Why a U.S. Bitcoin ETF Could Be a Real Thing in 2021

20 Oct 2021, 04:31 PM IST

(Bloomberg) -- Looking for the adrenaline rush of investing in Bitcoin but without the bother of crypto-exchanges and digital wallets? An exchange-traded fund might do the trick. For years U.S. regulators have blocked their development, even as similar products traded in Europe and Canada. But the Securities and Exchange Commission’s worries about volatility, potential manipulation and thin liquidity appear to have faded, in light of a new approach -- and a new SEC chairman. The first ETF tracking Bitcoin futures started trading Oct. 19, in a landmark event for the $6.8 trillion ETF industry and for the world of cryptocurrencies.

1. What do Bitcoin ETFs look like?

ETFs are part of a broader family known as exchange-traded products, though people frequently use “ETFs” to refer to all of them since they are by far the largest and most popular category. There are two types of ETFs that issuers are trying to launch: one that physically holds Bitcoin and one that invests in Bitcoin futures. While some say a fund holding Bitcoin would be preferred by investors, the Securities and Exchange Commission favors the futures approach, since that kind of fund can operate under the same rules that mutual funds follow, which SEC Chairman Gary Gensler says offer greater investor protections.

2. What’s the difference between Bitcoin and Bitcoin futures?

Futures are contracts to buy or sell an asset at a specified price at a later date. They are widely used in many markets, like oil, by investors who want to speculate on price movements without having to own the asset directly. As the price of Bitcoin swings up or down according to direct trading, Bitcoin futures track the cryptocurrency’s spot price indirectly on the Chicago Mercantile Exchange. The contracts require that investors put down cash to trade, as a form of collateral. Futures can also be useful in shorting Bitcoin or hedging bets.

3. What’s been available before now?

The largest Bitcoin ETP -- the $1.5 billion Bitcoin Tracker EUR, listed on the Stockholm Stock Exchange -- invests in swap contracts to mirror the cryptocurrency’s returns. The Purpose Bitcoin ETF (ticker BTCC), which debuted in Toronto in February, invests directly in “physical/digital Bitcoin,” its issuer, Purpose Investments Inc., said. Meanwhile, several U.S. investment trusts have been following Bitcoin in a manner that’s similar to ETFs but with certain restrictions. The Grayscale Bitcoin Trust (ticker GBTC) is what’s known as “physically backed,” meaning that it holds Bitcoin.

4. What’s happening now?

ProShares Bitcoin Strategy ETF became the first U.S. Bitcoin futures ETF, opening on Oct. 19 to strong demand, with more than $900 million worth of shares changing hands in its first day. Valkyrie Investments Inc. is launching its own version under the ticker BTFD, while Grayscale Investments LLC is filing to convert GBTC into an ETF that would “physically” hold Bitcoin -- a structure that the SEC has yet to approve.

5. How much demand is there for an ETF?

GBTC has swelled in size during Bitcoin’s bull run in 2021, with total assets soaring to almost $40 billion from $5.4 billion a year earlier. The Bitwise 10 Crypto Index Fund’s (ticker BITW) assets swelled to $1.3 billion less than a year after its launch. In Canada, demand has been robust. The Purpose Bitcoin ETF saw more than $165 million worth of shares change hands at its debut and accumulated more than $1 billion in assets in its first six months. When demand is strong it’s not unusual for the value of these funds to exceed the holdings, which means investors pay a premium for access. The fund’s value can also be lower than that of the assets when demand is weak.

6. Why would investors pay such premiums?

Because buying investment trusts is easier than purchasing the coins themselves. Shares can be bought and sold on brokerage platforms, without the need to set up digital wallets or move money to a crypto exchange. Industry experts argue that the premiums on trust products would dwindle with the introduction of a Bitcoin ETF. The problem with trusts is, unlike ETFs, new shares can’t be quickly created. For example, only accredited investors can create BITW shares with a minimum initial stake of $25,000. A lockup period bars the sale of new shares for 12 months. The supply constraints helped contribute to those soaring premiums.

7. Why did regulators shun a Bitcoin ETF for so long?

As well as worries that prices can be manipulated and liquidity is insufficient, there had been concern that Bitcoin’s famous volatility may be too much for regular investors. Bitcoin’s last three full-year returns were a 74% loss followed by gains of 95% and 305%. Also, the SEC questioned whether funds would have the information necessary to adequately value cryptocurrencies or related products. There have also been questions about validating ownership of the coins held by funds and the threat from hackers.

8. Who else is interested in launching one?

The Winklevoss twins first filed to launch a Bitcoin ETF in 2013, followed by issuers like Direxion, ProShares, First Trust, Grayscale, WisdomTree and GraniteShares. After the SEC received a request for the VanEck Bitcoin Trust in December, firms such as Galaxy Digital Holdings Ltd. and Fidelity Investments applied within months. Then, once Gensler signaled a preference for the futures-based version, a slew of filings from the likes of BlockFi, Valkyrie, VanEck and Bitwise soon followed. One proposed fund is even co-branded with Cathie Wood’s Ark Investment Management.

9. When will a physical Bitcoin ETF be approved?

So far, the SEC is most comfortable with funds filed through the Investment Company Act of 1940, which governs mutual fund rules and offers more investor protection. A physical Bitcoin ETF would have to be submitted under the Securities Act of 1933 -- which has fewer investor safeguards -- because Bitcoin is not yet defined as a security. Analysts expect the SEC to watch how the Bitcoin futures ETFs perform for a while before greenlighting a physical version.

The Reference Shelf

A beginner’s guide to buying Bitcoin.
A QuickTake explainer on Bitcoin and another on the its origin and blockchain. More detailed Q&As cover halving, new flavors of crypto, Bitcoin lingo, security tokens, central banks and digital currencies, China’s moves toward a digital currency, yield farming and decentralized finance applications.
An article on the rise in Bitcoin ownership concentrated among so-called whales.
An update on Grayscale’s plan to turn its GBTC fund into an ETF.
How the first Bitcoin futures ETF performed in its first day.
A story on an ETF tracking Bitcoin futures with the ticker BTFD.
An explainer on why it might be better to just buy Bitcoin.