Understanding Bitcoin ETFs: A Quick Overview
By Laxmikant Khanvilkar
Delving into comprehend What exchange-traded funds (ETFs) for Bitcoin are, and how do they function!
The bitcoin price is fast approaching the $60,000 mark, as of February 28, and has yielded the best return among all asset classes in 2023 as well as in the current year so far.
Bitcoin has jumped about 35% this year to its highest since December 2021. Approving 11 spot bitcoin ETFs in January 2024 provided buoyancy, offering traditional investors an easier way to invest in bitcoin.
Prior to the 50% cut, it is expected to gain more momentum. Bull runs in bitcoin’s price occurred in 2012, 2016, and 2020, the first three halvings. It is anticipated that the price will be much higher after the forthcoming halving in April 2024. Analysts predict prices will surpass $100,000.
Investment banker Benchmark expects Bitcoin to reach $125,000 at the end of 2025.
On January 10, 2024, the SEC gave the green light to 11 new spot bitcoin exchange-traded funds (ETFs). Exchange-traded funds, or ETFs, are a class of financial instrument that follows the fundamental performance of a group of stocks or commodities.
A spot bitcoin ETF is an exchange-traded fund (ETF) that tracks bitcoin’s spot price of bitcoin is known as a spot bitcoin ETF. Since the ETF is backed by an identical amount of bitcoin for each share that is sold, it truly has bitcoin backing.
Spot bitcoin ETFs are among the simplest ways to add bitcoin exposure to your portfolio, given the obstacles one must overcome in order to hold bitcoin, which include exchange accounts, digital wallets, private keys, network transfers, etc.
Spot ETFs, such as the recently introduced spot bitcoin ETFs, allow fund shares to be created or redeemed in response to market changes.
Investing in a spot bitcoin exchange-traded fund (ETF) allows individuals to profit from fluctuations in bitcoin’s market value without actually holding the commodity.
In contrast, bitcoin futures exchange-traded funds (ETFs) are limited to trading bitcoin futures and were approved for trading by the U.S. Securities and Exchange Commission in October 2021.
Futures are sophisticated derivatives instruments that follow the underlying asset’s prospective future price movements.
How Do Spot Bitcoin ETFs Operate?
Custodians keep a certain quantity of bitcoins bought by spot bitcoin ETFs in a safe digital wallet. These custodians provide safe vault storage for bitcoin. Insiders in the cryptocurrency space refer to the majority of these vaults as air gapped in “cold storage,” indicating that the bitcoin keys are kept offline and inaccessible via the internet.
After that, the ETFs issue shares to correspond with the bitcoins the fund owns. Investors can exchange these shares on conventional stock markets, pricing them to reflect the spot price of bitcoin at the moment.
Retail investors and traders may now purchase and sell an asset linked to the value of bitcoin at any time without having to own the actual cryptocurrency, thanks to spot bitcoin exchange-traded funds (ETFs). Additionally, they enable investors looking for visibility.
Spot ETF Pricing Dynamics
Custodians keep a certain quantity of bitcoins bought by spot bitcoin ETFs in a safe digital wallet. These custodians provide safe vault storage for bitcoin. These custodians keep the bitcoin keys offline and inaccessible via the internet in air-gapped “cold storage,” as insiders in the cryptocurrency space refer to it.
After that, the ETFs issue shares to correspond with the bitcoins the fund owns. Investors can exchange these shares on conventional stock markets, pricing them to reflect the spot price of bitcoin at the moment.
Retail investors and traders may now purchase and sell an asset linked to the value of bitcoin at any time without having to own the actual cryptocurrency, thanks to spot bitcoin exchange-traded funds (ETFs). They also give investors a much easier option than forming a self-directed IRA that might hold bitcoin directly if they want exposure to the cryptocurrency in retirement funds.
Maintaining the Price of a Spot ETF
A spot ETF’s price may differ from the underlying asset’s true value.
Authorized participants, or APs, create or redeem large blocks of shares to align the fund with the asset’s true value. APs are usually big banks that take advantage of the arbitrage opportunity that arises when the price of an ETF is greater or lower than the value of the underlying asset.
The Future of Spot Bitcoin ETFs
The SEC had been turning down requests for a spot bitcoin exchange-traded fund (ETF) for years, with over 20 rejections between 2018 and 2023.
On January 10, the SEC approved eleven spot bitcoin exchange-traded funds (ETFs), signaling a change in the way authorities view cryptocurrencies. The SEC has received a flurry of new applications for clearance, indicating that there might be more spot bitcoin ETFs in the works.
It’s important to keep in mind that the SEC may not approve other cryptocurrency ETFs just because spot bitcoin ETFs have received approval.
Gary Gensler, chairman of the SEC, stated in the SEC’s announcement of the approval of spot bitcoin ETFs, “Importantly, today’s Commission action is cabined to ETPs holding one non-security commodity, bitcoin. It should in no way signal the Commission’s willingness to approve listing standards for crypto asset securities.”
In the near future, these spot ETFs will make it easier for more people to invest in bitcoin. Buying money from cryptocurrency exchanges to meet the demand for spot ETFs could lead to increased demand for bitcoin.
Before putting any money into a spot bitcoin ETF, investors should be aware of the risks involved.
Spot Bitcoin ETFs: Pros & Cons
Legitimacy:
Now that spot bitcoin ETFs have been approved, people view the original Bitcoin as a more respectable asset class. Almost every kind of investment account, including 401(k)s and individual retirement plans, allows investors from all walks of life to invest in bitcoin.
Liquidity:
Large blocks of bitcoin may be bought and sold by ETFs in response to demand, which might eventually boost liquidity and contribute to price stability.
Cost:
Although the price of bitcoin is not directly impacted by a spot ETF, over time the price may rise due to increased demand and purchases of bitcoin by these ETFs.
Commission:
Through increased use and accessibility via a spot ETF, investors might be able to access bitcoin with lower trading fees than some crypto exchanges.
Regulation:
Now linked to the price of bitcoin, are strictly regulated securities. Regulatory actions can impact the prices of spot bitcoin ETFs and bitcoin itself.
Bitcoin custody:
Investors can track the price of bitcoin by investing in a spot bitcoin exchange-traded fund (ETF), but they cannot keep ownership of the asset. You’re entrusting your bitcoin to be “HODL”d by an outside custodian. Not your bitcoin, not your keys,” claims Zlatic.
Annual charges:
The yearly expense ratios of spot bitcoin ETFs may make ownership more costly than buying and storing the cryptocurrency yourself, even though trading them might be less expensive in the short run.
Erratic behavior:
Even if spot bitcoin ETFs will contribute to a greater adoption of bitcoin, it is still a highly volatile asset with sharp price swings, which can be detrimental to investors who aren’t ready for the risk associated with bitcoin ownership.
There are other ways to invest in bitcoin outside of spot bitcoin exchange-traded funds (ETFs), which can give you immediate exposure to the price of bitcoin. You can buy bitcoin directly, invest in ETF futures, or buy stocks or shares of a bitcoin mining company.
As far as Indian investors are concerned, their participation in foreign stock and ETF markets is regulated by the Reserve Bank of India’s Liberalised Remittance Scheme (LRS). Under this scheme, investors from India can allocate up to $250,000 for investments, including in US ETFs.
Remember, cryptocurrencies are not legal in India via any explicit set of regulations; they are not illegal either. However, the government has rolled out a 1% TDS and capital gains tax on virtual digital currencies (VDAs) in 2022, thus setting the tone for legitimacy and the regulatory framework.
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