Cryptocurrency has become increasingly popular in the lives of investors. However, many investors are still unaware of the differences between ETFs and the distinction between Spot and Futures ETFs. This lack of knowledge has led to confusion regarding the potential approval of a Bitcoin ETF by the SEC.
What is an ETF?
An ETF (Exchange Traded Fund) is an investment product similar to stocks that allows investors to buy and sell on exchanges. These funds have underlying assets, which can be stocks, commodities, or cryptocurrencies. For example, an ETF issuer can create a Danish Food ETF by collecting shares of food companies in Denmark. This is similar to owning a basket of shares in the issuer’s company.
To provide a real-life example, let’s consider the S&P 500 ETF. This ETF holds shares of companies listed in the S&P 500 index and aims to replicate the index’s performance. If the index components change, the ETF manager adjusts the fund’s assets to reflect these changes and continue tracking the index’s composition and performance.
What is a Bitcoin ETF?
A Bitcoin ETF allows investors to invest directly in Bitcoin while relying on the issuer company. The ETF price fluctuates based on Bitcoin’s price performance, allowing investors to have exposure to Bitcoin.
What is a Spot Bitcoin ETF?
A Spot Bitcoin ETF directly holds Bitcoin (BTC) as the underlying asset. The issuer company holds physical BTC corresponding to the ETFs it has issued. When you buy an ETF, the selling company must actually purchase Bitcoin and hold it (through a custodial partner).
For example, let’s consider the Bitcoin ABC Spot ETF. This ETF is introduced by an issuer company like BlackRock. If the issuer claims to hold 10,000 Bitcoins and has issued 1 million shares, each share theoretically represents 0.01 Bitcoin.
Some benefits of a Spot Bitcoin ETF include:
- Allows BTC investment without the risk of storing BTC.
- Brings more liquidity to BTC as it trades on traditional exchanges.
- Legitimizes BTC and alleviates concerns for institutional investors.
- Attracts accredited and institutional investors, driving up the price of BTC.
- As interest in issuer companies and ETFs increases, the fund’s reserves of BTC grow in proportion to the ETF’s market size, causing a scarcity of supply.
Some downsides of a Spot Bitcoin ETF include:
- High volatility.
- Negative pricing due to ETF fees and periodic pressure. The fund’s value may fall below its expected value. Lack of demand is a significant issue here.
- ETF fees make Bitcoin investment more costly. Fees can reach up to 2.5%, increasing the cost of ETFs. However, it is expected that fees will be significantly reduced due to competition in the soon-to-be-approved ETFs.
What is a Futures Bitcoin ETF?
In this type of fund, BTC is not held directly. Instead, it invests in Bitcoin futures contracts, which are agreements to buy or sell Bitcoin at a predetermined price on a future date. As we mentioned earlier, volatility increases at the end of contract periods.
Therefore, most experts consider Futures Bitcoin ETFs as paper Bitcoins. They do not contribute much to price due to the lack of scarcity. Binance explains this with a good example:
“Let’s imagine a Bitcoin Futures ETF called ‘BitFutures,’ whose primary purpose is to track the future price of Bitcoin by purchasing Bitcoin futures contracts. A financial institution establishes and manages the BitFutures ETF. Let’s say BitFutures plans to purchase 1,000 Bitcoin futures contracts, each representing the right to buy one Bitcoin at $55,000 in three months.
To raise the capital to purchase these contracts, BitFutures issues 10 million shares representing claims on the profits (or losses) that these futures contracts may generate. This means that each share represents a 0.0001 portion of each futures contract.
Investors can buy BitFutures shares just like they would buy shares of any other company on regular exchanges. If the market believes Bitcoin will be worth more than $55,000 in three months, the shares can trade at a premium. Conversely, if the market is pessimistic, the shares can trade at a discount.
Let’s say BitFutures is trading at $10 per share. An investor who believes that Bitcoin prices will rise in the next three months can buy 1,000 shares for $10,000. If the futures contracts turn out to be profitable, the value of BitFutures shares will likely increase. If the investor’s belief is correct and the price of each share rises to $12, their investment will be worth $12,000, resulting in a $2,000 profit.”
Essentially, when you buy shares of a Bitcoin Futures ETF like BitFutures, you indirectly bet on the future price of Bitcoin without actually holding the cryptocurrency or the futures contracts.”
