What is a Bitcoin ETF?

Exchange-traded funds (ETFs) are an incredibly popular investment option for those looking to diversify their portfolio and reduce their risk. ETFs can be invested into many things — something hundreds or thousands of things at any one time — and they are somewhat similar to mutual funds, except they can be traded just like regular stocks.

In this AAG Academy guide, we’ll explain what an ETF is and look at the many different types of ETFs available today, including Bitcoin ETFs.

What are ETFs?

An ETF, or exchange-traded fund, is a type of pooled investment security, much like a mutual fund. It gives investors the opportunity to put their cash into a larger pot that tracks a particular commodity, index, sector, or other assets. ETFs can contain hundreds or even thousands of underlying assets, making them a popular choice for investment diversification.

While larger ETFs can contain stocks from across various industries, many are focused on one industry or sector. For example, some funds are focused on banks or healthcare companies. In the United States, most ETFs are open-ended funds, which means there is no limit on the number of investors that can be involved.

Just like mutual funds, exchange-traded funds are often managed by experts, so investors themselves play no part in deciding which stocks or commodities are included. All they have to do is buy into the ETF by acquiring shares in it, and then eventually sell them when they are ready to cash in on their investment. This makes ETFs a passive investment method.

The big difference between an ETF and a mutual fund is that ETFs can be traded on a stock exchange in the same way a regular stock can. The value of an ETF’s shares fluctuates throughout the day as shares are bought and sold, whereas mutual funds are traded only once per day after the market has closed.

The first ever ETF was the SPDR S&P 500 Trust, which first launched in January 1993 and is still active today. Investment in ETFs has grown exponentially over the past decade. Data from Reuters shows that in 2011, around $1.77 trillion was invested into ETFs worldwide. As of 2022, that figure has rocketed to over $9.9 billion.

What are the different types of ETFs?

There are a wide variety of ETFs investors can choose from, and while most of them operate in much the same way, some are a little different. Here are some of the ETFs available today:

Active and passive ETFs
ETFs can be either actively or passively managed. Those that are actively managed have portfolio managers who decide which securities the fund should be invested into. This careful selection process can have benefits over passively managed ETFs, but actively managed ETFs are usually a more expensive investment option.

Passively managed ETFs don’t have portfolio managers, so they typically target an index of securities, such as the S&P 500.

Stock ETFs
Stock ETFs feature a bundle of stocks from a particular industry or sector. They aim to be diverse, so established and high-performing companies may feature alongside new entrants that are yet to prove themselves, but they aren’t as diverse as ETFs that have a broader focus. Stock ETFs don’t involve actual ownership of securities, unlike stock mutual funds.

Bond ETFs
Bond ETFs feature underlying bonds — which might include corporate bonds, government bonds, and municipal bonds — that provide investors with a regular income. Bond ETFs do not have a maturity date, unlike the bonds themselves.

Commodity ETFs
Commodity ETFs are based on commodities such as gold, natural gas, oil, and meat. They give investors the opportunity to hold shares in these commodities without actually requiring possession of them, which is much cheaper. They also help diversify a portfolio that may be susceptible to downturns when there is a slump in the stock market.

Currency ETFs
Currency ETFs track the performance of currency pairs, including domestic and foreign currencies. They give investors the opportunity to speculate on how the price of currencies may change over time as a result of economic or political developments.

Sector ETFs
Industry or sector ETFs, like stock ETFs, invest in stocks from a carefully selected bundle of companies that all offer similar products or services. For instance, one might invest in a technology company ETF that includes the likes of Apple, Amazon, Google, and Microsoft.

How does a Bitcoin ETF work?

As you might have guessed, a Bitcoin ETF is an exchange-traded fund that invests in Bitcoin and other assets related to Bitcoin’s price. Like other ETFs, they are traded on a traditional stock exchange, not a cryptocurrency exchange, and they give investors the opportunity to access to the world’s most valuable currency without them actually buying BTC.

One important thing to note about Bitcoin ETFs is that they do not invest in BTC directly, which is not approved by the U.S. Securities and Exchange Commission (SEC). Instead, they use Bitcoin futures contracts — agreements between two parties to trade Bitcoin on a certain day at a certain price — traded on the Chicago Mercantile Exchange.

Shares in a Bitcoin ETF are priced based on the current price of one contract unit, which consists of 5 BTC.

What are the benefits of Bitcoin ETFs?

As we touched on above, Bitcoin ETFs allow investors to put their money into Bitcoin without them having to buy and hold BTC themselves. They make investing in the world’s most valuable cryptocurrency more familiar to those who already use ETFs in their investment strategy. They are also considered more secure since there’s no need to protect actual BTC.

What’s more, an ETF makes investing in Bitcoin more accessible. The price of a single Bitcoin today, while the cryptocurrency industry as a whole is suffering a slump, is close to $17,000. When Bitcoin reached its record high last year, a single BTC cost over $65,000. Even for big investors, that is incredibly costly. An ETF gives you exposure to Bitcoin for a lot less.

What are the problems with Bitcoin ETFs?

While Bitcoin ETFs remain a great investment option for some, they do have some downsides. One is the management fees that ETFs usually charge for the service they provide. The other, which is arguably the biggest problem, is in the nature of ETFs themselves, which are designed to have multiple holdings in the name of diversity.

The issue with this is that, because Bitcoin ETFs aren’t based solely on BTC, a sharp and significant rise in BTC’s price may not mean the same for the value of Bitcoin ETFs. So, for some investors, simply buying BTC is a much more attractive option. It also offers more flexibility, since BTC can be swapped for other cryptocurrencies or used for other things.

References

• Exchange Traded Fund
• Types of ETFs
• Bitcoin etfs explained
• Bitcoin etfs
• Best bitcoin etfs