Spot Bitcoin exchange-traded funds (ETFs) have emerged as a significant addition to the realm of Bitcoin trading. These funds, joining Bitcoin futures ETFs that have been operational since 2021, offer traders a unique way to wager on Bitcoin's price. However, despite their common focus on Bitcoin, they differ significantly in their mechanisms and have a crucial impact on performance. Let's delve into how spot Bitcoin ETFs and Bitcoin futures ETFs work and what you need to know.
Unlock the Potential of Bitcoin with ETFs
How do spot Bitcoin ETFs work?
Just like other exchange-traded funds, spot Bitcoin ETFs hold an underlying asset, which in this case is Bitcoin. These funds acquire and store bitcoins, making them a substantial part of the fund's assets. As new funds flow in, the managers purchase more bitcoins to add to the holdings. Since January 2024, following SEC approval, this type of Bitcoin ETF has been actively trading.This structure enables the funds to closely track the actual price movement of Bitcoin. For instance, if Bitcoin rises by 10 percent, these funds will follow suit, with a slight deduction for management fees. From an investor's perspective, this ability to accurately mirror Bitcoin's price is highly valuable. It provides a means to own the asset through the fund without directly purchasing Bitcoin.If you seek the price performance of the cryptocurrency without the hassle of a crypto exchange, a spot Bitcoin ETF is an excellent choice. Moreover, you don't have to worry about safely storing your own crypto as the fund company takes care of it. This is one of the reasons for paying the management fee. You can have peace of mind knowing that security is handled by professionals.The best Bitcoin ETFs usually have low fees and are easy to buy. Even if you choose to invest in fractional shares, there are brokers available that specialize in fractional share investing.How do Bitcoin futures ETFs work?
Bitcoin futures ETFs do not own the cryptocurrency directly. Instead, they hold futures contracts on Bitcoin, aiming to benefit from the returns of the world's largest cryptocurrency. Futures are standardized contracts where a seller commits to delivering a certain number of bitcoins to the buyer on a specific date. The buyer provides a portion of the contract's total value and may need to add more funds if Bitcoin's price declines.The manager of the Bitcoin futures ETF conducts these operations on behalf of the fund's investors, and the actual investment returns are reflected in the growth of the fund's net asset value.Since futures ETFs do not own Bitcoin directly but only futures contracts, their performance does not always closely track Bitcoin's price. While Bitcoin futures may move in tandem with Bitcoin prices, they can be more volatile.This tracking error can be a significant drawback for traders who expect a fund to perform exactly like the underlying asset. Additionally, these specialized ETFs tend to have higher management fees, making them less appealing compared to lower-cost, non-leveraged funds.What are the pros and cons of spot Bitcoin ETFs and Bitcoin futures ETFs?
Advantages of Bitcoin ETFs:- Direct access to Bitcoin: Spot Bitcoin ETFs own Bitcoin directly, ensuring that each fund share is correlated to a certain amount of the held crypto. It's like having Bitcoin wrapped in a convenient fund.- Low fees: Spot Bitcoin ETFs have low expense ratios and handle the purchasing and securing of Bitcoin holdings. In many cases, it's more cost-effective to invest in the fund and pay fees than to buy Bitcoin directly with commissions.- Accurate price tracking: These ETFs closely follow Bitcoin's price movements, making them an ideal way to own the cryptocurrency.- Liquidity: Both spot Bitcoin ETFs and Bitcoin futures ETFs enhance the liquidity of the Bitcoin market, making it easier to buy and sell.- Easy access on the stock exchange: Being traded on stock exchanges, they provide traditional investors with an accessible way to invest in Bitcoin without the need to set up crypto exchange accounts.- Greater security: Fund management companies take care of securing Bitcoin and its futures, reducing the risk of theft.Disadvantages of Bitcoin ETFs:- Tracking error: Due to using financial derivatives, Bitcoin futures ETFs may not accurately track Bitcoin's price.- Inefficiency: Related to tracking error, Bitcoin futures ETFs need to roll their contracts when they expire to maintain exposure to the cryptocurrency. This can occur at unfavorable times and incur transaction costs.- No direct Bitcoin ownership: Bitcoin futures ETFs do not own Bitcoin directly but trade futures to earn returns. If you want direct Bitcoin ownership, you need to invest in a spot Bitcoin ETF.- No self-custody: The fund companies hold all the investments, which may not suit those who prefer self-custody for security reasons.Other kinds of Bitcoin ETFs
Traders have other options if they want to make leveraged bets on Bitcoin's price appreciation. For example, they can trade leveraged Bitcoin funds that aim to multiply Bitcoin's daily price movements. These funds use financial derivatives and have higher costs compared to spot Bitcoin ETFs.Despite their intended goals, these funds often have significant "tracking error," meaning they deviate from their expected performance due to their structure. There are also other riskier ways to trade Bitcoin and achieve higher returns, but they come with even greater risks.Bottom line
Spot Bitcoin ETFs offer nearly the same price performance as Bitcoin at a low cost, making them an ideal choice for those seeking the convenience of an ETF. In contrast, Bitcoin futures ETFs may not accurately track Bitcoin's price and have higher fees and other issues. The emergence of spot Bitcoin ETFs allows traders to feel like they are almost directly trading Bitcoin.Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. Past investment product performance does not guarantee future price appreciation.
