🧾 With the introduction of Bitcoin Exchange-Traded Funds (ETFs), Bitcoin is finally arriving on Wall Street. With BlackRock, the largest investment firm in the world, filing for a Bitcoin ETF and many other large firms following suit, the question is: what exactly is an ETF, and why are Bitcoin ETFs causing such a stir?
In this blog post, we look at the basics of ETFs, focusing on Bitcoin ETFs. We look at what makes Bitcoin ETFs special, how they differ from real Bitcoin, and what impact they can have on the price of Bitcoin.
💬 WHAT IS AN ETF?
An ETF (Exchange-Traded Fund) is an investment fund that tracks the price of an underlying asset or a group of underlying assets. ETFs are traded on the stock exchange, similar to individual shares. The advantage of ETFs is that they offer an easy way to invest in a specific asset class or sector. And often at a lower cost than buying the assets directly.
ETFs are a relatively new financial product since the early 1990s. The first successful ETF in the United States was the Standard & Poor’s Depositary Receipts (SPDR), launched in January 1993. This ETF, commonly known by its ticker symbol “SPY”, was designed to track the S&P 500 stock index. This allows investors to invest in the entire index of the 500 largest listed companies in the USA via a single financial product.
Since then, ETFs have become popular due to their low cost, tax efficiency, and ease of trading. This has spawned numerous other ETFs that track various asset classes and indices. ETFs have evolved considerably since their introduction and have become a popular investment instrument for private and institutional investors, especially in recent years.
💬 WHAT TYPES OF ETFS ARE THERE?
Different types of ETFs (Exchange-Traded Funds) are geared toward different asset classes, strategies, and markets. Equity ETFs, for example, track equity indices or specific equity segments, such as sectors, countries, or regions. Bond ETFs invest in bonds and attempt to replicate the performance of bond indices. Commodity ETFs provide access to commodity markets, from precious metals such as gold and silver to agricultural commodities and energy. Sector ETFs focus on specific industries such as technology or healthcare. Regional ETFs invest in stocks or bonds from specific geographic regions or countries. Factor ETFs use quantitative factors such as dividend yield or volatility to select stocks. There are also thematic ETFs focusing on trends such as renewable energies or artificial intelligence.
A basic distinction can also be made between spot and futures ETFs:
🔸 SPOT ETF (PHYSICAL ETF):
A spot ETF invests in physical assets that are traded on the current market, and its value depends directly on the performance of these assets. Spot ETFs are often used for long-term investments.
🔸FUTURES ETF (INDEX OR FUTURES-BASED ETFS):
A futures ETF uses derivatives such as futures contracts to track the performance of an index or asset class. Its value depends on the performance of these futures contracts and may differ from the actual assets. Futures ETFs are often used for short-term trading purposes.
🔺 HOW DOES A BITCOIN ETF WORK?
A Bitcoin ETF works on the same principles as a traditional ETF but focuses on Bitcoin, the first and most popular cryptocurrency. A Bitcoin ETF aims to track the market price of Bitcoin and offers investors a way to participate in the Bitcoin market without having to buy, hold, or manage the actual asset directly. This is particularly interesting for investors interested in the potential gains from Bitcoin’s price movements but do not want to or cannot deal with the technical aspects of proper storage.
In the case of the Bitcoin ETF applied for by BlackRock, it is a spot ETF. This means that BlackRock buys and holds real bitcoins for clients who invest in the Bitcoin ETF. The value of the ETF shares traded on the exchange then reflects the current market value of those bitcoins. When investors buy a share in a Bitcoin ETF, they acquire a share in the collective pool of Bitcoins held by the ETF.
For more traditional or large institutional investors, a Bitcoin ETF is an important step towards integration into traditional investment portfolios. It provides a familiar investment vehicle to access a new asset class. It avoids the difficulties and risks associated with setting up a wallet, buying Bitcoin on an exchange, and storing it securely. This added security and regulatory compliance layer could attract investors who have previously hesitated to invest in Bitcoin.
🔺 BITCOIN ETF VS. REAL BITCOINS: WHAT’S THE DIFFERENCE?
While a bitcoin ETF reflects the price of bitcoin, it’s important to note that investors in a bitcoin ETF do not own real bitcoins. Instead, they hold a security that tracks the market price of Bitcoin. This distinction is important for several reasons, particularly concerning ownership rights and the philosophy behind Bitcoin.
BITCOIN ETFS ARE ATTRACTIVE TO INSTITUTIONAL INVESTORS FOR THE FOLLOWING REASONS:
Regulatory oversight: Bitcoin ETFs will be traded on regulated exchanges and thus subject to financial regulators, providing oversight and security that meets institutional investment standards.
Reduced custody risks: Investing in Bitcoin ETFs eliminates the need to store and manage bitcoins securely, reducing the risks associated with cryptocurrency custody.
