Whose ETF is it, anyway?
Views expressed in the article below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.
ETF fever has dominated the crypto space in recent weeks as traditional exchanges gear up to provide additional access to bitcoin’s price action through tailor-made funds. Let’s take a minute to explore what ETFs are, and why they’re important for crypto.
Defining an ETF
An ETF is an exchange-traded fund, which allows investors to speculate on a market without actually owning the underlying asset. ETFs mirror the price of the asset they are created to represent. ETFs often comprise a basket of individual assets to allow for increased diversification. In the context of crypto, a bitcoin ETF mirrors the price of bitcoin.
Why not just buy BTC?
A bitcoin ETF allows traders to speculate on the price of bitcoin without being responsible for the storage or management of any actual bitcoin, encouraging new investors from traditional exchanges and markets to speculate on its price. People intimidated by the security and storage considerations of crypto investment may see ETFs as a friendlier alternative. Larger institutional players may also be attracted to ETFs as a means to gain bitcoin exposure without having to carry added regulatory burdens.
Why now?
BTC evangelists have been seeking approval for a bitcoin ETF since 2016. Gemini exchange co-founders, Cameron and Tyler Winklevoss, have attempted to file for an ETF numerous times in vain over the last five years, and they’re certainly not the only ones to walk this path.
List of ETF applications as of August 2019
Thus far, the market’s novelty and volatility has made the US Securities and Exchange Commission (SEC) reluctant to allow an ETF. SEC chief Gary Gensler has recently been less resistant to a futures-backed Bitcoin ETF - based on the BTC derivatives market, rather than spot trading.
Several firms have declared intent to list a futures-backed bitcoin ETF with ProShares leading the charge, indicating that its BITO ETF could start trading as early as Tuesday. This means that those trading in regulated traditional markets will now be able to gain exposure to bitcoin.
What does this mean for bitcoin?
It’s important to note that the ETFs being considered this week are based on the price of the bitcoin futures market, rather than the spot price of bitcoin itself. The development of a spot-based BTC ETF would require exchanges to hold reserves of BTC relative to the ETFs offered, thus making it a far more strenuous undertaking.
While a futures based ETF may appear to be easier to administer than one based on spot BTC, it also has a notable drawback. It’s quite possible that a futures based ETF will trade at a large premium to spot BTC and you’ll observe that futures markets often trade at a premium to spot during a bull market, for example.
The obvious consequence of this is that if you buy the ETF out of convenience (or FOMO), you might not realise you’re buying at a higher cost than you could through your favourite crypto exchange. That premium is ripe for funds to capture an arbitrage opportunity by selling the ETF and hedging that trade by buying spot BTC, with retail footing the bill.
So whose ETF is this, anyway? Probably one for the professional traders and middlemen, who can prey on premia, execute arbitrage at scale and charge admin fees. However, a futures based ETF is a real step along the path to making towards making crypto more easily accessible to the 96% of the world that does not currently participate in the most interesting market in the world.
As a proponent for increased crypto adoption, this writer is excited to see where this development takes us. The impetus already appears to be building for a spot ETF, with murmurs that Grayscale is once again thinking about converting GBTC into a spot ETF. Finally, a little more spot buying pressure from funds arbing premia may make for an even more interesting market in Q4 2021.