Bitcoin ETF: Everything You Need to Know
Recently, the SEC delayed its decision on VanEck’s Bitcoin ETF by another 45 days after its deadline on August 27.
It all started back in 2014 when the Winklevoss twins became the first company to file an ETF proposal with cryptocurrency. At the time, the SEC rejected their proposal, along with many that came after that.
Even though the future of Bitcoin ETFs seems pretty obscure and unpredictable, a few companies and organizations found a way to work around the system for investors to indirectly invest in cryptocurrencies through ETFs.
But first, for those who don’t know, what are ETFs?
What is a Bitcoin ETF?
Bitcoin ETFs are essentially the same as usual ETFs, except in a Bitcoin ETF, the underlying assets are Bitcoins.
Well, then the question becomes – what is an ETF?
An ETF combines the excellent diversification benefits of mutual funds and the accessibility of stock trading.
ETFs are a collection of different investments, which may include gold, stocks, securities and whatnot. However, only the ETF providers own the underlying assets. Investors can only buy shares of the fund and profit off its price trends without actually owning the underlying assets.
The price trends of these shares are closely correlated with the actual price of the underlying assets. Otherwise, it would create an arbitrage opportunity for traders to make a profit.
So, in a Bitcoin ETF, the fund manager must have a Bitcoin reserve (a stash of bought Bitcoins) that they can use to anchor the price of their ETF shares. This is what we call spot ETFs.
Its Regulatory Status in the US
Unfortunately, spot Bitcoin ETFs are not yet approved by the SEC. Since the Winklevoss twins filed the first ETF proposal with cryptocurrency, the SEC has rejected over a dozen applications for spot Bitcoin ETF for reasons we’ll discuss in a later section.
Just when it seemed all hope was lost, the SEC approved its first-ever Bitcoin Futures ETF, the ProShares Bitcoin Strategy ETF, in October 2021.
Though Bitcoin Futures ETFs are not the same as spot Bitcoin ETFs, it still allows investors to dabble around with cryptocurrencies without actually owning them.
But what are Bitcoin Futures ETFs and how is it different from spot Bitcoin ETFs?
How does a Bitcoin Futures ETF Work?
To understand how Bitcoin Futures ETFs work, we must go a few steps back and understand how people profit off price derivatives.
In simple words, derivatives are a type of contract where people profit from the performance of an underlying asset. There are many tools to do this, one of which is Bitcoin Futures. In a Futures contract, a buyer and seller will agree (on a contract) to make a transaction on a fixed date at a fixed price.
So, even if the asset (Bitcoin in this case) is trading for more than the agreed price on a Futures contract, the buyer must oblige to the contract terms and complete the transaction, incurring a loss.
Now, coming back to ETFs, instead of tracking the price movements of actual Bitcoin (spot ETFs), Bitcoin Futures ETFs track the performance of Bitcoin Futures contracts.
So, just like a Bitcoin ETF must have a Bitcoin reserve to anchor its price, a Bitcoin Futures ETF must hold positions in the Bitcoin Futures market to do the same. In the US, this is done on the Chicago Mercantile Exchange (CME).
Keep in mind that the prices of Bitcoin Futures and actual Bitcoin may vary. If more people are betting for Bitcoin prices to rise, Bitcoin Futures will trade for more than the actual market price of Bitcoin, and vice versa.
Benefits and Drawbacks of a Bitcoin ETF
Needless to say, Bitcoin ETFs have many benefits, whether it’s a spot ETF or Futures ETF. However, it’s not a one-size-fits-all solution, as it has a few but significant drawbacks too.
Benefits
Accessible for Masses: Since ETFs are a much more mainstream and traditional investment instrument, adding cryptocurrency to its roster will expose the masses to new investment opportunities and make it more accessible.
Portfolio Diversification: This is an obvious one but worth mentioning. Diversifying is one of the fundamentals of a good investment strategy. Many people would like to diversify their portfolio with crypto but can’t. ETFs are a great way to do just that without actually owning crypto, which brings us to…
Invest in Crypto Without Owning One: Whether it’s a spot Bitcoin ETF (if approved in the future) or a Bitcoin Futures ETF, you only profit off of the performance of the underlying assets.
