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Spot Bitcoin ETFs: Exploring Potential Impacts on the Crypto Landscape

2023-12-04

Main Takeaways

  • Bitcoin exchange-traded funds (ETFs) enable investors to safely access cryptocurrency without needing to handle digital assets directly. Potential approval of spot bitcoin ETFs by U.S. regulators has led to growing optimism in recent months.

  • A U.S.-regulated spot bitcoin ETF could potentially increase BTC’s accessibility, liquidity, demand, and price. However, there are also costs associated with such an innovation.

  • In an optimal scenario, direct BTC investment would coexist with various regulated instruments, enabling diverse strategies and catering to varying investor needs.

A bitcoin exchange-traded fund (ETF) is a financial instrument enabling exposure to cryptocurrency in a secure, regulated manner while sparing the hassle of handling BTC directly. Such products already exist in Canada and Europe, and U.S. investors have been able to purchase ETFs tracking the price of bitcoin futures since 2021. Yet, a notion has taken hold that a regulated ETF in the U.S. holding “physical” bitcoin – most commonly referred to as spot bitcoin ETFs – could become a real game-changer for the industry.

On a narrative level, encouraging developments in U.S. regulation have helped stoke investor optimism in recent months. As many observers believe a turning point is on the horizon, crypto investors should arm themselves with a solid understanding of key concepts and potential scenarios that the emergence of a regulated spot bitcoin ETF could trigger.

Key Definitions

An ETF is a type of financial product that tracks the price of a specific asset, index, or basket of assets and is bought and sold on a stock exchange. Generally, ETFs provide an avenue to invest in various assets while allowing the flexibility to trade on an exchange. As such, they often serve as a practical tool for diversifying market exposure.

With the advent of crypto, two major types of BTC ETFs emerged: futures and spot. A futures bitcoin ETF invests in contracts betting on BTC’s future price, providing exposure to its price movements without holding the cryptocurrency. A spot bitcoin ETF has to hold the underlying asset, reflecting its price more directly, which makes owning its shares more akin to owning BTC itself. You can refer to this Binance Academy article for a more detailed comparison.

Bitcoin trusts are another somewhat similar vehicle, differing in structure and operation. A trust acts more like a traditional investment fund, holding actual BTC. Investors own shares that represent a piece of the digital asset pool held by the trust. However, unlike ETFs, trusts are subject to premiums or discounts, meaning the price of a share could significantly diverge from the value of the underlying BTC it represents.

Grayscale Bitcoin Trust (GBTC) launched in 2015 to become the first publicly traded bitcoin fund in the U.S. As of early December 2023, Grayscale’s application to turn GBTC into a spot ETF is under consideration by the Securities and Exchange Commission (SEC). The first bitcoin futures ETF went live on the New York Stock Exchange Arca in October 2021. Now, several such products are available to U.S. investors. Of all the instruments described in this section, only spot bitcoin ETFs remain out of reach, though many believe this could soon change.

Seeking SEC Approval

The first spot BTC ETF application came to the SEC in 2013, and many more followed. The SEC initially highlighted several prerequisites for approval, including well-regulated bitcoin-related markets and surveillance-sharing agreements to prevent fraud and market manipulation. In subsequent years, multiple firms submitted revised applications. Unfortunately, these attempts faced similar outcomes: denial due to ongoing concerns or withdrawal in anticipation of denial.

However, the landscape began to shift in 2023. Many were confused by the SEC’s decisions, as it was unclear why futures bitcoin ETFs were allowed while spot ETFs were not. In August, U.S. courts seemed to uphold this notion, with the judge presiding over Grayscale’s case against the SEC ruling in favor of Grayscale, demanding the SEC reconsider its rejection of converting GBTC to a spot ETF and ruling the differential treatment to be “arbitrary and capricious.”

Another milestone came in June, when BlackRock, the world’s largest asset manager, filed for a spot bitcoin ETF. The proposal included surveillance-sharing agreements to deter fraud and market manipulation, potentially mitigating the SEC’s key concerns. Coupled with BlackRock’s stellar track record in ETF application approvals, this movement encouraged other firms to follow suit.

Together, these developments have fueled market optimism in the fall of 2023, with a flurry of companies refiling previously rejected applications. Anticipated deflationary pressures from the upcoming halving in 2024 furthered the positive outlook. As these events unfold, the market keenly watches for signs of a breakthrough.

