An exchange-traded fund, or ETF for short, is a type of security that can be made up of many other securities, like stocks or bonds. Sometimes ETFs track an underlying index, but there are almost endless ways ETFs can be structured to invest in any kind of asset or assets.
It’s common for ETFs to focus on a group of stocks that have a common theme that binds them together, such as renewable energy, legal cannabis companies, or the video game and e-sports industry, for example. A Bitcoin ETF is another such example.
A Bitcoin ETF invests in assets that are intended to correlate to the price of Bitcoin (including Bitcoin itself). When Bitcoin goes up in price against the US dollar, Bitcoin ETFs should also go up. When the Bitcoin price in dollar terms falls, then Bitcoin ETFs should also fall in price.
Bitcoin ETFs have a much narrower focus than most other ETFs. If the goal is to have an investment vehicle that mimics the price of Bitcoin alone, the fund would have relatively limited options in terms of what it could invest in to achieve that goal.
What is Bitcoin?
Bitcoin was conceptualized in 2008 when a pseudonymous person or group under the name of Satoshi Nakamoto published a white paper for a “peer-to-peer electronic cash system” in October 2008. In January 2009 the network went live with the creation of the “genesis block,” the first block in a blockchain (the technology that underlies the Bitcoin network)—but even today, many people still wonder, what is Bitcoin?
Bitcoin allows people to transfer monetary value to each other without needing a third-party intermediary like a bank or a payment app to facilitate the transfer.
Instead, the money is transferred through the Bitcoin network, which consists of a large number of powerful computers located around in the world (these computers are referred to as “miners”). Being distributed in this way means there’s no central point of failure for the network, like a single server or headquarters that could be hacked or compromised.
In exchange for processing transactions, miners are rewarded with newly minted Bitcoin (they also receive a small fee for each transaction). This is the only way new coins can come into existence, and there will only ever be 21 million Bitcoins total, according to the protocol.
Bitcoin is sometimes referred to as “digital gold”: It has a fixed supply limit and requires physical resources (electricity and computing power) to create additional supply. Gold also requires physical resources to mine and has a fixed supply limit according to how much of it exists in the Earth’s crust.
Additionally, Bitcoin serves as a messaging system. Bitcoin transactions can include a text message at the same time they transfer money.
Creation of a New Asset Class
The invention of Bitcoin created a new asset class, and many other types of cryptocurrencies have sprung up in the years since. But Bitcoin is the only one that has so far stood the test of time and continued to exist “in the wild,” so to speak—there is no central organization maintaining or promoting Bitcoin outside of a loose-knit group of volunteer programmers.
Because Bitcoin is such a new asset class, there has been a long and arduous struggle to get regulators to approve related investment vehicles like a Bitcoin ETF. Many have tried. Most have failed.
ETFs of any kind must be approved by the Securities and Exchange Commission (SEC) before being listed on any American stock exchange. And so far, the SEC has been very hesitant to grant most proposed Bitcoin ETFs the right to become tradable securities.
This can be seen as an unfortunate circumstance, as many investors might like to have this kind of option to invest in Bitcoin for numerous reasons.
Why Choose a Bitcoin ETF?
Two reasons an investor might choose to invest in a Bitcoin ETF rather than invest in Bitcoin are universal to ETF investing in general. (For investors who already know how ETFs work, some of this may be a refresher.)
• ETFs provide a seemingly easy way to profit from rising asset prices without having to actually own those assets. For example, if an investor thinks the price of gold will go up but doesn’t want to buy and hold physical gold, she could buy shares of a gold ETF. Those shares should go up with the price of gold.
This both avoids the need for physical ownership of the underlying asset while also making it easier to sell shares and take profits. Holding real gold would require storing it and then finding a buyer in order to take profits.
• An ETF might also let investors gain exposure to assets they could never buy otherwise. For example, if an investor believes the price of oil will go up, they could buy shares of an oil ETF, rather than buying physical barrels of crude oil, holding onto them, and finding someone to sell them to after the price rises.
Aside from these reasons, Bitcoin ETFs have a few other, unique factors that might attract investors.
Bitcoin ETF: No Technical Expertise Required
Buying a Bitcoin ETF requires little tech know-how beyond knowing how to use a computer, open a brokerage account, and place a buy order.
