Exploring Bitcoin and Ethereum ETFs: What You Should Know?

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Introduction

The securities regulator body in the US, the SEC (Securities and Exchange Commission) that rejected several applications for crypto ETFs over the years has finally approved 11 spot Bitcoin ETFs, and might just approve some Ethereum ETFs soon. Let’s uncover why and how come the sudden turn of events along with the salient features of this latest investment product in the US, that will arguably spur the cryptocurrency adoption. 

Prior to the recent approvals of spot Bitcoin ETFs in the US, Grayscale, one of the institutions behind several Bitcoin investment trusts, challenged the SEC’s rejection of their own spot Bitcoin ETF application in court. The courts once again took a favorable stance with the cryptocurrency industry based on established protocols and logical reasoning. The court’s position on the matter was almost immediately followed by the subsequent approval of other spot Bitcoin ETFs. This major development seems to be influencing other jurisdictions like Hong Kong, which are now seeing an influx of applications for similar products. The SEC, however, has maintained that the approval of spot Bitcoin ETFs are not an endorsement of the product.

Note that the US is not the first country to offer spot Bitcoin ETFs – they have been in existence in Canada, Brazil, and Australia among others since at least 2021. While the US is not a pioneer in offering spot Bitcoin ETFs, it has a global influence like none. Hence its approval is a significant development for the cryptocurrency market within the country and beyond.  It is also noteworthy to mention that the US had approved Bitcoin futures ETFs in the past. And that is because futures products are distinct from spot products by design and hence enjoy a more relaxed regulatory/tax oversight. We’ll cover more on that in the later section of this post. Now let’s get straight into the topic.

What are Bitcoin and Ethereum ETFs?

Bitcoin and Ethereum are the two of the top cryptocurrencies by market cap. At their all time highs (ATH), Bitcoin’s market cap was over $1 trillion (yes, you heard that right!) and Ethereum’s market cap was over $550 billion. As of this writing, the highest price 1 bitcoin reached was around $69k and the highest price 1 ether reached was around $4.8k. This highlights the significant innovation, growth and investment interest both cryptocurrencies (and the underlying protocols) have garnered over the years. 

Bitcoin and Ethereum trades typically occur on specialized platforms known as cryptocurrency exchanges. However, the appeal of Bitcoin and Ethereum ETFs lies in their convenience and safer haven, offering investors the opportunity to invest in both the assets without the need to directly engage with these specific exchange platforms or the cryptocurrencies.

For traditional investors looking to dip their toes into the cryptocurrency market, Ethereum and Bitcoin ETFs provide a seamless option. Essentially, Bitcoin and Ethereum ETFs are exchange-traded funds that mirror the values of Bitcoin and Ethereum, allowing them to be traded on conventional stock exchanges. This arrangement offers the best of both worlds: you can participate in the dynamic world of cryptocurrency trading to experience the potential of crypto assets while still operating within the familiar framework of traditional investment platforms that offer reasonable insurance and assurance. 

Source| Bitcoin ETFs and Ethereum ETFs democratizing the capital markets

History of Bitcoin and Ethereum ETFs

This is how the history of Bitcoin ETFs panned out in the US:

