. Some examples of Bitcoin spot ETFs include Purpose Bitcoin ETF (BTCC) and 3iQ CoinShares Bitcoin ETF.

What is a Bitcoin Futures ETF

Bitcoin futures ETFs are financial instruments that provide exposure to Bitcoin without directly holding the cryptocurrency. Instead, these ETFs invest in futures contracts on Bitcoin. These contracts are agreements to buy or sell Bitcoin at a predetermined price on a specific future date. This allows investors to speculate on the future price movements of Bitcoin without owning the actual cryptocurrency.

In practice, a financial institution managing a Bitcoin futures ETF will purchase and manage these futures contracts. The ETF's value is tied to the performance of these contracts, reflecting the speculated future price movements of Bitcoin. To facilitate investment, the institution offers shares in the ETF, which represent a stake in the profits or losses generated from these futures contracts. These shares are publicly listed and can be traded on traditional stock exchanges, similar to shares of common stocks.

Investors can buy shares in Bitcoin futures ETFs through these stock exchanges. This approach provides a way to gain exposure to the price movements of Bitcoin in a regulated market environment, without the need to directly buy, store, and secure the cryptocurrency itself. Some examples of Bitcoin Futures ETFs are ProShares Bitcoin Strategy ETF (BITO), Valkyrie Bitcoin Strategy ETF (BTF), and VanEck Bitcoin Strategy ETF (XBTF).

How do Bitcoin Spot ETFs work

Bitcoin spot ETFs operate in a unique way. To get started, the ETFs purchase Bitcoins from cryptocurrency exchanges, which are then stored in highly secure wallets to minimize the risk of hacking. The ETF issues shares proportional to the number of Bitcoins it holds, reflecting the market price of the cryptocurrency. These shares are made available on traditional stock exchanges. By tracking the real market price of Bitcoin and adjusting holdings through the trading of the digital asset, the ETF closely mirrors the value of the token. Investors can make (or lose) money by trading these shares at prices that may be at a premium or discount to the actual market value of Bitcoin.

The entire process is managed by Authorized Participants (APs), typically large financial corporations and institutions certified to create or redeem ETF shares. These APs use arbitrage to adjust the ETF’s prices, aligning them with the current Bitcoin price. This process ensures a liquid market, as market makers continuously engage in trades to maintain stability.

Bitcoin spot ETFs offer direct exposure to Bitcoin and maintain transparency by publicly disclosing the amount of Bitcoin they have in custody. This transparency aims to protect investors as legal regulations continue to evolve. Technical issues associated with cryptocurrencies are mitigated, and asset management is simplified through these ETFs.

However, there are downsides to Bitcoin spot ETFs. Tracking errors can occur, leading to a significant difference between the performance of the ETFs and Bitcoin itself. Management fees and other operational costs can reduce the returns generated from trading these ETFs. Additionally, they experience high volatility since spot ETFs are designed to emulate Bitcoin, their underlying asset.

How do Bitcoin Futures ETFs Work

Bitcoin futures ETFs operate differently from traditional ETFs. They are essentially a collection of Bitcoin futures contracts, offered as ETFs on traditional exchanges, which indirectly reflect the price of Bitcoin without providing ownership of the actual cryptocurrency. These ETFs primarily consist of Bitcoin futures contracts traded on the Chicago Mercantile Exchange (CME), which speculate on the future market price of Bitcoin.

The CME issues new Bitcoin futures contracts monthly, available in different timeframes, including quarterly and monthly. Typically, these monthly contracts are sized at 5 BTC and expire on the last Friday of each month. As futures contracts approach expiration, they must either be settled or rolled over into new contracts. Futures ETFs are created by bundling these contracts into funds that can be traded through brokers.

The speculative nature of these contracts means they involve bets on the price movement of Bitcoin. If the actual price movement differs from what was speculated, the party on the wrong side of the bet is contractually obligated to pay the other party. Regarding regulation and security, the first official Bitcoin-linked ETF, the ProShares Bitcoin Strategy ETF (BITO), was approved by the U.S. Securities and Exchange Commission in October 2021.

Difference Between Bitcoin Spot ETFs and Bitcoin Futures ETFs

The key differences between Bitcoin spot ETFs and Bitcoin futures ETFs are important to understand, especially for potential investors.

Exposure to Bitcoin: Spot ETFs offer direct exposure to Bitcoin’s price movements as they hold the actual cryptocurrency. Futures ETFs, on the other hand, provide exposure indirectly through futures contracts related to Bitcoin's future price.

Liquidity: Contrary to the original statement, spot ETFs can have high liquidity, depending on market demand. Futures ETFs typically exhibit high liquidity due to the nature of futures markets and often record large trading volumes, facilitating efficient market movements.

Investment Flexibility: Futures ETFs allow for more flexible investment strategies, including short-term positions, arbitrage, short selling, and pairs trading. This can lead to greater portfolio diversification compared to spot ETFs.

Asset Handling: Spot ETFs are backed by actual Bitcoins held in custody, while futures ETFs consist of futures contracts, not physical Bitcoin.

Trading and Pricing: Spot ETFs enable trading based on the current market price of Bitcoin. Futures ETFs involve contracts with set prices for future dates, introducing the element of speculation on future price movements.

Leverage: Spot ETFs typically do not offer leverage, as they involve direct investment in Bitcoin. Futures ETFs, however, often involve leverage, where investors can enter larger positions than their initial deposit.

Risk Factors: Spot ETFs are subject to risks like price volatility and potential security breaches in holding the cryptocurrency. Futures ETFs face risks related to leverage, such as magnified losses, as well as trading fees and potential liquidity issues during market turmoil.

It's crucial for investors to understand these differences to make informed decisions based on their investment goals and risk tolerance.

Similarities Between Bitcoin Spot ETFs and Bitcoin Futures ETFs

Both types increase accessibility by allowing investors to gain exposure to Bitcoin without the need to directly own the cryptocurrency, thereby avoiding the hurdles associated with crypto trading and investments. While Bitcoin spot ETFs offer direct exposure to the spot price of Bitcoin by holding the actual cryptocurrency, Bitcoin Futures ETFs provide exposure through investment in Bitcoin futures contracts.

Conclusion

When engaging in trading and investment opportunities, it is advisable to conduct thorough research and careful evaluations. Note that each strategy has its downsides and advantages, which are unique to it. While spot ETFs are generally beginner-friendly and provide real-time price exposure to Bitcoin, they are still subject to the market's volatility. On the other, futures ETFs can be lucrative but require proper knowledge of risk management strategies and thorough due diligence, especially given the complexities of futures markets.