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Bitcoin ETFs Explained: What are they & how do they work?

The launch of Bitcoin in 2009 revolutionized the financial industry forever. Besides the fact that this digital coin introduced the concept of decentralization to finance, it has also helped to eliminate the need for intermediaries, which has eased the process of financial transactions. Currently, BTC is one of the most valuable assets in the world, which has drawn the attention of investors around the globe. While its volatile nature excites some investors, others are still scared of risking it all. But have you ever thought of accessing the full potential of Bitcoin without the stress of directly owning it? If you have, then you may find the concept of Bitcoin EFTs interesting. Check out what Bitcoin EFTs are and how they work in this detailed article.

What is a Bitcoin ETF?

So what are Bitcoin EFTs and how do they work? Let’s start by discussing the meaning of Bitcoin ETFs. Bitcoin ETFs are simply publicly traded investment funds that allow investors to get exposed to Bitcoin and its potential without actually owning the digital coin. Consider them to be like an investment vehicle that covers Bitcoin. Rather than purchasing and storing BTC yourself, you just buy shares in an ETF that stores BTC on your behalf. 

When you invest your funds in a Bitcoin ETF, you’re actually not directly buying Bitcoin itself. Rather, you’re just purchasing shares in a fund that possesses Bitcoin. This investment vehicle is specially designed to make it easy for traditional investors to get exposed to the price movements of Bitcoin without needing to securely buy and store the token. This way, the technological hindrances of investing in crypto are alleviated.

Unlike cryptos that can be traded on crypto exchanges, ETFs are generally traded on traditional securities exchanges. So you can find them on the New York Stock Exchange or Nasdaq.

How do Bitcoin ETFs work?

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Bitcoin ETFs operate just like the traditional exchange-traded funds that you are familiar with. Usually, an ETF issuer (most likely an asset management firm), buys the underlying asset and safely keeps it with a custodian. Subsequently, the firm issues shares to its funds to give investors access to the underlying asset kept in the fund.

Then, in exchange for a fixed management fee, the financial institution oversees the buying, storing, and safekeeping of the Bitcoin assets on behalf of the ETF’s investors. In simple terms, when you invest in a Bitcoin ETF, you are practically purchasing shares in a pool of Bitcoin

ETF Shares and Bitcoin Prices

Generally, the value of a Bitcoin ETF’s shares is related to the performance of Bitcoin. Hence, as the price of Bitcoin shifts, the value of the ETF shares also changes accordingly.

To guarantee that the ETF shares remain in sync with the market prices of Bitcoin, market makers try to actively buy and sell, which maintains a reasonable equilibrium between supply and demand. However, if the ETF’s price begins to deviate from the actual price of Bitcoin, market makers simply step in to restore balance and earn a lot of profit in the process.

Why choose a Bitcoin ETF over buying Bitcoin directly?

There are several reasons why you should go for a Bitcoin ETF, rather than buying Bitcoin directly. Some of these reasons include:

1.  Accessibility

ETFs trade on traditional stock exchanges. This makes them very easy to buy and sell via your existing brokerage account. So you don’t have to open a different crypto exchange account to purchase BTC.

2. Security

When it comes to Bitcoin ETF, you wouldn’t need to bother yourself about finding a wallet to store your own Bitcoin and facing the endless fear of hacking. The ETF issuer automatically handles the safekeeping of your BTC.

3. Regulation

ETFs are generally subject to stricter regulations, unlike some unregulated crypto exchanges. This offers you potentially better protection for your investment.

4. Diversification

It will be easy for you to add Bitcoin to your existing portfolio together with other stocks and bonds, which spreads your risk and may boost your final returns.

Check this out: What does spot Bitcoin ETF approval mean for the crypto industry?

What are the types of Bitcoin ETFs?

There are two major types of Bitcoin ETFs. Listed below are the two types of Bitcoin ETFs available for investors:

1. Bitcoin Futures ETFs

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These kinds of ETFs don’t directly hold Bitcoin. Rather, they operate by investing in futures contracts, which are agreements to purchase or sell Bitcoin at a fixed cost in the future. This strategy helps them to avoid the stress of storing Bitcoin, however, comes with more risks, as it may not completely track the real Bitcoin price.

2. Spot Bitcoin ETFs

Spot Bitcoin ETFs are the more recent kind of Bitcoin ETFs, which were authorized in the U.S. in 2024. These kinds of ETFs directly store Bitcoin in secure vaults, intending to imitate its price trends as closely as possible. Although this offers more direct and firsthand exposure to Bitcoin, it still comes with its own specific set of regulatory and security deliberations.

Why is a Spot Bitcoin ETF Considered Such a Big Deal?

