Cryptocurrency has gained tremendous traction during the pandemic, with it peaking the interests of not only large scale but also retail investors. However, the huge funds required to invest along with the unregulated markets made investors wary of the cryptocurrency markets, investors being largely hesitant. This increasing interest, nonetheless, brought about the Bitcoin ETF. An exchange traded fund is a financial instrument that tracks the price movement of the underlying asset and can be traded into on a normal stock exchange. It acts as an alternative to buying and selling individual assets.
Similarly, a bitcoin ETF imitates the price of the respective cryptocurrency and lets investors diversify their portfolio without directly dealing in bitcoin itself.
For cryptocurrency investors and individuals interested in capitalizing on the increasing popularity of exchange traded funds (ETFs), this combination definitely provides the best opportunity.
The United States was a pioneer in this aspect, with the country releasing the first-ever Bitcoin ETF, which was listed on the New York Stock Exchange (NYSE) in October 2021. The ProShares Bitcoin Strategy ETF which trades under the ticker BITO tracks Bitcoin prices through futures contracts traded at the Chicago Mercantile Exchange (CME). This ETF allows investors to purchase bitcoins through a futures contract without actually buying it on a cryptocurrency exchange. Instead of investing in bitcoin directly, they have access to Bitcoin by investing in a fund that tracks bitcoin futures. Those who invest in this opportunity are actually wagering on the potential rise in the share of the ETF in the coming future. The price of these shares are determined by Bitcoins since these future contracts are derivatives of bitcoins despite not being backed up by physical Bitcoins.
Bitcoin ETF does not rely on the final price of the Bitcoin on the day of trading since its trading is done on the basis of a predefined price, which leads to a difference between the spot price of bitcoin and the futures contract. Therefore, one party earns a profit while the other suffers a loss. The potential margin of profits for one party can be exponentially high. BITO operates at regular market timings, unlike Bitcoin which can be traded off-market hours too. Although investors can place orders at any time of the day, it is executed during market hours only.
BITO is being considered as a very promising investment option due to the number of advantages it offers. Primarily, investors do not have to learn the security procedures associated with investing in a cryptocurrency like bitcoin. Furthermore, since an ETF can be traded on traditional stock exchanges, investors are not required to deal with cryptocurrency exchanges. Most importantly, Bitcoin ETFs are safe for investors who want to participate in the crypto world as it is regulated by the U.S. Securities and Exchange Commission, making it the first regulated cryptocurrency investment vehicle to make its way to the public.
Moreover, since the Bitcoin ETF is an investment vehicle, it allows interested individuals and investors to short sell shares of the ETF if they expect Bitcoin prices to plunge. Shortselling of shares is not in practice in the traditional cryptocurrency market. Its popularity can also be attributed to the fact that ETFs are better understood by the general public as compared to the nuances of cryptocurrency. Investors are more likely to get attracted to an investment vehicle that they already understand rather than get involved in the intricate details of a digital currency. This investment vehicle makes it simpler to buy and sell the futures contract as it removes the cost and requirement of storing the asset.
However, the Bitcoin ETF does come with its share of criticism and concerns. Firstly, since bitcoin, the largest cryptocurrency in the world by market capitalization, is unregulated it raises many concerns regarding the safety of investments. Additionally, if longer-dated futures contracts have higher prices as compared to short-term contracts, then there is a significant chance of huge losses for funds that track the prices of volatile assets like bitcoin. Currently, the Bitcoin ETF has an expense ratio of 0.95% which is quite high as compared to the average low-cost index funds which have an expense ratio of around 0.30%. Since this is a new asset class, there may be many middlemen and the price of the futures ETF is likely to be high until more competition brings down the fees and expenses related to this ETF.
So, should one invest a Bitcoin-linked ETF?
Cryptocurrencies are still very new as compared to traditional stock market investing, therefore it lacks the historical track record which can be used by investors to predict future performance. While there may be a difference in the price of Bitcoin and the price of BITO, Bitcoin is the underlying asset whose price is mimicked by BITO, thus, the ETF is also likely to see similar volatility. First time investors or those with limited experience must remember that investments in any speculative investment vehicle should never be made at the expense of other financial goals since these are high-risk-high-return assets in the portfolios. Therefore, it comes with its fair share of risk.
Despite various concerns, this ETF will allow many investors who were looking to invest in Bitcoins and other Cryptos a safer platform to invest in. It’s like getting the best of both worlds – investing in cryptocurrency with governmental regulation.
By Manasvi Mathur