What is the Bitcoin ETF and why is it important?

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2 years ago

An ETF is an investment fund whose units are traded and settled in exactly the same way as shares.

Eight years after the Winklevoss brothers filed the first application for a Bitcoin exchange-traded fund (ETF), the first U.S. Bitcoin ETF began trading on the New York Stock Exchange (NYSE) today, Tuesday, October 19, 2021.

An ETF is a mutual fund whose units are traded and settled in exactly the same way as stocks. There are more than a few beginners who do not know how to buy Bitcoin. With the arrival of the Bitcoin ETF on the stock exchange, a new world of possibilities is opening up.

Why is the launch of the Bitcoin ETF important?

ProShares - a Bethesda, Maryland-based provider of specialized exchange-traded products - on Friday filed an application to begin trading the Bitcoin Strategy Fund on Oct. 19, 2021. The fund, which trades under the ticker BITO, will track Bitcoin (BTCUSD) prices through futures contracts traded on the Chicago Mercantile Exchange (CME).

Michael Sapir, CEO of ProShares, noted that the ETF's launch is a milestone. "1993 is remembered for the first equity ETF, 2002 for the first bond ETF and 2004 for the first gold ETF. 2021 will be remembered for the first ETF linked to cryptocurrencies," he stated, as we read in Yahoo Finance.

Douglas Yones, head of exchange-traded products at NYSE, also referred to the momentous occasion, but suggested that there is still progress to be made in cryptocurrency investment products. "This is an exciting step, but not the last," he told The New York Times.

Sapir said the ProShares fund will provide cryptocurrency exposure to investors who have a brokerage account "but don't want to go through the hassle and learning curve of setting up another account with a cryptocurrency provider ... or are concerned that these providers may be unregulated and subject to security risks."

The launch of trading in the shares of the ProShares fund is the result of inaction by the Securities and Exchange Commission (SEC). The agency has 75 days to comment on a proposed ETF. The funds can begin trading if the SEC allows the deadline to expire. The deadline for the ProShares funds expired on the morning of Oct. 18.

Other bitcoin ETF applications that have an SEC comment expiring this month include those from investment firms Invesco Ltd, Valkyrie Investments and VanEck Associates Corp. According to reports, the agency is expected to follow a similar course of action for their applications and pave the way for the listing of more futures-based bitcoin ETFs in the public markets.

A rocky road to approval

The road to approval of Bitcoin ETFs has been rocky. Some consider a Bitcoin ETF to be the holy grail because it could open the door to the injection of massive investments in the asset class by institutional investors. But the SEC has dashed this dream by rejecting numerous applications from funds that track bitcoin spot prices. The agency laid out its concerns with the bitcoin ecosystem in a January 2018 letter released after the 2017 bitcoin price spike3.

In general, it is concerned about the volatility of cryptocurrency prices and the potential for price manipulation in the largely unregulated bitcoin ecosystem. The major cryptocurrency exchanges, which are used to set spot prices for bitcoin exchange-traded products, are not registered with the SEC, making it difficult for the agency to verify their trade flow.

Current SEC Chairman Gary Gensler has repeatedly referred to the cryptocurrency ecosystem as a "Wild West" and has called on Congress to bring cryptocurrency exchanges under its oversight. But he has said the agency remains open to ETFs based on bitcoin futures traded on the CME.

Futures prices are based on bets made by trades on the price of an asset in the future. They do not involve the ownership of actual bitcoin or the trading of spot prices. Instead, the CME calculates a Bitcoin reference rate (BRR) during a one-hour window based on the trading flow of the major spot exchanges.

A Bitcoin ETF based on futures prices on the CME will also not present a regulatory problem because the Commodity Futures Trading Corporation (CFTC) oversees the CME. Since their introduction in December 2017, CME bitcoin futures have witnessed a steady increase in prices and trading volumes. The contracts are popular with institutional investors who use them to hedge risk while minting quick profits from a volatile asset class.

Warnings about investing in futures-based Bitcoin ETFs.

While providing exposure to a fast-growing asset class, ETFs based on bitcoin futures prices have several caveats. For one, they can trade at a significant premium or discount to the spot price of bitcoin. For example, the annualized premium of CME bitcoin futures increased 15% compared to the bitcoin spot price in recent days due to investor expectations about the approval of a bitcoin ETF.

A situation in which longer-term futures contracts are priced higher compared to shorter-term contracts, known as contango, could lead to losses for funds that track volatile asset prices such as bitcoin.

Karan Sood, chief executive of Cboe Vest, told The Wall Street Journal that actual returns for funds based on cryptocurrency futures contracts can be "very different" from the spot price of bitcoin.

Bitcoin ETFs based on CME futures contracts could also be more expensive than other similar products. Bloomberg Intelligence estimates that fees for a bitcoin ETF will be 1% per $1,000 invested. According to the firm, the average active equity ETF charges 0.71% in fees.

Bitcoin ETF costs will be further magnified during the expiration of the underlying futures, when long-term investors roll the contracts over to a new period. "Traders can use the new Bitcoin ETFs, but we expect their appeal to long-term investors and advisors to be lower due to futures rollover costs," wrote Eric Balchunas and James Seyffart, analysts at Bloomberg Intelligence, in a note.

Still, the debut of a futures-based Bitcoin ETF is cause for celebration. It represents a significant evolution in the move toward a fund based on bitcoin spot prices.

Matt Hougan, chief investment officer at asset management firm Bitwise Investments, told CNBC that the "homework" shows that the cryptocurrency market has changed. "The bitcoin market has matured to the point where the CME bitcoin futures market is actually the primary source of price discovery around the world," he said. "Prices move on the CME market before they move on Coinbase, Kraken, FTX ... and, as a result, it satisfies the SEC's hurdle for potential approval of a spot-based ETF."

After holding solidly in the $50,000 range, the Bitcoin price set a new record high on Sunday, October 17, surpassing $63,000, following news of the impending listing of the first Bitcoin ETF in the U.S. markets.......

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