Potential Effects

Many investors are curious about the impacts of a prospective U.S. spot bitcoin ETF on financial markets, both traditional and crypto, and the blockchain industry at large. While these may be difficult to ascertain, such an innovation has the potential to significantly impact the bitcoin price, demand for digital assets, liquidity, and adoption. Primarily, optimists expect that it would encourage further adoption and innovation in the space, as the legitimization and accessibility of an ETF would appeal to a wider range of potential crypto investors. While these effects are likely, their size and scale are difficult to anticipate.

The historical case of gold ETFs is worth examining in this context, although a spot BTC ETF cannot be expected to produce similar effects. Much like bitcoin, gold is relatively difficult to access for the general public, with both assets requiring particular effort and resources to buy and store directly. In 2004, SPDR Gold Shares (GLD), the largest gold ETF by assets under management, was launched and quickly garnered over $1 billion in total asset value. By 2010, it had surpassed $50 billion.

Though ETFs forgo direct ownership of the underlying asset, this sacrifice enables greater accessibility. Thus, a broader range of investors can gain exposure, prompting increased demand and liquidity for the asset. The rise of gold ETFs marked a significant shift in the asset’s trading dynamics, with increased accessibility leading to enhanced market volumes and liquidity.

Such benefits could arise with a U.S. spot bitcoin ETF, potentially ushering in a new era of adoption and innovation. While bitcoin is often seen as “digital gold,” we can’t use one asset’s history to forecast another’s future. Still, parallels can be drawn to give insight into potential effects. Let’s dive deeper by exploring the benefits and drawbacks of a U.S. spot bitcoin ETF.

As with gold ETFs, this heightened accessibility could introduce a new wave of adoption, potentially increasing bitcoin’s price, demand, and liquidity. Additionally, this enhanced liquidity and diversification of the investor base could help stabilize bitcoin’s price volatility, thereby enabling greater market fluidity, predictability, and investor confidence in the asset.

Beyond BTC market dynamics, the approval of a U.S. spot bitcoin ETF could serve as a legitimizing sign for the crypto industry, indicating new levels of acceptance, credibility, and maturity that could encourage further innovation and adoption.

A spot ETF would bring additional regulatory oversight and transparency with standardized reporting, thereby increasing security and reducing the risk of fraud or theft. This would enhance the credibility of the cryptocurrency industry in the broader financial landscape, expanding the foundations of trust for a wider audience.

Drawbacks and Risks

Despite the prevalence of positive narratives surrounding prospective U.S. spot BTC ETF approvals, there are risks and drawbacks worth keeping in sight. Firstly, removing direct bitcoin ownership would mean investors’ inability to participate in the BTC ecosystem and enjoy the benefits of owning a decentralized digital asset. 

Also, ETFs could introduce additional costs to crypto investment, as they typically charge management fees that would likely exceed the costs of holding bitcoin directly. Nevertheless, many investors should be willing to accept this trade-off, given the peace of mind that ETFs offer.

The broader cryptocurrency market remains less predictable than more traditional financial markets. Because ETFs aim to track the price movements of their underlying assets, this volatility would also be reflected in the price of a spot bitcoin ETF. Furthermore, the price of the ETF may diverge from the price of bitcoin due to market forces or administrative issues. This could lead to the ETF being overpriced or underpriced relative to bitcoin. 

Finally, the introduction of a spot bitcoin ETF would tie BTC more closely to regulation, making the market more sensitive to policy decisions. Adverse regulatory actions could negatively affect the ETF’s value, which in turn could potentially lower Bitcoin’s price.

Closing Thoughts

A U.S.-regulated spot bitcoin ETF could significantly impact the cryptocurrency industry and broader financial landscape, potentially fostering wider adoption, credibility, innovation, and regularity clarity. Such a development would simplify access to crypto markets, enabling even less tech-savvy investors to gain exposure to BTC price fluctuations without the complexities of managing the cryptocurrency themselves. However, as with any emerging investment vehicle, we cannot ignore the potential disadvantages and risks.

In a most harmonious scenario, spot bitcoin ETFs would take their place among existing avenues for crypto investment. Direct investment in BTC and various regulated instruments will likely coexist, enabling diverse investment strategies and catering to various risk profiles and preferences. The advent of U.S.-regulated spot bitcoin ETFs will signal an exciting new era of adoption and legitimacy, not just for bitcoin but also for the broader crypto space.

Further Reading

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