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Understanding Spot Bitcoin ETFs
By Laxmikant Khanvilkar
Recently, the U.S. financial markets regulator, the Securities and Exchange Commission (SEC), approved the first US-listed exchange-traded funds (ETF) to track bitcoin, a watershed moment for the world’s largest cryptocurrency and the broader crypto industry.
The SEC has given the green light to 11 ETFs for bitcoin in the US, opening the door to cryptocurrencies for many new investors who don’t want to take the extra steps involved in buying actual bitcoin.
Let us understand: What is an ETF, and how does it help investors?
Investing in a portfolio of assets or a collection of assets via an exchange-traded fund (ETF) is a simple alternative to buying individual assets.
What is a Spot Bitcoin ETF?
Spot bitcoin exchange-traded funds (ETFs) provide average people with access to the price fluctuations of bitcoin via their standard brokerage accounts. An exchange-traded fund (ETF) that tracks the price of bitcoins rather than futures contracts is known as a spot bitcoin ETF.
Regular investors now have a regulated and readily accessible way to buy digital money via spot bitcoin exchange-traded funds (ETFs). However, management fees and brokerage commissions still exist, despite the absence of time- and exchange-related costs associated with directly purchasing and holding bitcoins.
U.S. regulators were initially wary due to concerns about custodial risk and market manipulation, despite the wide acceptance of both kinds of ETFs in other nations. The U.S. Securities and Exchange Commission approved the first bitcoin spot ETFs in January 2024 and the first bitcoin futures ETFs in 2021.
Noticeable aspects of investing in a spot bitcoin exchange-traded fund (ETF):
- Spot bitcoin ETFs provide investors with a regulated and easier way to profit from fluctuations in bitcoin prices.
- Bitcoin is really owned by a spot ETF, as opposed to a futures-based ETF.
- More stable pricing and quicker price discovery in the bitcoin market might be the result of enhanced liquidity, which spot bitcoin ETFs make possible.
- The costs of acquiring and trading bitcoin might cause Bitcoin spot ETFs to have higher fees compared to other products.
- On January 20, 2024, the first eleven bitcoin spot ETFs were authorized by the SEC after many rejections of petitions by crypto asset managers.
Spot Bitcoin ETFs: How They Work
To keep bitcoins, secure in a digital vault, spot bitcoin ETFs use licensed custodians.
Forbes. “High Probability of Year-End Approval Is Indicated by SEC’s Active Engagement with Spot Bitcoin ETF Issuers.”
Cryptocurrency Exchange-Traded Funds (ETFs) attempt to track the price of bitcoins on the market. To get started, the ETF acquires bitcoins from other holders or through approved cryptocurrency exchanges. Digital wallets often utilize several levels of protection, including offline or cold storage, to reduce the danger of hacking, after which the tokens are stored in them.
After that, the ETF issues shares in proportion to the total number of bitcoins it owns. An ETF share’s price should correspond to the current cryptocurrency market price, and the public can trade shares on conventional stock exchanges. Consequently, the ETF’s holdings are frequently adjusted by buying and selling tokens, and the price of the ETF’s shares aims to closely match that of bitcoins.
Authorized participants handle both the creation and redemption processes (APs). Usually, big financial organizations issue or redeem ETF shares in response to market demand. Because APs create or redeem ETF shares in large blocks, they are able to arbitrage the gap between the ETF shares’ trading price and the actual price of bitcoin, bringing the two prices closer together.
Purchasing shares of a spot bitcoin ETF is similar for traders and investors to purchasing shares of any other ETF or investment. Market makers are the people who regularly offer to purchase and sell shares of the ETF, keeping the market efficient and liquid. Their actions are essential to keeping the market steady and enabling investors to acquire or sell ETF shares with ease when needed.
In general, institutional, and retail investors may have additional options to speculate on bitcoin thanks to spot bitcoin ETFs, which eliminate the need to manage cryptocurrency wallets or worry about private key security.
Comparing Spot and Other Bitcoin ETFs
Spot bitcoin ETFs and derivatives-based bitcoin ETFs differ in their design and the level of exposure they offer to bitcoin price fluctuations. Bitcoin ETFs that are based on derivatives use tools like futures contracts to track bitcoin prices, whilst bitcoin ETFs that are based on spot store bitcoins itself.
Thus, spot bitcoin ETFs hold bitcoins directly. Since this exposure is more natural, investors will have an easier time identifying bitcoin ETFs. Spot bitcoin ETFs are able to be more open and honest since each share shows the exact amount of bitcoins owned.
Investors may find these ETFs less transparent because futures contracts, which indirectly determine the value of derivatives-based exchange-traded funds (ETFs), are subject to various market conditions beyond the actual price of bitcoin.
Bitcoin has always required users to either open an online wallet or sign up for a cryptocurrency exchange like Binance or Coinbase to purchase the digital currency. If this were to happen, cryptocurrency proponents say, the once-obscure financial sector of the internet would be much more integrated into the system.
While it approved the new ETFs, the SEC stated that it remained extremely dubious about cryptocurrencies and that its choice in no way implied that it supported or approved of bitcoin.
“Investors should remain cautious about the myriad risks associated with bitcoin and products whose value is tied to crypto,” said Gary Gensler, the agency’s chairman. (Source: https://www.theguardian.com/technology/2024/jan/11/bitcoin-etf-approved-sec-explained-meaning-securities-regulator-tweet)
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