Bitcoin ETFs were all over the news during 2018.
Many voices called them out as some kind of magical act that would lead the price of Bitcoin to its former glory and maybe even higher than that.
While an approved ETF could be the catalyst that kicks off a new bitcoin bull run, there is still misunderstanding and misinformation among crypto enthusiasts.
It’s time to answer some burning questions: what is a bitcoin ETF? What consequences will it have for the future bitcoin price? And, of course, how likely it that a bitcoin ETF is approved in the coming months?
What is an ETF? (A Simple Explanation)
To start with, let’s define an ETF itself.
ETF stands for Exchange-Traded Fund. It’s a fund that tracks and mirrors the price of an underlying asset (like gold, for example). An ETF might also track a basket of assets (like tech stocks).
Shares of an ETF are traded on real stock exchanges and generally do not differ from traditional stocks in terms of trading.
Some of the most popular ETFs include those for gold (GLD) and crude oil (USO).
The main advantage of an ETF is simplicity and convenience. It is much easier to trade an ETF than it is to purchase gold or bitcoin or oil itself.
Who Makes and Approves ETFs?
ETFs are created by asset management firms. The firm buys the underlying assets (i.e. bitcoin) and keeps them under custody before creating an ETF.
The US Securities and Exchange Commission (SEC) is responsible for approving an ETF. Once they are approved, investors can buy shares of the ETF from a stock exchange.
An ETF share represents a certain percentage of the fund, but it does not represent ownership of the underlying asset. If you buy a bitcoin ETF, you are not buying bitcoin itself.
ETFs are popular investments for diversifying portfolios with minor monetary and timely expenditures.
What is a Bitcoin ETF?
A bitcoin ETF is an investment tool that would track the price of bitcoin. If approved, it would introduce an easy way for investors to get exposure to bitcoin without having to buy or store it directly. Traders would be able to buy and sell shares of the bitcoin ETF on a regulated stock exchange.
Although Bitcoin is already one of the most liquid assets on earth, it still can’t be traded on a regular stock exchange.
As well as the added convenience, investors could buy the bitcoin ETF through their existing, familiar investment account.
Why a Bitcoin ETF Could Lead to “Big Money” Institutional Investors
The most significant benefit of buying ETF shares instead of real bitcoins, apart from its availability on stock markets, is the fact that institutional investors don’t have to store it themselves.
Therefore, there is no risk of the bitcoins getting stolen.
Big institutions are currently prohibited from buying bitcoins directly, but an ETF would make their participation in the market a reality.
Regarding that, there are currently two different types of bitcoin ETFs proposed by multiple asset management firms: physical-backed ETFs and futures-backed ETFs.
What is a Physical-Backed Bitcoin ETF?
As you might have already suspected, a physical-backed bitcoin ETF gains its value through actual bitcoins.
This means an asset management firm needs to buy bitcoins from the market and then store them in their own wallets or custody service.
Price swings in the ETF should, therefore, be reflected by the price of an actual bitcoin. If bitcoin’s price increases by one percent, the price of a physical-backed ETF should rise by one percent as well.
What is a Futures-Backed ETF?
When trying to set up a futures-backed ETF, the issuing company does not have to buy actual bitcoins, but bitcoin “futures contracts”. Futures are financial instruments that are used to bet on the future price of that asset.
All futures contracts expire on a certain date, although there are different timeframes, e.g. weekly or quarterly.
Futures traders are confronted with higher risks, but also higher rewards. Regarding the ETF, the issuing company has to update their future contracts every time the contracts expire.
Historic Bitcoin ETF Proposals and Rejections
Although Bitcoin ETFs received a lot of media attention in 2018, there have been dozens of attempts to push one through before.
Two of the most popular applicants might be the Winklevoss twins, who have supported bitcoin for several years. As CoinDesk investigated in 2017, the brothers submitted their first ETF proposal in mid-2013, with numerous additional proposals in the following years. Unfortunately, the SEC was not satisfied with their offerings so far.
Besides Cameron and Tyler Winklevoss, many other players are heavily interested in issuing a Bitcoin ETF. As Block Explorer previously reported, the SEC rejected nine applications solely in August this year. This includes multiple proposals for a futures-backed ETF by ProShares, Direxion, and GraniteShares, in collaboration with the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE).
