Bitcoin has come a long way since the days of P2P trades via forums and, later, the first “formal” exchange platform, Mt. Gox, in 2010. As the demand for Bitcoin grew globally, attracting hundreds of millions to the asset and network, on-ramps sprung up to meet this demand.
Centralised exchanges sprung up and became the go-to platforms for buying and selling Bitcoin. Exchanges came in a range of flavours; some focused on spot trades with their own trading engine, and others offered more exotic products to speculate with, like futures.
Some exchanges focused only on a specific local market; others would act as a global exchange, and each platform found its niche.
As the market matured and large sums of money flowed into these platforms, it attracted all sorts of characters, and we later found out that some of these businesses were rife with fraud and mismanagement, resulting in customers losing their funds.
Many exchanges have failed over the last 15 years. Quadriga CX, FTX, and Cryptopia are some of the names that come to mind.
Some investors have taken these failures to mean Bitcoin itself isn’t safe to invest in. While regulators took these exchange failures as a sign to bring in stricter regulations, today, exchanges with the most significant trading volume tend to be complained about by the KYC and AML laws.
With exchanges, especially those wanting to access and serve the US market, willing to comply with regulatory bodies like the SEC, they hoped to add legitimacy to their service and attract larger pools of capital.
Exchanges in their current form have helped facilitate trillions in global Bitcoin trade volumes, set an international price as traders arbitrage between the largest order books and provide liquidity. However, this only served a subset of financial markets.
Now, we’re diving into the latest financial frontier: spot Bitcoin ETFs. Think of it as a bridge between the familiar – ETFs you might trade in your brokerage app – and the volatile world of Bitcoin.
But before we build that bridge, let’s lay the foundation.
What’s an ETF?
An ETF or exchange-traded fund is a type of pooled investment security that operates much like a mutual fund. ETFs can comprise different investments and track a particular index, sector, commodity, or asset.
Imagine a basket of goodies (stocks, bonds, you name it) packed into a single package. That’s an ETF. It trades just like a stock on an exchange, but instead of one company, you’re buying a slice of the whole basket.
Convenient, right?
ETF products in the Bitcoin space have existed for some time; some focused on grouping stocks of Bitcoin companies, while the other was a futures ETF.
So, what’s a Spot Bitcoin ETF?
Unlike futures ETFs or sector-based ETFs, A spot bitcoin ETF allows investors to gain direct exposure to Bitcoin without holding it. Each spot Bitcoin ETF is managed by a firm that issues shares based on its own Bitcoin holdings purchased through an authorised cryptocurrency exchange.
The shares issued backed by the Bitcoin holdings are traded on the stock market, separate from Bitcoin spot markets.
This ETF aims to track the spot price of Bitcoin – its current market value, not some future prediction. Owning shares acts as a proxy for owning a fraction of the Bitcoin held by a particular issuer without the hassle of digital wallets and security risks.
A Bitcoin spot ETF comes in two flavours, “cash-settled” and “in-kind” versions.
- Cash-settled means you own no Bitcoin; the ETF settles its price movements with cash.
- In-kind ETFs, on the other hand, hold the real Bitcoin under the hood, mimicking its price more closely.
So far, this round of ETFs will be cash-settled.
Why is a US spot ETF a BIG deal?
Because it’s been on hold for ages, the SEC, the financial guardian in the US, was wary of Bitcoin’s wild swings and potential manipulation. But finally, in January 2024, the dam broke, not without a curveball or two.
During the week of the announcement, the SEC’s official Twitter account was hacked, pushing out messaging that the ETF was approved, leaving the SEC with egg on their faces. Gary Gensler, the chairman of the SEC, even came out on his own Twitter account to post a retraction, only to 1 day later approve the ETF.
Yes, it’s safe to say It’s been a “Bit” of a clown show.
Bitcoin spot ETFs have been available for some time in markets like Canada or Brazil. But they didn’t manage to attract as much interest, with the first US spot of Bitcoin ETFs getting the green light, opening the floodgates for mainstream investors in the world’s biggest capital markets, who were previously hesitant to dive into the Bitcoin realm.
Who cracked the code?
