Bitcoin ETFs are exchange-traded funds that track the value of Bitcoin and trade on traditional market exchanges rather than cryptocurrency exchanges. They allow investors to invest in bitcoin without having to go through the hassle of using a cryptocurrency exchange while providing leverage to its price.
How It Works
An ETF (exchange-traded fund) is an investment fund that tracks the price of an underlying asset or index. Today, ETFs are available for several assets and industries, ranging from commodities to currencies.
A Bitcoin ETF works the same way – the price of one share of the exchange-traded fund would fluctuate with the price of bitcoin. If bitcoin increases in value, so does the ETF, and vice versa. But instead of trading on a cryptocurrency exchange, the ETF would trade on a market exchange like the NYSE or TSX.
Advantages of Bitcoin ETFs
Investing in a bitcoin ETF provides leverage to the price of bitcoin without having to learn about how bitcoin works, having to sign up for a cryptocurrency exchange, and taking on the risks of owning bitcoin directly. For example, bitcoins are held in a wallet, and if an investor loses the password to the wallet, their bitcoin is lost forever. A bitcoin ETF simplifies the process of investing in bitcoin.
An ETF can hold more than just one asset. For example, A Bitcoin ETF could comprise bitcoin, Apple stocks, Facebook stocks, and more—providing investors with the opportunity to mitigate risk and diversify their portfolio. Similarly, by trading on a regulated market exchange, a bitcoin ETF would provide investors with the chance to diversify their existing equity portfolios.
- Tax efficiency
Given that bitcoin is unregulated and decentralized, the majority of the world’s tax havens and pension funds do not allow for purchases of bitcoin. On the other hand, a bitcoin ETF trading on traditional exchanges would likely be regulated by the SEC and eligible for tax efficiency.
Disadvantages of Bitcoin ETFs
- Management fees
ETFs usually charge management fees for the convenience they provide. Therefore, owning a significant amount of shares in a bitcoin ETF could lead to high management fees over time.
- ETF inaccuracy
While ETFs track the price of an underlying asset, they can also have multiple holdings in a bid to diversify the portfolio. However, this suggests that a 50% rise in the price of bitcoin may not be accurately reflected in the value of the exchange-traded fund due to its other holdings. Therefore, while an ETF provides leverage to bitcoin’s price, it may or may not be an accurate tracker of its price.
- Limits to cryptocurrency trading
Bitcoin can be traded for other cryptocurrencies, like Ethereum, Litecoin, XRP, and more. A bitcoin ETF would not be eligible to trade for other cryptos, as it is not a cryptocurrency but simply an investment fund that tracks the price of bitcoin.
- Lack of Bitcoin ownership
Bitcoin serves as a hedge against central banks, fiat currencies, and equities. By being independent of central banks, bitcoin provides a way to mitigate risks associated with the financial system. Bitcoin also protects users and investors by providing privacy through the bitcoin blockchain. A bitcoin ETF would be regulated by the government, eliminating these benefits.