The launch of a spot Bitcoin ETF is seen as a major development in the cryptocurrency world for numerous reasons. Some of these reasons include:

1. Mainstream adoption

A spot bitcoin ETF is capable of attracting a wider range of investors to crypto, including institutional investors. These kinds of investors have always been reluctant to invest directly in the crypto market due to regulatory reasons. This move will lead to the mainstream adoption of Bitcoin and make it a regular investment asset.

2. Convenience and accessibility

Spot bitcoin ETFs are generally more convenient and accessible. Essentially, they make it much easier for retail investors to get exposed to the full potential of bitcoin without needing to undergo the technical challenges that come with wallet management and private key security. So a Spot bitcoin ETF offers investors a more user-friendly and regular investment vehicle.

3. Regulatory approval

The establishment of spot bitcoin ETFs pressed for regulatory authorization from the SEC, which may provide an extra level of legality and supervision to the cryptocurrency markets. This may pave the way for better regulatory clarity and full approval of cryptocurrencies in traditional markets.

4 Market maturity

The launch of spot bitcoin ETFs may also indicate that the cryptocurrency market has evolved to a point where it can easily support standardized and regulated investment products. This may attract more institutional capital, thereby increasing market stability.

What is the difference between a Bitcoin futures ETF and a spot Bitcoin ETF?

The major difference between a Bitcoin futures ETF and a spot Bitcoin ETF is in the underlying digital assets they invest in.

Essentially, a bitcoin futures ETF primarily invests in futures contracts that get their value from the anticipated future price of Bitcoin. These future contracts allow investors to speculate on the movement of Bitcoin’s price without owing the cryptocurrency itself.

On the other hand, spot bitcoin ETF deals with Bitcoin itself and invests directly in the digital asset. Usually, investors in a spot Bitcoin ETF possess a share of the real cryptocurrency, and the value of the ETF is directly related to the price of Bitcoin in the crypto market.

How does a spot Bitcoin ETF contribute to the overall liquidity of the Bitcoin Market?

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Spot Bitcoin ETFs may help to enhance the general liquidity of the Bitcoin market because they provide more buyers and sellers. Subsequently, more liquidity will lead to more stable prices of BTC and make it far less volatile. This will make Bitcoin more attractive to regular investors.

Do spot Bitcoin ETFs pay dividends?

No, spot bitcoin ETFs are not exactly like traditional ETFs and do not pay dividends to investors because Bitcoins do not yield any income. Essentially, the investment value of spot Bitcoin ETFs is acquired primarily from the appreciation (or devaluation) in the market price of bitcoins. So, as a potential investor in Bitcoin ETFs, you need to be aware that the major purpose of investing in it is capital appreciation from the movements of Bitcoin’s price, not revenue from dividends.

Exciting read: SEC approves Bitcoin ETFs for daily trading

Are there minimum investment requirements for spot Bitcoin ETFs?

spot bitcoin ETFs generally do not have any high minimum investment amount. This means that ETF shares can be bought in just a single-share quantity, which makes them available to retail investors. Nevertheless, note that the ETF’s expense ratio and transaction fees may have more impact on smaller investments. 

Where can I purchase Bitcoin ETFs?

You can purchase Bitcoin ETFs through authorized online brokers that offer traditional securities, such as stocks and bonds. While some of these online brokers may offer you the chance to invest in Bitcoin directly, others may just permit you to trade Bitcoin futures only.

Are Bitcoin ETFs regulated?

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All ETFs that are traded on U.S. exchanges are fully authorized and regulated by the Securities and Exchange Commission. Hence, Bitcoin ETFs are regulated since they are traded on U.S. exchanges.

Who should invest in Bitcoin ETFs?

If you are seeking a more traditional method of investing in digital coins, then investing in a Bitcoin ETF may just be a suitable option for you. Since investing directly in Bitcoin in the crypto market can be very complicated, your safest option as a traditional investor is to invest in Bitcoin ETFs. ETFs remove the whole complexity involved by packaging Bitcoin into traditional ETF form.

Ultimately, Bitcoin ETFs offer you an easier, safer, and more convenient way to gain exposure to the volatile world of Bitcoin. However, due to the extremely volatile nature of Bitcoin (and other cryptos), you must not forget to do your research, understand the risk involved, and always invest an amount you are comfortable with losing. Bitcoin is still a high-risk investment with a relatively short trading history and zero underlying cash flows to give support to its value. Hence, you must always approach investment or trading this digital asset with the utmost caution. 

Bitmama offers a secure marketplace for crypto enthusiasts. Perform activities like crypto trading and creating virtual dollar cards for online payment. Get started today by downloading the Bitmama app.

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Emmanuel

Jan 17, 2024

8 mins read

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