Several ETF providers, like Blackrock, ProShares and Valkyrie, secured approval with different structures and permissions, along with GBTC, getting the approval to convert itself from a close-ended fund into an ETF.
| ETF | Ticker | Fees |
|---|---|---|
| ARK Invest/21Shares | (ARKB) | 0.0% (after first six months: 0.21%) |
| Bitwise | (BITB) | 0.0% (after first six months: 0.2%) |
| Fidelity Wise Origin Bitcoin Trust | (FBTC) | 0% (after July 31, 2024, 0.25%) |
| Franklin Bitcoin ETF | (EZBC) | 0.29% |
| Grayscale Bitcoin Trust | (GBTC) | 1.5% |
| Hashdex Bitcoin | (DEFI) | 0.9% |
| Invesco Galaxy Bitcoin ETF | (BTCO) | 0.0% (after first six months: 0.39%) |
| iShares Bitcoin Trust 0.12% | (IBIT) | (after first 12 months: 0.25%) |
| Valkyrie Bitcoin Fund | (BRRR) | 0.0% (after three months 0.49%) |
| VanEck Bitcoin Trust | (HODL) | 0.25% |
| WisdomTree Bitcoin Trust | (BTCW) | 0.0% (after first six months 0.3%) |
The conversion of GBTC
Prior to the launch of the spot ETF, one way to get exposure to Bitcoin was through the Grayscale Bitcoin Trust. The fund was launched in 2013 and holds over 600,000 BTCs as one of the only products of its kind.
Since the approval, shares of GBTC will commence trading on NYSE Arca on January 11, 2024. Once GBTC shares start trading on NYSE Arca, GBTC shares will cease trading on the OTC Markets and will have automatically been uplisted to NYSE Arca as shares of a spot Bitcoin ETF.
As a GBTC shareholder, you do not have to take any action prior to GBTC’s expected uplisting to NYSE Arca.
But wait, isn’t that just buying Bitcoin?
Not quite.
When you purchase Bitcoin on an exchange, you can withdraw it to self-custody; depending on the exchange, you can also use different withdrawal options like on-chain, Liquid Network or the Lightning Network.
An ETF doesn’t trade allows you the option of interacting with Bitcoin, the asset, or the network directly.
An ETF also tries to track the spot price of Bitcoin as closely as it can, but there can be times when there is a mismatch, while ETF holders are also subject to management fees.
ETFs offer some perks—no need for private wallets or complex security measures. Plus, you can trade them alongside your other investments in your familiar brokerage account.
But remember, you’re still exposed to several counterparties in the process.
The downside of an ETF
While the potential of spot Bitcoin ETFs is exciting, it’s crucial to understand the operational complexities and inherent risks involved. Let’s unpack the points you mentioned with a technical lens:
Operational Risk:
- Technology Failures: An ETF is not the Bitcoin blockchain, and you’ll deal with third-party software and databases. A custodian’s technology infrastructure failing could mean delayed transactions, loss of access, or even irreversible asset loss.
- Process Breakdowns: Complex internal processes at the custodian’s office could lead to errors, human mistakes, or system inconsistencies. Incorrect asset allocations, inaccurate recordkeeping, or delayed redemptions could negatively impact your holdings.
- Key Management: The private keys to the held Bitcoin are vital. If lost or stolen, access to the stored Bitcoin becomes impossible, resulting in permanent loss. Inadequate key management protocols and security practices pose significant risks.
Fraud Risk:
- Misappropriation: Even reputable custodians are not immune to internal malfeasance. Collusion or insider fraud could lead to the misappropriation of client assets, including their Bitcoin holdings. Robust internal controls and independent audits are crucial safeguards.
- Market Manipulation: The custodian could potentially manipulate the price of Bitcoin to benefit itself or specific clients. This could involve wash trading, creating artificial demand, or influencing exchange order books. Regulatory oversight and transparency measures are essential to mitigate this risk.
Credit Risk:
- Custodian Insolvency: While unlikely for established institutions, there’s always a possibility that the custodian could become insolvent due to internal mismanagement, market downturns, or unforeseen events. In such cases, client assets may not be fully protected, leading to potential losses.
- Counterparty Risk: If the custodian relies on third-party services, like cryptocurrency exchanges or liquidity providers, the insolvency or default of those counterparties could impact the ETF’s ability to fulfil its obligations and safeguard client assets.
Legal and Regulatory Risk:
- Regulatory Ambiguity: The legal landscape surrounding Bitcoin and cryptocurrencies is evolving rapidly. Uncertainty and evolving regulations could lead to legal challenges for the ETF, potentially impacting its operations and exposing investors to unforeseen risks.