Many people have concerns about investing in and holding cryptocurrency, but some also want to experiment with it. ETFs are a fine little middle ground for them where they can potentially make money on crypto’s price trends without the risk of actually owning one.
Easier & More Convenient: If not the concerns of holding crypto, it’s the presumed steep learning curve and technical jargon that scare people off of crypto and blockchain.
With ETFs, investors don’t have to set up crypto wallets or accounts on crypto exchanges. They don’t have to worry about hacks or private keys getting stolen.
It allows you to make money from cryptocurrency using a method you trust and are used to.
Drawbacks
No Ownership of Cryptocurrency: While we listed this exact feature as a benefit above, some people view this as a disadvantage.
Not actually owning the crypto can strip you of the power to experience the full range of use cases and opportunities that cryptocurrency technology has to offer.
Inaccurate Price Movements: Since, as of now, you can only invest in Bitcoin Futures ETF, it leaves a huge room for price disparity (between the actual Bitcoin prices and Bitcoin Futures prices), especially when there are sudden market swings, which is pretty common in the crypto space.
Will Crypto ETFs Get Approved by the SEC?
After rejecting many applications for Bitcoin ETFs and suffering a lot of pressure and criticism, the SEC finally issued a letter in 2018 explaining why they don’t think ETFs with crypto are safe. The reasons included – lack of transparency at crypto exchanges, risk of market manipulation and low liquidity levels in the crypto market.
It’s worth noting that at the time, the chairman of SEC was Jay Clayton, who was considered to have a hostile and narrow-minded attitude towards cryptocurrency.
But of course, since then, a lot has changed.
Most crypto exchanges are now public companies working with the government to prevent tax evasion, money laundering and terrorist funding. A new exchange gets launched practically every month. Liquidity levels have skyrocketed. And lastly, the chairman of SEC has been replaced by Gary Gensler, a well-known proponent of cryptocurrency and blockchain technology.
Things are looking better but nowhere close to perfect. Gary Gensler has clarified his position on Bitcoin ETFs, stating that he’s on the same page as the former SEC chairman.
Recently, on June 30, 2022, Grayscale, a company that deals in Bitcoin Trusts, filed a lawsuit against the SEC, asking the U.S. Court of Appeals for the District of Columbia Circuit to review the decision of the SEC rejecting their application to convert its Bitcoin Trust into a spot Bitcoin ETF.
As of now, it’s hard to predict the future of Bitcoin ETFs.
Its Regulatory Status in Other Countries
While the future of crypto ETFs in the US seems unpredictable at best, other countries have decided to ride the crypto wave and capitalize on this opportunity.
In Canada, Purpose Bitcoin and CI Galaxy Bitcoin are among the first few Bitcoin ETFs.
In Brazil, there is QR Capital’s Bitcoin ETF.
Europe has seen some of the most Bitcoin ETFs launched, including 21Shares Bitcoin ETP, VanEck Bitcoin ETN, Bitpanda Bitcoin ETC and Iconic Funds Physical Bitcoin ETP, just to name a few.
Taxes on Bitcoin ETFs
From what we know about how crypto taxes in the US (or in most countries) work, whenever you dispose of your crypto (exchange crypto for fiat currency), you trigger a capital gains taxable event.
Using that logic, investing in a Bitcoin ETF or a Bitcoin Futures ETF shouldn’t have any tax consequences since you don’t own the underlying crypto assets in that ETF. Right?
That would be true if gains from ETFs weren’t taxable in themselves. You see, gains from ETFs have their own tax consequences. So, while you may not pay “crypto taxes”, you’ll pay “ETF taxes”.
So then, the question becomes – how are ETFs taxed?
Gains from ETFs are taxed under the same capital gain tax rates as stocks, securities and crypto. So, coming full circle, taxes on gains made from Bitcoin ETFs are practically the same as gains made on an ordinary crypto transaction.
Final Thoughts
Many people are making a living from trading cryptocurrencies, while many are playing the long-term game. By comparison, crypto ETFs are a safer way to make money than actually HODLing or trading crypto.
But at the end of the day, whether you should dabble around with Bitcoin ETFs or not depends on your goals, priorities and risk appetite.