• The world of crypto has a habit of starting at either Bitcoin or Ethereum for most things, and the ETF instrument isn’t an exception. The first suggestions of a Bitcoin spot ETF came right after Bitcoin prices started a persistent upward trajectory since 2013 when it first crossed $1000 per coin. Remember, in the early 2010s, traditional retail and institutional investors lacked direct avenues to invest in Bitcoin. This gave way to a heightened demand for mechanisms that enabled Bitcoin trading within familiar, regulated financial settings
• The demands culminated in the first Bitcoin spot ETF application with the US SEC. Of course, this was rejected. The SEC, like other top government regulatory bodies around the world, have opposed decentralized financial instruments from the beginning as they saw its design and volatility as a risk to traditional financial markets (which hit rock bottom not too long ago ironically due to the problems caused by centralization). 
• In the initial days of crypto, criminal elements leveraged its anonymity and advanced technology for illicit activities. This misuse drew significant attention from law enforcement and became a focal point for regulatory officials fueling skepticism among authorities for the right reasons. Over time, the authorities increasingly used this narrative to discourage widespread crypto adoption, which was perceived by industry insiders as an attempt to unjustly maintain control over the general public and their resources
• In 2017, as Bitcoin approached the $20k mark, the cryptocurrency trading infrastructure was still developing, with a very limited number of exchanges and market makers available. This scarcity again fueled a growing demand for both spot and futures Bitcoin trading options. However, all applications pursuant to such offers, were rejected by regulators citing the volatility, scams, illegal activities in the industry
• The onset of COVID-19 marked a pivotal period for cryptocurrency and capital markets in general, significantly accelerating their adoption globally. This era witnessed a surge in interest towards digital assets and currencies as both retail and institutional investors sought alternative investment avenues amidst the pandemic’s economic uncertainties. This shift in sentiment led to regulatory advancements and the approval of spot Bitcoin ETFs in various countries, further legitimizing crypto as a viable asset class. 
• In 2020, Grayscale upgraded its trust fund to an SEC-reporting entity. While it wasn’t classified as an ETF, it stands as the inaugural publicly traded Bitcoin fund in the U.S
• In the US, this wave of adoption culminated in 2021 with the launch of the ProShares Bitcoin Strategy ETF (BITO), a futures-based ETF, and subsequent approval by the SEC. 
• In 2022, the SEC and the CFTC, which regulates commodities in the US, labeled Bitcoin as a commodity. CFTC, in fact, labeled Ethereum as a commodity too. Although they were clear to dismiss the remaining cryptocurrencies are more or less “unregistered securities”, this move was widely viewed as significant progress, demonstrating a deeper understanding of cryptocurrency and its underlying technology by regulatory bodies
• The FTX collapse in late 2022, though, spurred the SEC and other regulators to adopt stringent measures against key industry players such as crypto exchanges, employing a strategy that became widely referred to as “regulation by enforcement.” The regulators started taking on every major player in the US seemingly at will even curtailing the businesses of few companies.
• In 2022, the SEC rejected several applications including Grayscale’s application, a digital asset manager
• Grayscale challenged the SEC’s rejection of its spot Bitcoin ETF proposal, a position that received support from the court. The court ruled that the SEC did not justify why it had rejected its proposal. Throughout 2023, cryptocurrency companies experienced several victories against regulators in the backdrop of the industry gaining widespread acceptance and recognition as a legitimate asset class, with increasing institutional adoption and wider public recognition
• After deciding not to challenge or appeal the court’s position on Bitcoin ETFs, on January 10, 2024, the SEC approved 11 spot Bitcoin ETFs. These were offered by big names like BlackRock, Fidelity, and the aforementioned Grayscale. Soon billions of dollars started flowing into these ETFs highlighting the widening acceptance of the top cryptocurrency. As of this writing, several top banks, which were initially pessimistic about the Web3 ecosystem, were actively planning to submit their own applications for a spot Bitcoin and Ethereum ETFs.

Salient Features of Bitcoin And Ethereum ETF

What are the key features that make Ethereum and Bitcoin ETFs unique? Here is the appeal of them, summed up for you:

• Bitcoin and Ethereum ETFs represent rapidly developing investment tools, offering investors a way to tap into the potential of leading cryptocurrencies without the complexity of direct ownership or management. Their allure lies in blending familiarity with the cutting-edge possibilities that these digital assets present
• Ethereum and Bitcoin ETFs streamline the cryptocurrency investment process, broadening their appeal and accessibility. With the backing of esteemed firms like BlackRock, these ETFs lend significant credibility to the crypto sector, encouraging a broader spectrum of investors and average people to consider participating in the sector for potential benefits
• Another notable advantage of Bitcoin and Ethereum ETFs is their potential for tax efficiency. ETFs generally offer more favorable tax treatment compared to direct cryptocurrency holdings, as they can possibly minimize capital gains taxes through mechanisms like in-kind transfers. This tax efficiency makes ETFs an attractive option for investors seeking to incorporate cryptocurrencies into their portfolios while optimizing their tax implications

Are Bitcoin and Ethereum ETFs Regulated?

Before they become available to the public for trading, crypto ETFs like Bitcoin and Ethereum ETFs have to be approved by regulatory entities like the US SEC depending on the jurisdiction. This is keeping in mind regulators always take a proactive stance to protect the interest of average investors. Therefore, crypto ETFs available for investment in your jurisdiction likely are regulated, although make sure to double check before investing. While crypto itself is still unregulated in most parts of the world, Ethereum and Bitcoin ETFs are regulated products. 

As a side note, it is important to recognize that being unregulated doesn’t inherently mean illegal. Cryptocurrency is legal in numerous countries worldwide. However, the regulation of spot financial instruments, including those based on cryptocurrencies, requires time. Legislators must first comprehend the products, underlying technologies, historical context, and market trends before effective regulations can be formulated. This process ensures that regulations are informed and beneficial, paving the way for broader and safer access to these innovative investment opportunities.

