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A Closer Look at Spot Bitcoin ETFs

January 26, 2024

 

With the recent SEC approval on January 10, 2024, of the first U.S.-listed Exchange-Traded Funds to track Bitcoin, I thought it made sense to explain what exactly that is. A spot Bitcoin ETF is a financial product that allows investors to gain exposure to the price movements of Bitcoin without actually owning the cryptocurrency itself. I’ve outlined how it typically works along with the associated risks:

1. Bitcoin Exposure: A spot Bitcoin ETF holds “physical” Bitcoin. When you buy shares in the ETF, you indirectly own a portion of the underlying Bitcoin held by the fund. The Risk: Bitcoin ETFs rely on financial institutions and custodians to hold and secure the actual Bitcoin. These custodians may face security breaches or insolvency, which can jeopardize the safety of your investment. While reputable custodians take security seriously, there's always a risk involved when you trust third parties with your assets.

2.Trading on Exchanges and Liquidity: Like traditional ETFs, spot Bitcoin ETFs are traded on exchanges. This means you can buy and sell shares of the ETF just like you would with stocks. In addition, ETFs are generally more liquid than buying actual Bitcoin. You can buy or sell ETF shares on the stock exchange during trading hours, which can be more convenient than dealing with cryptocurrency exchanges. The Risk: Bitcoin ETFs can sometimes trade at premiums or discounts to the actual Bitcoin price. This discrepancy can occur due to supply and demand dynamics within the ETF market. Investors may end up paying more or receiving less than the actual Bitcoin price when buying or selling shares of the ETF.

3. Price Tracking: The ETF aims to track the price of Bitcoin. So, if the price of Bitcoin goes up, the value of your ETF shares should also increase, and vice versa. The Risk: Bitcoin ETFs aim to track the performance of Bitcoin, but they may not always do so perfectly. Factors like management fees, trading spreads, and tracking errors can result in differences between the ETF's performance and the actual Bitcoin price. These discrepancies can erode your returns over time.

4. Accessibility: ETFs provide an easier way for investors to invest in Bitcoin without having to manage and secure their own cryptocurrency holdings. It's particularly appealing to institutional investors who may have regulatory constraints or custody concerns when it comes to holding cryptocurrencies directly. The Risk: One of the key advantages of owning actual Bitcoin is having control over your private keys and wallet. When you invest in a Bitcoin ETF, you don't own the underlying asset directly. Instead, you own shares in the ETF, which represents ownership in a fund that holds Bitcoin. This lack of direct ownership means you have less control over your investment, and you are dependent on the fund manager's decisions.

5. Regulated Investment: Spot Bitcoin ETFs are typically regulated financial products, subject to the rules and oversight of the relevant financial authorities in the jurisdiction where they are offered. This can provide investors with a level of security and confidence. The Risk: The regulatory landscape surrounding cryptocurrencies and Bitcoin ETFs is constantly evolving. Depending on your jurisdiction, there may be uncertainties about how these assets are treated for tax purposes and whether they comply with existing regulations. Changes in regulations can impact the performance and legality of Bitcoin ETFs.

6. Other Risks and Features of Note: Bitcoin itself is known for its price volatility, and Bitcoin ETFs are not immune to this volatility. In fact, the value of Bitcoin ETF shares can be even more volatile due to factors like trading hours, futures contracts, and investor sentiment. Also, unlike most traditional stocks, Bitcoin doesn't pay dividends or generate income. When you invest in a Bitcoin ETF, you won't receive any income from your investment. Your potential returns rely solely on the price appreciation of Bitcoin.

The cryptocurrency market is relatively young compared to traditional financial markets. Due to this and other factors, including its high volatility, security and technology risks, along with the evolving regulatory environment, we do not have plans to include a spot Bitcoin ETF in our models at this time. We will, however, stay on top of this and other new products to make sure we are taking advantage everything available when making recommendations for your investments.

As always, thank you for entrusting us with the management of your investments. We value our relationship with you and look forward to continuing to help you achieve your financial objectives.