In this case, the ensemble is proposing a physical-backed ETF. Experts think this particular group has a higher chance of approval, due to their past experience issuing ETFs.
The date for a decision has already been postponed by the SEC for the second time. While the next date would be on December 29, it is very likely that it will be changed another time.
What Does the SEC Need to See Before It Approves a Bitcoin ETF?
According to most experts, it probably seems more logical to introduce a physical-backed ETF than a futures-backed one.
However, from the angle of an asset management firm, it’s actually quite the opposite. Roughly 85% of all Bitcoin ETF applications are futures-backed ETFs.
A major reason for this trend is, without a doubt, the frequently discussed custody question. Securely storing large amounts of cryptocurrencies has been a great stumbling block for many big players, like exchanges, in the past and present.
Additionally, bitcoin futures are already a financial instrument open to institutions and have been approved by the SEC before. Consequently, it appears like a smaller step to introduce a futures-backed ETF.
However, a very critical development the SEC wants to see, before approving an ETF, is a steep reduction of market manipulation and fraud attempts.
When rejecting nine ETF proposals in August, the SEC stated that
“…the Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange’s rules be designed to prevent fraudulent and manipulative acts and practices.”
Further reading: Bitcoin ETFs: Why Do They Keep Getting Rejected?
Bitcoin ETF Quotes and Predictions
Since ETFs are one of the hottest topics this year, there have been several voices expressing their opinions, about if and when an ETF could be on the cards.
For example, FIC Network Founder Arturs Ivanovs told Finance Magnates that:
“Volume from institutional investors would facilitate a significant regulated market that would reduce the scale of price manipulation thereby easing the SEC’s concerns. An ETF would also open up the market to more retail investors.”
After being asked for a date, Ivanovs said, “2020 is my prediction.”
Income Locker CEO Csaba Csabai thinks that there might be other hurdles that need to be cleared. “There is still technological development needed to make Bitcoin exchange-tradable because when buying an ETF, someone has to actually purchase bitcoins,” he said in a conversation with Finance Magnates. Nevertheless, Csabai also sees a silver lining, as he went on with “if the rate of adoption continues to grow at the current pace, we will soon see an ETF, because it’s the only way institutions can access this asset class, so solving it as soon as possible is in their best interest.”
In an interview with ETF.com, Spencer Bogart, Needham & Co vice president of equity research said:
“We have pegged the odds at less than 25 percent. That is because the very first thing the SEC lists in its own mission statement is protecting the investing public. When you think about the game theory aspect of this, if I work at the SEC and I approve this ETF. and it goes well, nobody is probably going to come around and pat me on the back and give me a promotion. But if I approve it and a lot of money flows into it, and something goes wrong, I am likely to lose my job.”
However, there are also parties that don’t believe in a Bitcoin ETF at all. Nouriel “Dr. Doom” Roubini believes that the crypto space has several issues, like fraud and manipulation, that will make an ETF not feasible in the near future. In a debate at CoinTelegraph’s BlockShow, Nouriel recently stated that “The academic evidence is, that this market is totally manipulated.” He later continued, “How do you expect anybody, who is an institutional investor, who has to be compliant with the rules and regulation, KYC/AML, to enter the space.”
Could an ETF Influence Bitcoin’s Price?
To answer this question, one clearly needs to distinguish between a futures-backed and a physical-backed ETF. As already elaborated in the beginning, to create a physical-backed ETF the issuing firm needs to buy bitcoin from the market.
Although those deals wouldn’t be made on a regular crypto exchange, it would inevitably have an effect on bitcoin’s price, due to the immense amounts of bitcoin that would be needed for an ETF.
In addition, an approved ETF would attract countless speculators, who would probably buy bitcoin right away. So yes, a physical-backed ETF would, with almost full certainty, have a great impact on the price of bitcoin.
In regard to a futures-backed ETF, the impact might not be as big as with the physical one. The issuer would only need to buy futures contracts, hence the price wouldn’t be directly affected.
Futures would most probably help to spread adoption in institutional circles, but this would only be valid in the long term. In the worst case, it could even have a negative impact on bitcoin, as the past has already shown when bitcoin futures were introduced for the first time.
Still, we can’t be sure about the impact before an ETF has even been officially approved.
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