Operational and trading efficiency: ETFs provide a familiar, efficient, and liquid investment vehicle that allows institutional investors to incorporate Bitcoin into their portfolios without the complexity of direct cryptocurrency transactions.
HOWEVER, OWNING REAL BTC (BITCOIN) HAS DISTINCT ADVANTAGES FOR RETAIL INVESTORS:
Full ownership and control: direct ownership of Bitcoin allows complete control. Investors can manage, transfer, or use their bitcoins without relying on a third party such as a bank or financial services provider, providing greater autonomy and privacy.
Potential for higher returns: Owning Bitcoin directly allows investors to benefit fully from price appreciation. Unlike ETFs, which come with fees that can somewhat diminish returns, owning real BTC means that potential gains are not reduced by management or operational costs.
Consistency with Bitcoin principles: Investing in real Bitcoins aligns with the basic principles of Satoshi Nakamoto’s idea – decentralization and disintermediation. It supports the ethos of a financial system free from traditional banks and government control, a key appeal of Satoshi Nakamoto’s invention for many investors.
⚠️ POSSIBLE DISADVANTAGES AND RISKS OF BITCOIN ETFS
When discussing Bitcoin ETFs, addressing the potential downsides and risks is important.
One main risk is the potential centralization of the Bitcoin holdings that can be compared. In addition, the involvement of large financial institutions in the Bitcoin market via ETFs could affect the supply and demand dynamics of Bitcoin. As investors in Bitcoin ETFs do not own the actual Bitcoin but a share in a fund that tracks the price, the direct link between supply and demand could be obscured. This could result in price movements in Bitcoin ETFs not accurately reflecting actual market sentiment or the underlying asset’s value.
Another aspect is the potential impact on the Bitcoin network and technological development. Institutional exposure to Bitcoin, especially through ETFs, could influence network upgrades and change decisions. There is a risk that institutional investors’ priorities may not align with those of the broader Bitcoin community, particularly in terms of improving the privacy and scalability of the network.
While Bitcoin ETFs offer investors a convenient and familiar way to invest in Bitcoin, they also carry risks related to centralization, market dynamics, and the future development of Bitcoin technology. These factors need to be carefully considered by investors and enthusiasts as Bitcoin continues to intersect with traditional financial structures.
📊 THE IMPACT OF A BITCOIN ETF ON THE BITCOIN PRICE
The introduction of a Bitcoin ETF is expected to impact the price of Bitcoin significantly. Firstly, it opens the doors to a wider range of investors, especially those familiar with traditional investment vehicles. This may lead to increased demand and drive up the price. However, looking at this with a balanced perspective and considering volatility and the complex interplay of various economic factors is important.
It is important to note that it is impossible to predict the exact impact on the Bitcoin price. The Bitcoin market is known for its high volatility and is influenced by many factors beyond supply and demand. These include the global economic situation, regulatory changes, technological advances, and investor sentiment swings. A Bitcoin ETF is another variable in this complex mix.
❓ IS OWNING A BITCOIN ETF THE SAME AS OWNING BITCOIN ITSELF?
No, owning a Bitcoin ETF is fundamentally different from owning real Bitcoin. When you own a Bitcoin ETF, you invest in a financial product that tracks the price of Bitcoin, not the cryptocurrency itself. This means that you don’t have the same control over Bitcoin as you would if you owned it directly, such as the ability to use or transfer it directly.
❓ CAN A BITCOIN ETF INFLUENCE GENERAL MARKET SENTIMENT TOWARDS BITCOIN?
Yes, the introduction of a Bitcoin ETF can have a significant impact on market sentiment. It represents a form of validation and mainstream acceptance of Bitcoin and could attract more investors into the cryptocurrency space. This could lead to increased demand and potentially influence the price of Bitcoin.
❓ WHAT SHOULD INVESTORS CONSIDER BEFORE INVESTING IN A BITCOIN ETF?
Before investing in a Bitcoin ETF, you should consider factors such as Bitcoin’s inherent price volatility, how it aligns with your investment goals, and the differences between owning a Bitcoin ETF and real Bitcoin. Understanding the ETF’s fee structure and how it can affect your returns is important.
❓ HOW CAN A BITCOIN ETF DIFFER FROM OTHER TRADITIONAL ETFS?
While a Bitcoin ETF is similar in structure to traditional ETFs, it tracks the performance of a highly volatile and relatively new asset class – Bitcoin. This means it may have higher volatility and different risk/return characteristics than ETFs that track stocks, bonds, or commodities.
❓ COULD A BITCOIN ETF LEAD TO GREATER SCRUTINY OF BITCOIN BY REGULATORS?
Introducing a Bitcoin ETF could draw the attention of regulators to Bitcoin and the wider cryptocurrency market. As Bitcoin ETFs would be regulated financial products, they could prompt regulators to establish clearer guidelines or rules for the cryptocurrency market, which could have far-reaching consequences for Bitcoin investors and users.