What is a Bitcoin ETF [Types and How it Works]

15 January 2025 at 16:59

What is a Bitcoin ETF? It’s an investment vehicle offering exposure to Bitcoin without requiring investors to directly purchase, store, or manage the asset. Similar to other ETFs (Exchange-Traded Funds) that track the price of commodities or indexes, such as gold or the S&P 500, a Bitcoin ETF mirrors BTC’s price movement. This makes it an attractive option for an investor looking to enter the cryptocurrency market while staying within the structure of traditional financial systems.

If you want to tap into cryptocurrencies and seek a safer way to benefit from BTC, keep reading this article to learn more about BTC ETFs and how they work.

What Does a Bitcoin ETF Mean?

What is BTC ETF? It combines elements of the cryptocurrency and stock markets, bridging the gap between traditional finance and the digital currency space. When investors purchase BTC ETF shares, they buy a stake in a fund that holds Bitcoin or its derivatives on traditional financial exchanges, like the NYSE or NASDAQ. This allows investors to tap into Bitcoin’s potential growth within the framework of a conventional brokerage account. Moreover, it’s also possible to hold Bitcoin ETFs in tax-advantaged accounts like IRAs or 401(k)s, which may not be an option when holding BC directly.

Though closely related, BTC and BTC ETFs are not the same. To better understand what is the ETF for Bitcoin, let’s outline the key differences that fall within a few significant aspects.

Ownership and Custody: Owning Bitcoin directly gives you full control over your asset, requiring you to manage its security and custody of your BTC. With the ETF, you don’t own the Bitcoin itself—the ETF provider is responsible for the BTC custody and security.
Risk Exposure: Security depends on how well you manage your wallet. Direct Bitcoin ownership is subject to risks like losing private keys, forgetting passwords, or being the victim of hacking. ETF reduce these risks, as providers use advanced security measures and often carry insurance.
Accessibility: ETFs are accessible through most brokerage accounts, making them more accessible and easier to manage and trade. Buying Bitcoin directly requires creating an account on a cryptocurrency exchange that requires a higher level of technical knowledge.
Liquidity and Trading Hours: Cryptocurrency exchanges operate 24/7, giving direct crypto owners the ability to buy or sell at any time. ETFs are traded during standard market hours. However, this limitation can help mitigate impulsive decisions.
Price: Direct BTC ownership provides a 1:1 exposure to its market value. Though the ETF closely tracks the current Bitcoin price, it may include small discrepancies due to an administrative fee or tracking errors.
Regulation: ETFs are heavily regulated by financial authorities, such as the SEC in the US, enforcing standards on transparency, security, and reporting.

Types of BTC ETF Explained

When considering BTC ETFs, there are two major types available. Each type offers unique advantages and limitations, so it’s essential to understand their differences for making an informed investment decision.

BTC Spot ETF

Often referred to as “physical” Bitcoin ETFs, spot ETFs track the real-time price of Bitcoin by holding actual Bitcoin assets in the fund. These ETFs aim to reflect Bitcoin’s live market price directly, allowing investors to benefit from any price increases or decreases as if they were owning Bitcoin themselves.

Pros

Cons

Direct Price Tracking: Spot ETFs closely follow Bitcoin’s real-time market value, providing investors with direct exposure to the cryptocurrency’s price movements without discrepancies.
Lower Tracking Error: By holding actual BTC, these ETFs reduce discrepancies between fund performance and Bitcoin’s market price.
Simplicity: Offers exposure to Bitcoin without the need to buy, store, or secure the crypto, Spot ETFs are an accessible option for traditional investors who want to diversify their portfolios with BTC.
Familiar Format: Trades like any stock, spot ETFs entail no hassles, intricacies, or risks with crypto wallets.

Regulatory Hurdles: Though the SEC approved 11 spot ETFs in January 2024, they are still subject to stringent regulatory scrutiny due to concerns over Bitcoin’s market volatility and susceptibility to market manipulation.
Management Fees: Investors are required to pay annual management fees, which can slightly reduce their overall returns compared to holding
BTC directly.
Limited Trading Hours: Trading only during standard market hours limits the investor’s ability to react to Bitcoin’s 24/7 price movements in real time.

BTC Futures ETF

Futures ETFs don’t hold Bitcoin directly. Instead, they invest in future contracts with Bitcoin. These are legal agreements to buy or sell BTC at a specified price on a future date. This approach allows investors to speculate on the future price without requiring the ETF provider to hold Bitcoin directly.

Such contracts are typically traded on regulated futures exchanges, adding a layer of regulatory oversight. Futures ETFs are structured to roll over these contracts on a regular basis. The fund buys new contracts as the old ones expire to maintain exposure to BTC price changes.

Pros

Cons

Regulatory Approval: Futures ETFs are more easily approved by regulators, especially in the US, since futures contracts trade on regulated exchanges and don’t hold the asset directly.
Easier of Access: Available on stock exchanges, futures ETFs make Bitcoin exposure accessible within traditional investment portfolios without needing a cryptocurrency wallet.
Managed Risks: With exposure to BTC price movements, futures ETFs do not entail the same security concerns of storing BTC directly, as these contracts are regulated and monitored by futures exchanges.

Tracking Errors: Futures contracts may not perfectly reflect Bitcoin’s price due to market speculation and “contango” (when higher future prices are higher than the current market ones).
Higher Costs: Futures contracts require frequent rollovers, which can incur additional fees and reduce returns.
Volatility: Reflecting traders’ expectations about Bitcoin’s future price, which may not align with real-time market conditions, futures ETFs are more unpredictable than spot ETFs.
Short-Term Focus: Due to potential tracking errors and higher associated costs, futures ETFs are often better suited for short-term trading than long-term investment.

How Does a Bitcoin ETF Work?

What is ETF Bitcoin? Now that you understand its basics and types, let’s dive deeper into how Bitcoin ETFs work.

BTC ETFs are typically created and managed by financial institutions or fund managers. Since Bitcoin requires digital security, the ETF provider partners with custodial services or secure storage providers. These partnerships ensure the underlying Bitcoin assets are safeguarded against potential theft or loss.

Managing a Bitcoin ETF incurs operational costs. Investors pay management fees, which help cover the costs of asset storage, custodial security, and administrative overhead. These costs are passed on to investors in the form of management fees, which are included in the ETF’s expense ratio.

The ETF’s value is closely tied to Bitcoin’s current market price. For Spot ETFs, this value directly reflects Bitcoin’s real-time price, while Futures ETFs depend on the pricing of Bitcoin futures contracts.