Spot Bitcoin ETFs are attracting many investors who had previously kept well away from crypto.
The US Securities and Exchange Commission’s decision to approve exchange-traded funds that invest directly in Bitcoin brought a new wave of investors to the oldest and biggest cryptocurrency.
ETFs have become an enormously popular way to invest money in equities, bonds, commodities, currencies and real estate; and the various flavours have been discussed in earlier articles. See here, here, and here.
Spot Bitcoin ETFs from the likes of Fidelity Investments and BlackRock Inc., available since January in the US, are expected to attract many of those investors who had kept crypto at arm’s length in the past.
What is a spot Bitcoin ETF?
The almost $10 trillion global ETF industry invest in or replicate the performance of a basket of assets or an index. ETFs trade publicly on exchanges like the NYSE and LSE (and many others), making buying or selling ETFs easily accessible.
The recently approved spot Bitcoin ETFs actually hold Bitcoin, unlike previously available ETFs that invest in Bitcoin futures. (Futures are contracts to buy or sell an asset at a specified price at a later date, so you might see them as merely promissory notes).
The SEC consistently rejected spot Bitcoin ETFs for the last decade before finally approving them in January 2024.
How does a Bitcoin ETF work?
The new Bitcoin ETFs, either directly or through third parties, buy and hold enough tokens to back the shares they issue.
These shares therefore track the ups and downs of Bitcoin’s spot price. This allows investors exposure to the virtual token without needing to buy and safely store Bitcoin themselves or rely on an exchange.
Issuers work with so-called authorised participants such as trading firms or large banks that create and redeem shares in the ETF as the market demands.
Meanwhile, market makers are on hand to buy and sell ETF shares in a bid to keep the fund’s price as closely tied to Bitcoin’s performance as possible.
Why did regulators resist a Bitcoin ETF for so long?
In addition to their worries about liquidity and manipulation, many regulators expressed concern that Bitcoin’s volatility might be too intense for ordinary investors. One can see why; - Bitcoin gained 60% in 2021, lost 64% in 2022, and more than doubled in 2023.
The SEC had also questioned whether funds would have the information necessary to adequately value tokens like Bitcoin, including whether they could validate who owns the underlying coins. In 2021, SEC Chair Gary Gensler suggested that the lack of regulatory oversight and surveillance in crypto markets had led to “concerns about the potential for fraud and manipulation.”
Similarly, the UK’s FCA has stated several times in recent years that ‘Consumers should be prepared to lose all their money if they invest in schemes promising high returns from digital currencies such as bitcoin’.
To allay some of the SEC’s concerns, BlackRock and other issuers proposed so-called surveillance-sharing agreements, a way to mitigate the risk of market manipulation and fraud. (This, one can suppose, effectively takes much of the burden of regulation away from the SEC). Coinbase Inc., the only publicly traded, pure-play spot-crypto exchange in the US, has emerged as ETF issuers’ market surveillance partner of choice.
How are the spot Bitcoin ETFs doing so far?
The spot Bitcoin ETFs attracted more than $4.2 billion in net new flows by mid-February, and Bloomberg Intelligence analysts expect the ETFs to gain a total of $10 billion in net new flows in the first year and says they are “on track to go beyond it.”
As I write this, however, (Sunday 24th March) the last week has seen net outflows every day for the last week, though I suspect some of this is simply a correction, after the exuberance of the last 2 months.
What’s next?
Issuers are already thinking about which other cryptocurrencies could be the next to gain approval for a spot ETF. Ether and XRP are both likely candidates, and BlackRock and Franklin Templeton have already applied for a spot Ether ETF.
I have always been sceptical of all cryptocurrencies, but perhaps access to ‘real’ Bitcoin using ETFs offers a new opportunity to invest in an asset limited to 21million only. And I can’t help but wonder if Blackrock, Fidelity et al see an opportunity to ultimately hold all 21 million of them?
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