Spot Bitcoin ETFs: Understanding what they are and their investment implications

Bitcoin, the world’s most popular cryptocurrency by market capitalization, has been making headlines lately with its soaring prices in anticipation of a spot bitcoin ETF approval. ^[1] Spot bitcoin ETFs are investment products that directly own bitcoin and trade on conventional stock exchanges, making them accessible to a broader range of investors. For years, the U.S. Securities and Exchange Commission (SEC) has been reluctant to approve such ETFs, citing concerns over the cryptocurrency industry, such as market manipulation, fraud, and lack of oversight. However, in January 2024, the SEC finally gave the green light to the first batch of spot bitcoin ETFs, which could be a watershed moment for the crypto industry.

Why do spot bitcoin ETFs matter?

Until now, investors have had four primary methods to obtain exposure to Bitcoin.

• First, they could buy bitcoin directly by exchanging fiat currency for it. Proponents valued owning the actual bitcoin for reasons similar to owning tangible gold. However, holding bitcoin can be challenging from a technological and security perspective, especially in its early days, making it a daunting task for some.
• Second, investors could purchase derivative-based bitcoin ETFs. These ETFs were easier to buy and sell but suffered from tracking error as bitcoin derivatives’ performance can diverge from actual bitcoin.
• Third, people chose to invest in public or private funds that held actual bitcoin. However, these funds sometimes had limited liquidity, high minimums, and large tracking error due to their structure. They were also potentially subject to investor accreditation requirements.
• Fourth, investors could gain bitcoin exposure indirectly through buying publicly traded bitcoin mining companies or companies that had purchased large amounts of bitcoin on their balance sheets, like MicroStrategy. While this was a more diversified approach to investing in bitcoin, its indirect nature made it complicated to manage target exposure, investors’ returns were less correlated with bitcoin’s price, and investors were exposed to additional risks from non-bitcoin-related businesses.

Spot bitcoin ETFs offer several advantages for investors wanting to gain bitcoin exposure, including:

• Ease of access: Bitcoin ETFs trade on regular stock exchanges, which means investors can buy and sell them using their existing brokerage accounts without the hassle of crypto wallets, exchanges, or private keys.
• Minimal tracking error: Due to holding actual bitcoin and the ETF’s structure, which helps keep the fund’s price very close to net asset value (NAV), spot bitcoin ETFs are expected to track the price of bitcoin closely.
• Transparency: Bitcoin ETFs are regulated by the SEC and subject to the same disclosure and reporting requirements as other ETFs. Therefore, investors can access reliable and up-to-date information about the fund’s performance, holdings, fees, and risks.
• Cost efficiency: Bitcoin ETFs have lower fees than other methods of investing in bitcoin, such as buying and storing bitcoins directly or investing in bitcoin trusts or funds, which often are subject to high management fees and/or transaction fees.

What are the risks of spot bitcoin ETFs?

Bitcoin ETFs are not without risks. While not an exhaustive list, investors should be aware of the following potential dangers before investing.

• Volatility: These ETFs are subject to the same volatility as bitcoin itself, which tends to be more volatile than most other assets and means investors can experience significant gains or losses.
• Operational risk: Bitcoin ETFs rely on various third parties, such as custodians, brokers, exchanges, and auditors, to operate and provide services. These third parties may face operational issues, such as technical glitches, cyberattacks, human errors, or fraud, which may compromise the security, integrity, or availability of the fund’s assets or data.

Is Bitcoin a good investment, and should you invest?

Bitcoin is different from traditional investments, given its intangible nature, lack of inherent value, and inability to generate cash flow. Proponents of bitcoin cite a variety of use cases and hypothesize several investment cases, such as using bitcoin as:

• Digital gold: Bitcoin is often compared to gold as a potential store of value due to its limited supply, increasing adoption, and potential inflation hedge. Bitcoin also has some advantages over gold, such as being easily divisible, more durable, and of finite supply.
• Global reserve currency: Bitcoin is a borderless and neutral alternative to national currencies, which may suffer from political and economic instability, devaluation, and censorship. Bitcoin offers a means for people to preserve and transfer their wealth across borders and jurisdictions without intermediaries.
• Uncorrelated asset: Bitcoin is a unique asset class that does not theoretically depend on the performance of traditional markets, such as stocks, bonds, commodities, or currencies. Therefore, it may offer unique diversification benefits.

Bitcoin has exhibited some or none of these characteristics at any given time, making it challenging to determine what Bitcoin’s actual investment case is. Several valuation models have been attempted, such as:

• Estimating Bitcoin’s total addressable market by replacing a percentage of the world’s currency or gold supply.
• Measuring its stock-to-flow (comparing current supply to new issuance).
• Valuing Bitcoin as a network.
• Evaluating its cost of production derived from the expense of mining.

All of these models are theoretical at this point. We believe it is too early to discern Bitcoin’s long-term investment case and whether it belongs in an investment portfolio. Our position continues to be that if investors want to allocate to bitcoin, it is best suited for a high-risk/high-potential, speculative role and they should limit it to a very small portion of their portfolio.

Conclusion

Spot bitcoin ETFs are a new and exciting way for investors to gain exposure to the most prominent cryptocurrency in their brokerage accounts. They offer several benefits, such as ease of access, liquidity, transparency, and cost-efficiency, but they also entail some risk, such as volatility, regulatory uncertainty, and operational liability. Investors should do their research and due diligence before investing in bitcoin ETFs and be prepared for this emerging asset’s potential risk/reward if they decide to allocate to it.

[1] In this article, Bitcoin is capitalized when describing the concept of Bitcoin or the entire network of cryptocurrency. Lowercase bitcoin is used to describe bitcoins as a unit of cryptocurrency.

As with any investment strategy, there is potential for profit as well as the possibility of loss. Blue Trust does not guarantee any minimum level of investment performance or the success of any investment strategy. All investments involve risk and investment recommendations will not always be profitable. Diversification does not guarantee investment returns and does not eliminate loss. Past performance does not guarantee future results.

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