In today’s Finshots, we oversimplify Bitcoin ETFs and tell you why everyone’s talking about them.
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The Story
In December 2023 Bitcoin's price rallied to nearly $45,000 a pop. That’s a 170% rise over its value at the beginning of that year. And just in case you didn’t know, Bitcoin prices had sharply fallen in 2022, with many predicting that it would never get back to these levels again. Courtesy, the collapse of crypto exchange platform FTX and a crisis in the US banking system. So this sudden price rise is something that crypto enthusiasts are celebrating.
But why did Bitcoin prices shoot up, you ask?
Well, one good reason was hope. Bitcoin investors hoped that the US Securities and Exchange Commission (SEC) would approve something called a Bitcoin Spot ETF. Okay, we know that sounds confusing or rather scary. Most of us might not even understand how Bitcoins work. So the term Bitcoin Spot ETF could seem gibberish.
But the fun part is that these ETFs help exactly the kind of people who are new to Bitcoin investments or consider it risky to directly invest in it. Here’s what we mean. See, Bitcoins are invisible currencies. They’re created or minted by computers that validate a set of transactions happening on a network called a blockchain. Now, there are only 21 million Bitcoins which could be fully mined by the year 2140. So they’re limited in a way. Add to that the fact that they’re not regulated by any kind of central bank or authority, and you’ll understand why Bitcoin prices can be extremely volatile. They could spiral up or down based on even a simple social media rumour. And that means investing in it is a risky business.
Enter Bitcoin ETFs. ETF stands for Exchange Traded Fund. And a bitcoin ETF is a fund that invests in or buys Bitcoins. These funds get listed on formal stock exchanges and can be traded. Investors can buy or sell them like they do with stocks. So when Bitcoin prices rise or fall, the prices of these ETFs move in tandem too.
Now, we know what you’re thinking. Why would someone who’s worried about Bitcoin’s riskiness even bother about investing in an ETF that tracks its prices?
It’s simple really. If you own a Bitcoin you have to store it in a wallet of sorts. You have to make sure that this wallet is secure, so digital thieves don’t steal your Bitcoins. And that means remembering a complex password and keeping that password safe too! On top of that, you have to worry about the tax rules your profits will attract in case you ever choose to sell your Bitcoins. It’s a lot of hard work. Bitcoin ETFs on the other hand give you exposure to Bitcoins without having to actually invest in them.
But here’s a little twist to the hopeful story of Bitcoin ETFs. This week Bitcoin shed nearly 10% of its rallying price simply because a financial services firm called Matrixport spread fear that the Bitcoin ETF may never be a reality. And its report may have some substance. Over a dozen companies including Grayscale Investments, BlackRock, Invesco, ARK Investments and others have applied to the US SEC to get their Bitcoin ETFs approved. But the SEC hasn’t been keen about giving them a go-ahead. It has rejected multiple applications to launch Bitcoin Spot ETFs in recent years, starting with Winklevoss Bitcoin Trust in 2013. Its reason?
It believes that the prices of these ETFs could be manipulated. You see, a Bitcoin ETF derives its price from Bitcoins itself. And if they start trading on unregulated platforms it could be as risky as investing in the real thing. Moreover, these ETFs actually hold Bitcoins. So if cybercriminals steal those or even worse, create spoofs of the real Bitcoin it could wreak havoc for these ETFs and their prices. It could shake investors’ confidence who were risk averse in the first place.
This was also the reason why the SEC rejected an earlier application by Grayscale for Bitcoin Spot ETF in 2022. But Grayscale didn’t sit quietly. It appealed to the Court.
Because here’s the thing. Bitcoin ETFs aren’t new. In June 2023 the SEC allowed something called a Bitcoin Futures ETF. These are quite different from Bitcoin Spot ETFs which folks like BlackRock and Grayscale are vying for. Sure, they’re derivatives. But they don’t derive their prices directly from Bitcoin. Instead, they depend on legal contracts between investors that give them the right to buy or sell Bitcoins sometime in the future. These contracts expire every month and they’re also regulated by the Commodity Futures Trading Commission. So manipulating them could be more challenging than manipulating Bitcoin Spot ETFs. That’s probably why the SEC approved them.
But that may have been a grave mistake simply because here’s what the court told the SEC when it heard Grayscale’s case “Hey, you approved a futures-based bitcoin product. The futures and the spot market are “like” products. If you approve one, you have to approve the other.”
So the SEC had to agree to review Grayscale’s application. And the Bitcoin fraternity has been hopeful ever since. But we’ll only know if Bitcoin Spot ETFs will even be a real thing by January 10, the deadline for the SEC to approve or reject it altogether. Which way will its decision sway? We’ll only have to wait and see.
Until then…
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