What is a Bitcoin ETF?

Bitcoin ETF
There has been a lot of talk about publicly traded bitcoin ETFs potentially being back on the table since the launch of regulated bitcoin futures contracts on the CME and CBOE.

In March 2017, the U.S. Securities and Exchange Commission (SEC) decided not to approve the first bitcoin ETF, the Winklevoss Bitcoin Trust ETF (COIN), due to the lack of transparency and regulation of bitcoin exchanges. Since then, the SEC has rejected several further bitcoin ETF proposals, as there are too many unanswered questions to allow for digital currency ETF without exposing investors to substantial risk, according to the regulator.

More specifically, in January 2018, the SEC’s director of investment management, Dalia Blass, said in a letter directed towards two industry groups who are advocating for bitcoin ETFs to be listed:

“[…] The growth in cryptocurrencies and cryptocurrency-related products has attracted significant attention, and we have seen interest among sponsors in offering registered funds that would hold these new digital products. [… ] The Division stands ready to engage in dialogue with sponsors regarding the potential development of these funds. We believe, however, that there are a number of significant investor protection issues that need to be examined before sponsors begin offering these funds to retail investors.”

Despite the SEC’s current stance toward a digital currency ETF, some still believe that a bitcoin ETF will trade on U.S. exchanges at some point in the future.

What is a Bitcoin ETF?

An exchange-traded fund, commonly known as an ETF, is a type of investment fund that tracks the price of an underlying asset, such as gold, oil, an index or a basket of stocks, and is traded on exchanges in the same way as stocks. That means that any investors – retail or institutional – can buy and sell holdings in an ETF to other market participants over the stock exchange.

ETFs are usually cheaper than mutual funds as they are usually set up as passive index tracking funds and they allow investors – even private investors – to gain access to asset classes and niche markets that would otherwise be difficult to invest in.

A bitcoin ETF, such as the one proposed by the Winklevoss twins, would have the digital currency bitcoin as an underlying asset. That means that by purchasing a bitcoin ETF, an investor would be indirectly purchasing bitcoin, as he or she would be holding the bitcoin ETF in their portfolio as opposed to the actual digital currency itself. However, as the ETF would closely track the price of bitcoin, for the investor it should make little difference whether he or she is holding a bitcoin ETF or the actual digital currency.

The main difference between buying a bitcoin ETF versus bitcoin itself would be that investors would be purchasing a regulated investment vehicle that they can buy and sell on exchanges instead of having to buy and securely store bitcoin.

The Benefits of an ETF for Bitcoin as an Asset Class

A bitcoin ETF is seen as the holy grail for bitcoin as an asset class by many investors. The ease of purchasing a bitcoin ETF would expose the asset class to several new types of investors with deep pockets that were previously not able to invest in bitcoin, such as mutual funds and pension funds, for example.

The approval of a publicly traded bitcoin ETF would also very likely boost the price of bitcoin to new highs as the above-mentioned institutional investors, as well as private investors who are not very versed in technology, would now be able to freely invest in the digital currency through the ETF.

In fact, that is what happened in the early 2000s when the ETF market opened up gold investing to private investors and the price of gold subsequently experienced a tremendous rally that peaked in 2011.

A similar scenario would be expected to happen to bitcoin, where new highs, well above its most recent all-time high, would be highly likely. This would especially be the case if mutual funds, pension funds, and private banks would jump onto the bitcoin investing bandwagon. Given the strong demand for the high returns that bitcoin could potentially offer, this would be likely.

Bitcoin ETF
The SEC still has considerable reservations about bitcoin ETFs.

Will Bitcoin Futures Pave the Way for Bitcoin ETFs?

With the regulatory approval of the CFTC to list bitcoin futures contracts on the CME and CBOE, the door has been pulled wide open for potential bitcoin ETFs in the future. This is the case not only because a major U.S. financial regulator has approved bitcoin-based financial products but also because this opens up the opportunity to base a bitcoin ETF on bitcoin futures, which are standardized, publicly traded, and transparent. This, of course, would address some of the issues that the SEC currently has with the listing of a bitcoin ETF based on “physical” bitcoin as the underlying asset.

In fact, the SEC has reportedly already received several bitcoin ETF proposals that use bitcoin futures as the underlying asset since the launch of bitcoin futures on the CME and CBOE. However, all of these applications were withdrawn after Blass’ staff letter on cryptocurrency ETFs was released on January 18, 2018.

“Until the questions [on valuation, liquidity, custody, and potential market manipulation] can be addressed satisfactorily, we do not believe that it is appropriate for fund sponsors to initiate registration of funds that intend to invest substantially in cryptocurrency and related products, and we have asked sponsors that have registration statements filed for such products to withdraw them,” the letter stated.

For now, the SEC is clear on the matter, saying that it will not approve any bitcoin ETFs in the near future. However, as the bitcoin market matures and the transparency surrounding its trading activities increases as well as the security measures of leading digital currency exchanges, it is not far-fetched to assume that a bitcoin ETF will eventually become listed on a major U.S. stock exchange.

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