- Non-Compliance: Failure to comply with existing or future regulations could result in fines, penalties, or even suspension of the ETF. This could negatively impact investor confidence and potentially lead to asset losses.
Counterparty Risk:
- Exchange Hacking: The current batch of ETFs is heavily reliant on Coinbase and, to a lesser extent, Gemini. These cryptocurrency exchanges used by the custodian can be targets for cyberattacks. If an exchange holding the ETF’s Bitcoin is hacked, client assets could be stolen, leading to significant losses. Diversification across reputable exchanges is crucial to mitigate this risk.
- Liquidity Risk: The underlying Bitcoin market can be illiquid at times, particularly during periods of high volatility. This could make it difficult for the ETF to buy or sell Bitcoin quickly at fair prices, potentially creating tracking errors and impacting investor returns.
| ETF issuer | Custodian |
|---|---|
| Ark/21 Shares | Coinbase |
| Bitwise | Coinbase |
| Blackrock | Coinbase |
| Fidelity | Self Custody |
| Franklin Templeton | Coinbase |
| Global X | Coinbase |
| Grayscale | Coinbase |
| Hashdex | N/A |
| Invesco/Galaxy | Coinbase |
| Valkyrie | Coinbase |
| VanEck | Gemini |
| Wisdom Tree | Coinbase |
Security Risk:
- Hot Wallet Hacks: If the custodian stores part of the Bitcoin in “hot wallets” connected to the internet for faster transactions, it becomes vulnerable to cyberattacks. Implementing layered security measures, including cold storage for most assets, is crucial for mitigating this risk.
- Physical Security Breaches: Physical theft of hardware wallets or servers storing private keys could result in irreversible loss of Bitcoin. Robust physical security measures and geographically dispersed storage locations are essential safeguards.
Remember, investing in a spot Bitcoin ETF involves a complex interplay of these risks. Carefully evaluating the custodian’s practices, underlying infrastructure, and legal framework is crucial before making any investment decisions.
Diversification, staying informed about regulatory developments, and understanding the inherent volatility of Bitcoin is crucial in navigating this emerging landscape with prudence.
Lays the groundwork for a 6102
The historical confiscation of gold through Executive Order 6102 in the US offers us a look at what governments can do as they try to manage fiat debasement. Bitcoin held in self-custody is not impossible to seize, but it requires boots on the ground, while an ETF and funds held with a custodian are far easier to confiscate.
While confiscating Bitcoin on a large scale remains highly unlikely due to the practical and legal complexities involved, potential government interventions are still a concern for Bitcoiners.
Diversifying your Bitcoin holdings and choosing non-custodial wallet solutions for individual Bitcoin holdings remain wise options, even with the launch of a spot ETF.
Buying Bitcoiners good graces
Speculation around the possible issues and attack vectors these ETFs can pose has left Bitcoiners uneasy. In order to extend an olive branch to the community, VanEck announced that the asset management firm will allocate 5% of the fund’s profits to support Bitcoin developers.
At the same time, Bitwise Asset Management put out a press release pledging to allocate 10% of profits from the Bitwise Bitcoin ETF (BITB) towards supporting Bitcoin open-source development.
So, what could this mean for the Bitcoin market?
Buckle up, folks.
More investors could join the party, potentially pushing up the price with this demand shock.
But it’s a double-edged sword.
Finding a balance between Bitcoins’ spot market that trades 24/7 globally and these ETFs might be complex. The ETF will also bring increased scrutiny from regulators, possibly even more volatility in the short run.
Spot Bitcoin ETFs are definitely not part of the Bitcoin ethos of “don’t trust, verify” but represent a significant step towards meeting a portion of the market halfway by offering a familiar on-ramp to the wild world of Bitcoin. This ain’t your grandma’s index fund, but at the same time, it is for your grandma because boomers and Gen X’ers have so far loved the ETF vehicle.
Think of an ETF as a custodial scaling solution for those who have no appreciation for censorship resistance, seizure resistance, provable ownership, network security and reliability but only want Bitcoin for its price appreciation.
If you do have funds in a retirement account or brokerage and would like to get some Bitcoin exposure, an ETF is an option, but before you jump in, do your research, understand the risks, and remember:
Not your keys, not your coins.
