What Are Bitcoin and Ethereum ETFs and How Do They Work?

Bitcoin and Ethereum ETFs are investment vehicles that track the price of BTC and ETH — and could bring increased liquidity and mainstream adoption.

Key Takeaways:

• ETFs, or exchange-traded funds, track the performance of an underlying asset and offer diversified exposure to various assets, providing liquidity and flexibility for traders.

• Bitcoin and Ethereum ETFs simplify trading by holding the cryptocurrency as their underlying asset and issuing shares that track their price.

• Spot Bitcoin ETFs directly own Bitcoin, while Futures Bitcoin ETFs use CFTC-regulated futures contracts to track Bitcoin’s price; each has its own risk profile and advantages.

• The wide-scale adoption of cryptocurrency ETFs depends on addressing regulatory concerns and building a trustworthy ecosystem while balancing innovation and trader protection.

What Are ETFs?

ETFs, or exchange-traded funds, are investment vehicles that typically track the performance of an underlying asset, such as a stock or commodity (for example, cryptocurrencies). They consist of a single asset or combination of various types of investments (an index of stocks, a basket of commodities) through their funding mechanism but are permitted to trade as a stock on US stock exchanges. ETFs are designed to provide traders with exposure to the underlying asset (or assets), but with some distinct advantages. 

Since they are traded on stock exchanges, ETFs allow traders to buy and sell them throughout the trading day at market prices, providing liquidity and flexibility compared to traditional mutual funds. ETFs offer traders the opportunity to gain broad market exposure and diversification, and potentially lower costs compared to actively managed funds. They are a popular choice for both individual and institutional traders seeking a passive investment strategy.

What Are Bitcoin ETFs?

Bitcoin ETFs are exchange-traded funds that track the value of Bitcoin, providing traders with an opportunity to gain exposure to the cryptocurrency through traditional stock market exchanges. These ETFs aim to simplify the process of trading in Bitcoin by offering a regulated and transparent investment vehicle. Currently, there are two types of cryptocurrency ETFs in the US: Spot Market ETFs and Futures Market ETFs.

To date, the US Securities and Exchange Commission (SEC) has approved Futures Market ETFs for Bitcoin and Ethereum, and, in January 2024, approved 11 Spot Bitcoin ETFs. As of mid-April 2024, the SEC has further delayed the decision on the Hashdex and ARK 21Shares Ethereum ETFs, extending the decision until May 2024.

What Are Ethereum ETFs?

Ethereum ETFs allow traders to gain exposure to the price movements of Ethereum (ETH) or a basket of cryptocurrencies that includes Ethereum without directly owning ETH. They are structured like traditional ETFs, where traders can buy and sell shares on stock exchanges throughout the trading day, a convenient way to trade Ethereum without dealing with the technical complexities of buying, storing, and managing it directly.

Note that some Ethereum ETFs are regulated financial products and available in certain jurisdictions where they have been approved by regulatory authorities. However, their availability may vary from one country to another.

Pros of Bitcoin and Ethereum ETFs

The introduction of Bitcoin and Ethereum Futures ETFs has had several implications in the cryptocurrency market. These ETFs provide a more accessible and regulated way for traditional traders to participate in the Bitcoin and Ethereum markets, potentially attracting more capital and increasing liquidity. This could lead to increased price stability and reduced volatility, as the ETFs introduce a new layer of institutional investment.

Spot ETFs, including on Bitcoin and Ethereum, could also contribute to the legitimisation and mainstream adoption of cryptocurrencies by bringing them within the framework of traditional financial (TradFi) markets. This could potentially lead to greater acceptance and integration of cryptocurrencies into existing financial systems. Because the Spot ETF holds the underlying asset(s), it also creates the opportunity for long-term purchase and holding of the underlying asset(s) by the ETF.

The Grayscale Bitcoin Trust (GBTC), one of the largest and most well-known Bitcoin investment products, was converted into an ETF in January 2024. GBTC allows traders to gain exposure to Bitcoin through a traditional brokerage account without the need for a separate cryptocurrency wallet. This example showcases how Bitcoin ETFs provide a convenient and familiar investment avenue for traders interested in cryptocurrencies.

Risks of Bitcoin and Ethereum ETFs

However, it is important to note that Bitcoin ETFs also come with certain risks. One of the primary risks is the correlation between the price of the ETF shares and the price of Bitcoin. If the price of Bitcoin experiences significant fluctuations, the value of the ETF shares can also be affected. Also, it is possible that the price of the ETF shares deviates from tracking the Bitcoin price closely, or the shares could sometimes trade at a discount or premium to the actual underlying Bitcoin the ETF holds.

It’s important for traders to conduct thorough research and consider their risk tolerance and objectives before trading in Ethereum ETFs or any other financial instruments related to cryptocurrencies.

What Is the Difference Between Spot and Futures Cryptocurrency ETFs?

