So, what exactly is a spot Bitcoin ETF and how does it work?
A LOT of verbiage was expended on the potential arrival of spot Bitcoin exchange-traded funds (ETFs) – and, when they did eventually arrive, it didn’t stop. There was plenty of speculation about crypto having access to untold amounts of investment and what that might do to the price, but there wasn’t anywhere near as much about what exactly Bitcoin ETFs are and how they work.
In the simplest terms, spot Bitcoin ETFs are a wrapper for holding actual Bitcoin within a package allowing it to be split and held by different people or institutions. In this respect, they are pretty much like an investment trust, which holds underlying investments and issues its own shares to be traded on a stock exchange.
In the same way, the Bitcoin ETFs themselves are regulated and have to abide by the rules laid down by the US Securities and Exchange Commission (SEC). The names behind these ETFs are large institutions with deep pockets – such as Blackrock and ARK – and are licensed by the SEC to operate the ETFs as their ‘authorised participants’.
In theory, these ETFs should be good for crypto as a whole, as more people will likely be reassured by the fact that their investments are regulated and managed much in the same way as traditional assets.
Having ETFs won’t stop the underlying Bitcoin being volatile, but the large APs should operate to smooth wild swings. If an ETF starts to trade at a premium to the underlying assets, then the APs will create additional units so that asset value and units are once again in line.
Similarly, if the ETF begins to trade at a level lower than the underlying assets, then the APs will retire units. One of the interesting things is that the SEC has insisted these AP transactions are conducted for cash and not for the assets. As SEC chairman Gary Gensler said: “We are not in any way approving or endorsing Bitcoin.”
The theory is ETFs should enable better price discovery of Bitcoin and, by adding to the pool of potential investors, make the underlying asset more stable with greater liquidity. The SEC was particularly wary of market manipulation possibilities and potential custodial hazards. Although nothing has been directly said, I’d be willing to bet that the APs have been told they will have to make up for any hack or loss themselves.
The single most important thing is that – going forward – the man in the street doesn’t need to be knowledgeable or capable in the crypto world to invest in Bitcoin. ETFs will be traded on well-known, regulated public exchanges accessible to everyone. Owning a spot Bitcoin ETF will be just like owning a share in BP or Marks and Spencer, albeit without the dividend these companies offer.
For those more familiar with the crypto world, rather than stocks and shares, they should know that the ETFs are not traded like digital tokens. Being on a traditional exchange means set trading hours – rather than the 24/7 usually associated with crypto markets. That in turn could potentially lead to extra volatility and arbitrage opportunities that would negate the advantages inherent in the ETF.
And, finally, what does the word ‘spot’ mean in this context? Well, it indicates the price is instantly knowable and the transaction is for immediate settlement. Fees from the APs will almost certainly be higher than stock trading fees, and there could be tracking errors, as the price of the underlying Bitcoin will be available from numerous exchanges.
The price of Bitcoin has largely floated around between $40,000 and $50,000 since the turn of the year. The surge that was predicted upon ETFs being approved started out in the wrong direction – but that may now be changing. Whatever happens with the price, the fact that Bitcoin ETFs now exist is another step in the assimilation of crypto into the world of regular finance – and all the better for that.
Temple Melville is CEO of The Scotcoin Project Community Interest Company (CIC)