On the other hand, holding actual Bitcoin requires a somewhat advanced level of technical expertise. Securely storing cryptocurrencies—for example, storing the private keys to a Bitcoin wallet—is most often done by using either a paper wallet that has the keys written in the form of a QR code and a long string of random characters, or by using an external piece of hardware called a hardware wallet.
When a user holds their own private keys (the code that can decrypt a crypto wallet and be used to take the funds stashed in it), that comes with a certain responsibility, as anyone who obtains the private key to a wallet can then steal the funds held within. That’s assuming the keys were stored correctly in the first place.
When done incorrectly or carelessly, the result could be a total loss of investment. Social media and cryptocurrency forums are rife with horror stories about users who sent coins to the wrong address, misplaced their backup passphrase, forgot their PIN number, or experienced other sad scenarios that created a world of hurt for investors.
The other option for owning Bitcoin directly would be holding coins on an exchange. Some cryptocurrency exchanges might be trustworthy, but some have also had a controversial history of being hacked, stolen from, or defrauded. Even reliable exchanges open investors up to counterparty risk.
Bitcoin ETF: Less Counterparty Risk
Counterparty risk arises whenever a third party holds onto something for someone else. In certain situations, the third party’s interests might run contrary to that of the investor’s assets that they hold.
Over the years, some service providers have sprung up promising to securely hold coins for users. This may or may not be a desirable or promising solution, but even if it were suitable in all cases, there would still be risk.
At best, an unforeseen event like a bankruptcy or market disruption could cause a business to withhold customer funds for a period of time, making them inaccessible when people might need those assets most.
At worst, counterparty risk can result in partial or total loss of investment, as has occurred several times in the past when cryptocurrency exchanges have been hacked or had funds stolen by their own employees.
By contrast, holding shares of a Bitcoin ETF gives an investor exposure to the price of bitcoin without the potential risks or hassle of holding actual bitcoin. (Although no bank or stock brokerage can be said to have zero counterparty risk at all, most are insured by the Federal Deposit Insurance Corporation and have never had a single customer lose funds).
Benefits of Bitcoin ETFs
The benefits of holding shares of a Bitcoin ETF derive from the fact that these shares can be held in a traditional brokerage account. These positive aspects include:
• It’s easy to buy and sell. Generally, purchasing shares of an ETF can be done rather easily. With a Bitcoin ETF, the limited choices make things even simpler.
• There’s no need to learn how to use the new tech. Buying Bitcoin can be confusing for less-than tech-savvy users. The process often involves setting up an account on a cryptocurrency exchange, most of which are largely unregulated. Buying an ETF negates the need for this step.
• There is less risk of losing funds. Beyond the normal risks associated with investing in general.
Risks of Bitcoin ETFs
The risks of a Bitcoin ETF come from both the traditional investment world and the world of cryptocurrency markets. There are two considerations many investigators look at.
Bitcoin ETF Risk: High volatility
The volatility comes from the occasional wild swings experienced in the price of bitcoin against most other currencies.
A Bitcoin ETF, which is intended to mimic the price action of bitcoin, should also experience similar price swings. This could scare investors that have a lower risk tolerance, enticing them to panic sell.
Bitcoin ETF Risk: Expense ratios cut into profits
One risk that comes from holding an ETF of any kind involves its expense ratio. This number refers to the amount of money a fund’s management charges in exchange for providing the opportunity for investors to invest in their fund.
If a fund comes with an expense ratio of 2%, for example, the fund management would take $2 out of a $100 investment each year. This figure is usually calculated after profits have been factored in, cutting into investors’ gains.
How to Invest in a Bitcoin ETF?
The SEC has only approved two Bitcoin ETF investment vehicles to-date—and the second ETF actually invests in the first one.
While there currently may not be any additional approved Bitcoin ETFs on the market, there are other ETFs out there that provide exposure to bitcoin-related securities such as stocks related to blockchain, the technology that underlies the bitcoin network.
For some investors seeking exposure to Bitcoin, the singular focus of a Bitcoin ETF—with fewer risks than direct Bitcoin investing—might be exactly what they want.
ETFs give investors the ability to diversify their investments without having to own the real assets themselves. Buying shares of an ETF can be a simpler alternative to having to select individual stocks to buy and sell.
But there is more than one way to get involved in Bitcoin. SoFi Invest® helps investors get started buying Bitcoin and other cryptocurrencies, without the hassle and fuss involved with traditional exchanges or brokerages.
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