Spot Bitcoin ETFs and Futures Bitcoin ETFs are two different types of exchange-traded funds that allow traders to gain exposure to the price movements of Bitcoin. Below is an explanation of the differences between Spot and Futures Bitcoin ETFs:

Underlying Assets: Spot Bitcoin ETFs directly hold Bitcoin as their underlying asset. This means the fund owns and manages actual Bitcoin. The price of the ETF then tracks the price movement of Bitcoin and has several embedded mechanisms to ensure the prices remain correlated. 

On the other hand, Futures Bitcoin ETFs hold futures contracts that normally have Bitcoin as the underlying asset. These contracts represent an agreement to buy or sell Bitcoin at a predetermined price on a future date.

Trading Mechanisms: Spot Bitcoin and Ethereum ETFs track the real-time price of Bitcoin or Ethereum, respectively. For example, when traders buy shares of a Spot Bitcoin ETF, the fund purchases and holds the equivalent value of Bitcoin. ETF customers, at times, can redeem shares of the ETF and receive the underlying asset through the redemption process. Thus, the ETF has embedded mechanisms to ensure the share price is directly correlated to the price of Bitcoin.

Futures Bitcoin ETFs, on the other hand, hold — and therefore track — the price of Bitcoin futures contracts, which are traded on regulated futures exchanges and have an expiration date. The ETF’s performance is tied to the performance of these futures contracts rather than the spot price of Bitcoin.

Risk Profiles: Spot Bitcoin ETFs carry the risks associated with owning and managing Bitcoin. These risks include price volatility, security concerns, and regulatory uncertainties. The value of the ETF can fluctuate based on the price movements of Bitcoin.

Futures Bitcoin ETFs introduce additional risks, such as the risk of futures contract expiration and the potential for price discrepancies between the futures price and the spot price of Bitcoin. These ETFs also carry market and liquidity risks associated with futures trading.

Advantages and Disadvantages: Spot Bitcoin ETFs offer traders direct exposure to the price movements of Bitcoin. They are relatively straightforward and easy to understand. Traders can benefit from the potential upside of Bitcoin’s price appreciation.

Futures Bitcoin ETFs provide a way for traders to gain exposure to Bitcoin through futures contracts. They offer more flexibility in terms of trading and are currently more readily available given the heightened regulatory challenges surrounding Spot Bitcoin ETFs.

However, both types of Bitcoin and Ethereum ETFs come with certain disadvantages. Price volatility and regulatory uncertainties in the cryptocurrency market can impact the value of the ETFs. Additionally, the risks associated with futures trading, such as contract expiration and price discrepancies, should be carefully considered.

Why Is the SEC Delaying the Approval of Spot ETFs?

The SEC is the securities commission of the US and governing body for financial securities on the market, an asset category that ETFs fall under. The SEC approved 11 Spot Bitcoin ETFs in January 2024, but there are primary concerns surrounding potential market manipulation and investor protection, according to its statements. The regulatory body claims to take a cautious approach to ensure that adequate safeguards are in place before granting approval.

Currently, Bitcoin and Ethereum Futures ETFs are already on the market, while multiple financial companies have applied for Bitcoin and Ethereum Spot ETFs to be launched in the US. However, as of mid-April 2024, the SEC has further delayed the decision on the Hashdex and ARK 21Shares Ethereum ETFs, extending the decision until May 2024.

The SEC says it wants to address the potential risks associated with cryptocurrencies and ensure that investors are adequately protected from any fraudulent activities or manipulative practices. Despite the delays, there is growing institutional interest in cryptocurrencies, which could eventually lead to the approval of more Bitcoin and Ethereum Spot ETFs, and even to Spot ETFs on other cryptocurrencies.

Conclusion — the Next Steps for Bitcoin and Ethereum ETFs

Bitcoin and Ethereum ETFs have the potential to revolutionise the cryptocurrency market by providing a regulated and accessible investment vehicle for both retail and institutional traders. While there are currently two main types of Bitcoin and Ethereum ETFs — Spot and Futures, each with their own risks and advantages — the conversation has primarily been focused on Spot ETFs. The SEC’s delay in the approval of Bitcoin and Ethereum Spot ETFs is primarily due to concerns regarding market manipulation and investor protection. 

However, once approved, Spot Bitcoin and Ethereum ETFs could bring increased liquidity, stability, and mainstream adoption to the cryptocurrency market — opening the door to other Spot ETFs on other cryptocurrencies. 

As the regulatory landscape continues to evolve and mature, it is crucial for market participants and regulators to collaborate and establish a framework that strikes a balance between innovation and trader protection. Ultimately, the future of cryptocurrency ETFs, starting with Bitcoin and Ethereum, hinges on the ability to address regulatory concerns and build a trustworthy ecosystem that instills confidence in traders.

Due Diligence and Do Your Own Research

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