What is a Bitcoin ETF, and How does it work?

Bitcoin is one of the most popular cryptocurrencies and enjoys the biggest market share in the domain of crypto. However, many people are still doubtful about purchasing Bitcoin. As a matter of fact, most of them believe that buying Bitcoin from crypto exchanges can be an intimidating process. In such cases, it is important to look for a Bitcoin exchange-traded fund or ETF as an alternative solution.

It is important to note that technical aspects of Bitcoin ownership, such as private keys, Bitcoin addresses, and crypto wallets, can create confusion for newcomers. The demand for a Bitcoin ETF gained momentum due to the need for a more transparent and easier method to invest in Bitcoin. With the arrival of ETFs, investors would find a direct channel for investing in Bitcoin. You must also note that ETFs offer an easy way to invest in bonds, currencies, and equities.  

The concept of ETFs has dominated traditional financial markets for years. It is important to note that ETFs make up a $7 trillion industry that allows investors to capitalize on performance of a basket of assets. The growing demand for BTC ETFs can be verified by the fact that major financial institutions in the US have applied to launch ETFs.

Some of the top names, such as Fidelity and BlackRock, have sent applications to the US Securities and Exchange Commission or SEC to launch ETFs. Interestingly, other countries in Europe, Canada, and Brazil have been quicker to come up with approvals for Bitcoin ETFs. Let us learn more about Bitcoin ETFs and how they work.

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Definition of a Bitcoin ETF

The definition of a Bitcoin ETF paints it as a publicly traded investment fund that can offer exposure to Bitcoin. The special highlight of ETFs is that you don’t have to own the cryptocurrency. If you are interested in Bitcoin ETFs trading, then you must know that ETFs cannot be traded on crypto exchanges like other cryptocurrencies.

On the contrary, ETFs are traded through traditional securities exchanges, such as NASDAQ and the New York Stock Exchange. In technical terms, the Bitcoin ETF tracks the performance of Bitcoin with the help of futures contracts. Future contracts are derivative investment securities that help investors speculate on the future prices of assets. 

A brief overview of the workings of Bitcoin ETFs showcases that Bitcoin futures contracts serve as agreements between two parties. Such contracts specify the conditions for buying or selling a particular amount of Bitcoin at a predefined price at a specific time in future. With the help of futures market, investors could find an effective solution for hedging against possible price fluctuations of Bitcoin. 

The most important highlight of a Bitcoin ETF guide is that you don’t have to purchase Bitcoin directly. In simple words, exchange-traded funds help in buying shares in a fund that holds ownership of Bitcoin. On top of it, regulations for ETFs also ensure that traditional investors can gain exposure to Bitcoin without technological hurdles.

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What are the notable Variables of Bitcoin ETFs?

If you want to know how Bitcoin ETF works, then you must know about the notable variants of Bitcoin ETFs. The most popular variant of Bitcoin ETFs is futures Bitcoin ETFs, while spot Bitcoin ETFs await approval from the US SEC. The futures Bitcoin ETFs do not actually hold Bitcoin and rely on Bitcoin futures contracts for offering exposure to Bitcoin. Bitcoin futures contracts help investors speculate on the future price of Bitcoin and bet on it.

The behavior of futures Bitcoin ETFs is different from that of spot Bitcoin ETFs. For example, you might come across additional costs for rolling over or settlement of futures contracts. As a matter of fact, some futures Bitcoin ETFs are tailored to offer inverse exposure to Bitcoin price, thereby helping investors leverage profits as well as losses. 

On the other hand, spot BTC ETF is an exchange-traded fund that offers direct exposure to the current pricing of Bitcoin. The term ‘spot’ implies the current or immediate price of the underlying asset or Bitcoin. Spot Bitcoin ETFs generally have ownership of actual Bitcoin and work by closely tracking the real-time pricing of Bitcoin. In other words, spot Bitcoin ETFs invest directly in Bitcoin. The value of ETF is directly correlated to the price of Bitcoin in the market.

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What is the Necessity of ETFs?

You might wonder why you should invest in Bitcoin ETFs when you can buy Bitcoin directly from crypto exchanges. It is important to look at Bitcoin exchange-traded funds from the perspective of regular retail investors. They still perceive that Bitcoin and other cryptocurrencies are a risky investment choice.

First of all, it is important to note that cryptocurrencies do not have clear regulations. You would need a Bitcoin wallet and trustworthy crypto exchanges to purchase Bitcoin. Any individual who is new to cryptocurrencies would have doubts regarding interactions with crypto exchanges. 

Ownership of Bitcoin also means that you have to take responsibility for security of the assets. You have to ensure safety of your private keys with the help of a hardware wallet or store your private keys in a secure location. On top of it, you might have to figure out the ideal methods for filing taxes on the sales of Bitcoin, which leads to capital gains. 

With the help of Bitcoin ETF trading, investors would not have to worry about storage, security, and their private keys. Users could only own shares in a Bitcoin ETF, like the shares of a company’s stock in traditional markets. It can help you gain exposure to Bitcoin without the hassles of purchasing and storing cryptocurrencies.

Therefore, ETFs are an extremely appealing value proposition for regular retail investors as well as institutional investors. Different types of investment firms and hedge funds have filed applications to the US SEC to obtain approvals for Bitcoin ETFs.

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Working Mechanism of Bitcoin ETFs

The next important highlight in a Bitcoin ETF guide points to its working mechanism. You must note that Bitcoin ETFs work in a similar manner as traditional ETFs. The big difference with Bitcoin ETFs is that they are linked to the performance of Bitcoin futures contracts rather than traditional assets such as bonds and stocks. Bitcoin ETFs invest in the related Bitcoin futures contracts alongside other financial instruments that replicate the performance of Bitcoin.