Understanding the Investor Profile for Ethereum and Bitcoin ETFs

Let’s find out what type of investors are expected to show interest in Ethereum and Bitcoin ETFs? They vary in nature, with some believing in the underlying technology and some here for short term trading/profit-taking among others. Here is a range of people you can expect to be interested in crypto ETFs:

• The Tech-Savvy: While the tech-savvy (say working for a Web2 company) may understand the advancements brought in by Bitcoin and Ethereum, they may not have had the opportunity to cut through the negative connotations associated with the industry and judge for themselves. With ETFs, they can now finally get their hands on these assets in a timely way knowing it is regulated by authorities and they are no longer seen as niche or speculative investments in the strictest sense.
• The Institutional Investors: Mutual funds, hedge funds, and other influential financial institutions, play a crucial role in the maturation of assets, including cryptocurrencies. Major financial asset managers like BlackRock and MicroStrategy have shown growing interest in Bitcoin and other cryptocurrencies for their economic potential among other reasons. This trend not only legitimizes the crypto market but also encourages individual/retail investors to consider crypto assets as viable investment opportunities
• The Retail Investors: They are increasingly exploring Bitcoin and Ethereum ETFs as avenues for diversifying their portfolios beyond traditional deposits, stocks and bonds. Given that cryptocurrencies often exhibit low correlation with conventional financial assets, they offer a compelling diversification strategy, enhancing the potential for balanced portfolio growth and risk management.
• The Risk-Tolerant Investors: Attracted by the potential for higher returns, these investors are gravitating towards cryptocurrencies en masse. This trend naturally positions crypto ETFs as an ideal choice for these investors, aligning perfectly with their preference for high-reward, high-risk investment avenues.
• Regulatory-Conscious Investors: They are keen to explore cryptocurrencies but have hesitated due to unclear regulations. Ethereum and Bitcoin ETFs present a solution, allowing investment in digital currencies within a clear regulatory framework, addressing their concerns and providing a safer entry point into the crypto market. They are not too dissimilar from the tech-savvy group – the only difference is these are your average investors seeking economic, tax and other potential benefits over time, albeit with lesser or no exposure to the underlying technology.

Difference Between Futures Bitcoin ETFs and Spot Bitcoin ETFs

Source| Difference between Bitcoin spot and future ETFs

Spot Market vs Futures Market

Spot markets are where transactions happen instantly, allowing for the direct transfer and ownership of digital currencies. This immediacy means that any profits from these transactions are subject to taxation, similar to gains from traditional investments while demanding stringent regulatory requirements due to its accessibility. 

Futures markets deal in contracts that bet on the future prices of cryptocurrencies without necessitating the immediate exchange of the underlying asset. Futures contracts can be settled in various ways, like cash settlements. They are typically traded in large volumes by HNI, institutional and retail investors. Crypto exchanges and stock brokers often validate the income proof or tax filings of investors before they are allowed to trade futures contracts on their platforms especially given their accessibility to leverages. This requirement aims to ensure that investors understand the risks involved and have the financial stability to engage in what is considered a business activity. And therefore they tend to receive more favorable tax benefits and regulatory relaxations. 

Spot Bitcoin ETF vs Futures Bitcoin ETF

Let’s now bring this context into the Bitcoin ETFs. A spot Bitcoin ETF directly invests in Bitcoin, allowing the ETF’s value to track the current price of Bitcoin closely. Investors in a spot ETF gain exposure to the actual Bitcoin market movements. 

On the other hand, a futures Bitcoin ETF invests in Bitcoin futures contracts rather than holding Bitcoin directly. This allows investors to speculate on the future price of Bitcoin without owning the cryptocurrency itself, potentially offering different risk and reward dynamics compared to a spot ETF.

Prominent Bitcoin and Ethereum ETFs Approved Recently

Here is the list of the Bitcoin spot ETFs the US SEC has approved recently:

• ARK 21Shares Bitcoin ETF (NYSE:ARKB)
• Bitwise Bitcoin ETF (NYSE:BITB)
• Blackrock’s iShares Bitcoin Trust (NASDAQ:IBIT)
• Franklin Bitcoin ETF (NYSE:EZBC)
• Fidelity Wise Origin Bitcoin Trust (NYSE:FBTC)
• Grayscale Bitcoin Trust (NYSE:GBTC)
• Hashdex Bitcoin ETF (NYSEARCA:DEFI)
• Invesco Galaxy Bitcoin ETF (NYSE:BTCO)
• VanEck Bitcoin Trust (NYSE:HODL)
• Valkyrie Bitcoin Fund (NASDAQ:BRRR)
• WisdomTree Bitcoin Fund (NYSE:BTCW)

As of this writing, the SEC is yet to approve any of the applications it received for Ethereum ETFs.

FAQ

Is There a 3x Bitcoin ETF?

A 3x Bitcoin ETF aims to offer investors the opportunity to leverage their investment, amplifying the potential returns or losses to three times the performance of the Bitcoin index or benchmark it follows. While such a highly leveraged Bitcoin ETF doesn’t exist currently, the financial industry may see its introduction in the future, presenting an aggressive investment strategy for those seeking amplified exposure to Bitcoin’s price movements.