Spot Bitcoin ETFs: A Primer

Introduction

On January 10, the SEC announced its approval of the listing and trading of a number of spot bitcoin exchange-traded products, such as exchange-traded funds (ETFs). From 2018 through March 2023, the SEC had denied approval for more than 20 filings for spot bitcoin ETFs. Among these filings, Grayscale Investments had filed a proposal to convert the Grayscale Bitcoin Trust into an ETF, which was denied with all the others. However, in response to a lawsuit filed by Grayscale contesting the SEC’s decision, the U.S. Court of Appeals for the District of Columbia vacated the Grayscale Order (in which the SEC denied Grayscale’s conversion request), holding that the SEC had failed to adequately explain its reasoning in disapproving Grayscale’s request. As a result, the matter was remanded back to the SEC, and the SEC ultimately decided that the best path forward was to approve the listing and trading of these spot bitcoin ETF products. The 11 approved ETFs began trading on January 11, 2024.

How the spot bitcoin ETFs work

Spot bitcoin ETFs allow investors to gain exposure to bitcoin in a traditional brokerage account without needing to open an account with a cryptocurrency exchange and take on the associated operational complexities. Spot bitcoin ETFs hold actual bitcoin, making them different from previously existing bitcoin ETFs, which held bitcoin futures. Like other ETFs, there are market makers and authorized participants who help ensure that the price of the ETF tracks the bitcoin spot price and that there are sufficient shares available to meet investor demand. The new ETFs will utilize third-party custodians, such as Coinbase, to hold the bitcoin. These custodians typically hold the keys to their cryptocurrency assets in offline locations that are not connected to the internet (these are known as “cold storage” locations) in order to reduce the risk of hackers accessing the accounts. This arrangement is similar to gold ETFs, which hold actual physical gold in vaults.

List of spot bitcoin ETFs and fees

Source: Morningstar Direct

Note that many of these funds are waiving some or all of their fees for a limited time or until they raise a set amount of capital in the fund.

General thoughts on bitcoin ETFs

• The introduction of spot bitcoin ETFs provides individual investors with an efficient method of gaining exposure to bitcoin through traditional brokerage or custodial accounts without opening an account with a cryptocurrency exchange.
• Since spot bitcoin ETFs all do the same thing, which is to provide exposure to the prevailing price of bitcoin, fees are an important differentiator between the funds. Your Corient Wealth Advisor can help you decide which fund is best suited for your specific needs.
• Liquidity will also be an important variable to consider when investing in these ETFs. Funds with larger assets under management (AUM) and higher trading volumes should, all else being equal, provide better liquidity for investors than funds with lower AUM and lower trading volumes. Keep that in mind if having ready access to your invested capital is important to you.
• There are numerous potential risks that investors should understand and be willing to accept before investing in bitcoin ETFs:
  • Regulatory risk – Despite the SEC’s approval of these types of investment vehicles, there continues to be a significant amount of regulatory risk surrounding cryptocurrencies. In Chairman Gensler’s statement from January 10, he notes that “bitcoin is primarily a speculative, volatile asset that’s also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing.”
  • Competitive risks from other cryptocurrencies – While there is only a fixed amount of bitcoin that will ever be mined, there are no limits on the number of additional cryptocurrencies that may be created, some of which may have more attractive features than bitcoin and may thus eclipse it in popularity and use.
  • Fraud/hacking – Despite the use of third-party custodians like Coinbase, the threat of loss due to fraud and/or hacking is real. There is no equivalent to FDIC or SIPC protection for bitcoin custodians.
  • Energy costs – Mining bitcoin is an energy-intensive enterprise. Rising energy costs due to input scarcity or heightened regulation may impact the ability of miners to continue their operations in a cost-effective manner.
  • Market manipulation – The use of cryptocurrencies by unethical actors, plus their ability and willingness to manipulate markets, has been an ongoing problem.
  • Price volatility – Bitcoin’s historical volatility has been extreme, even when compared to a commodity such as gold, which often serves a similar role in portfolios as a store of value and a hedge against inflation.

Source: Bloomberg

Conclusion

With the rollout of spot bitcoin ETFs, investors who wish to gain exposure to bitcoin now have an efficient option with which to do so within their existing brokerage accounts. The reduction of operational complexity with these products may be viewed as an improvement from the perspective of investor experience. However, these products do not change or mitigate the risks associated with investments in bitcoin (or cryptocurrencies in general). We have discussed several of these risks in the article. Again, contact your Corient Wealth Advisor to discuss the suitability of spot bitcoin ETFs in your investment portfolio.

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