Bitcoin ETFs are available on stock exchanges like individual stocks, and the pricing of the ETFs depends on the underlying Bitcoin futures contracts. Investors aspiring to gain exposure to Bitcoin market can purchase shares in a Bitcoin futures ETF just like any traditional ETF. 

The explanations for how Bitcoin ETF works show that they are similar to traditional exchange-traded funds. Generally, an asset management company or ETF issuer buys the underlying asset and stores it securely with selected custodians. Subsequently, the issuer would issue shares of the fund to provide access to underlying assets in the fund.

The financial institution takes an annual fund management fee and bears the responsibility of buying, storage, and safekeeping for Bitcoin on behalf of investors in Bitcoin ETF. Upon making investments in Bitcoin ETF, you would purchase shares in a pool of Bitcoin. The working of Bitcoin ETF also focuses on creating new ETF shares to match the demand. When users sell their shares, they are redeemed, thereby adjusting the supply of ETF shares.

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History of Progress of Bitcoin ETF

The introduction to BTC ETF also requires an in-depth review of the history of Bitcoin ETFs. When did the journey of Bitcoin ETFs begin? Interestingly, the famous Winklevoss Twins were the first players to advocate for ETFs by filing the first Bitcoin ETF proposal in July 2013. However, the SEC rejected the proposal and also thwarted their second Bitcoin ETF proposal in June 2018. The SEC continued rejecting Bitcoin ETF proposals till February 2020. In September 2020, the Bermuda Stock Exchange listed the first Bitcoin ETF.

Canada became the first country to launch its Bitcoin ETF in February 2021 and also approved two more ETFs in the same month. The first Bitcoin ETF listed in the US was launched in October 2021. Another notable milestone for Bitcoin exchange-traded fund history is the order by a US court to review the decision of SEC to deny application of Grayscale for a spot Bitcoin ETF.

Subsequently, the SEC did not appeal, and thus, the US Court of Appeals issued a formal order in October 2023 for the SEC to review the application of Grayscale. In December 2023, the chairman of SEC claimed that the regulatory authority has been reviewing applications for launching a sport Bitcoin ETF.

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What are the Reasons to Consider Investing in ETFs?

Bitcoin ETFs are tailored to help retail investors with simpler approaches to investing in Bitcoin and other cryptocurrencies. ETFs help in avoiding the expenses and complications associated with purchasing Bitcoin directly. The review of how Bitcoin ETF works provides multiple inputs on the reasons to use ETFs for investing in Bitcoin. Here are some of the most prominent value advantages of Bitcoin ETF.

• Security 

One of the most notable advantages of Bitcoin ETF is the assurance of enhanced security. When you store cryptocurrencies like Bitcoin in your wallet, you do not have actual virtual currencies in the wallet. On the contrary, you have to safeguard the security keys to protect Bitcoin under your ownership. You might have to store your keys on the exchange from which you purchase cryptocurrencies. 

It is important to note that hackers can steal the keys to wallets and crypto exchanges, thereby compromising your Bitcoin. With an ETF, you don’t have to worry about ownership of any cryptocurrency and ensure safe storage of keys. In addition, ETFs ensure that you don’t have to move your keys across different types of storage. Therefore, you can find better security with Bitcoin ETFs.

• Accessibility 

The next prominent reason to choose Bitcoin ETFs is the assurance of lower barriers to entry. Bitcoin is a high-end crypto asset, and its price could range up to $69,000 per unit. Due to the high cost, retail investors might refrain from purchasing Bitcoin. On the contrary, BTC ETF offers better exposure to Bitcoin within the desired budget, investment goals, and acceptable levels of risk tolerance.

• Diversification of Risks

Investing only in Bitcoin can open you up to multiple risks. However, Bitcoin ETF trading involves holding more than one asset. Bitcoin ETFs hold Bitcoin alongside Facebook stocks, Apple stocks, and other assets. Therefore, investors could find an easy opportunity for risk mitigation alongside diversifying their investment portfolio. Furthermore, Bitcoin ETFs can be traded on regulated market exchanges, thereby enabling opportunities for diversification of existing equity portfolios.

What are the Limitations of Bitcoin ETFs?

The most crucial highlight in a Bitcoin ETF guide would draw attention to limitations of Bitcoin ETFs. Some of the most notable setbacks of Bitcoin ETFs include inaccuracy, burden of management fees, and limitations on cryptocurrency trading. On top of it, ETFs also create limitations for Bitcoin ownership. ETF issuers charge a management fee for the convenience of maintaining exchange-traded funds.

You could not trade Bitcoin exchange-traded funds for other cryptocurrencies like Ethereum, XRP, and Litecoin. Another limitation of Bitcoin ETF is the involvement of government control that takes away all the benefits of decentralized ownership. Furthermore, Bitcoin ETFs may present inaccuracies in tracking the price of Bitcoin, thereby leading to broader implications.

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Final Words

The introduction of Bitcoin ETFs could change the conventional approaches to participation in crypto investments. It provides an effective tool for leveraging the capabilities of Bitcoin without the burden of risks of Bitcoin ownership. For instance, the description of how Bitcoin ETF works shows that they track the price of assets in a fund.

ETFs offer better security as investors do not have to own cryptocurrencies in their wallets. In addition, ETFs also provide an effective solution for regular retail investors to enter the cryptocurrency market without any confusion. Learn more about the fundamentals of Bitcoin ETFs and how you can interact with them right now.

*Disclaimer: The article should not be taken as, and is not intended to provide any investment advice. Claims made in this article do not constitute investment advice and should not be taken as such. 101 Blockchains shall not be responsible for any loss sustained by any person who relies on this article. Do your own research!