Institutional Bitcoin: The Future of Bitcoin ETFs
The Story of the Bitcoin ETF
In 2008, Satoshi Nakamoto, the pseudonymous creator of Bitcoin, published a white paper detailing a vision for electronic cash that could be exchanged directly between individuals without the need for any financial institution. This was a method to exchange value outside of the traditional financial system. It was a decentralized system.
Fast forward to January 10th 2024, the decentralized asset found its place in the centralised financial system; The U.S. Securities and Exchange Commission (SEC) made history by approving 11 spot Bitcoin exchange-traded funds (ETFs). This move allowed crypto-backed ETFs to trade on public markets for the first time ever. As a result, Bitcoin ETF trading volume reached $4.6 billion within just 24 hours, and the Bitcoin price temporarily surpassed $48,000.
At the same time, Grayscale's fund, the world's largest Bitcoin investment vehicle, saw outflows of $3.4 billion. Analysts believe that much of the money in the ten new funds could have originated from investors exiting Grayscale due to its higher fees compared to competitors.
BlackRock's iShares Bitcoin ETF (IBIT) became the first of its kind to surpass $1 billion in assets under management within its initial week of trading on January 17. Other prominent firms such as Fidelity, Ark21, and Invesco have also introduced Bitcoin ETFs. BlackRock attracted more inflows than rival asset managers partly due to its lower management fee of 0.2% (as opposed to Grayscale's 1.5%) and greater brand recognition. As a result, Grayscale's fund size has decreased from $28 billion earlier in the month to $22 billion by the close of trading on Monday. But what is a Bitcoin ETF? What makes it different and why was there so much enthusiasm?
What is the Bitcoin ETF?
The basic idea of a Bitcoin ETF is similar to that of any other ETF. An ETF is a kind of investment product that follows the performance of a specific index, sector, commodity, or other asset class, but unlike mutual funds, ETFs can be bought and sold on a stock market just like a regular share. Investors can use any brokerage platform to buy and sell shares in the ETF, as they would do with shares in Apple or Tesla. A Bitcoin ETF mirrors the current value of Bitcoin, and moves along with the fluctuations in Bitcoin’s price.
Some ETFs already have some exposure to Bitcoin indirectly - but a spot Bitcoin ETF will purchase the digital asset directly, “on the spot”, at its prevailing price, throughout the day.
The Bitcoin ETF is run by a company that acquires and holds the actual Bitcoin; the price of the ETF is linked to the amount of Bitcoin in the fund. The company registers the ETF on a conventional stock exchange, and you, the investor, trade the ETF as you would any other share.
However, there are also some important differences between a Bitcoin ETF and other ETFs. First, some ETFs, such as those that follow the S&P 500, consist of equity shares, so you receive a portion of the dividends that any company in the ETF distributes to their shareholders. When Tesla issues a dividend and you own shares in an ETF that contains Tesla, you receive a (smaller) dividend. Bitcoin is decentralized, so that does not occur with a Bitcoin ETF. Second, as with other ETFs, you have to pay fees to the company that provides the ETF. But with a Bitcoin ETF, some part of your fees would go to covering the custody and management costs for the acquisition and storage of the Bitcoin that supports the ETF.
What makes these ETFs different from investing directly?
The primary distinction between ETFs lies in their distribution method. Although investing in Bitcoin through an ETF is not the same as owning Bitcoin directly, the newer ETFs cater to a previously underserved market that prioritizes convenience above all else. The appeal of ETFs depends on the objectives of the investors, and various stakeholders in the crypto industry can coexist without conflicting with the goals of early adopters. Both institutional and retail investors can find common ground and thrive together.
So, why wouldn't investors simply purchase Bitcoin instead? For the average retail investor, Bitcoin and other digital assets may still be perceived as risky due to their uncertain regulatory environment and the need for a Bitcoin wallet and involvement with crypto exchanges, which may be uncharted territory for those unfamiliar with the space. Additionally, owning Bitcoin places the responsibility of security squarely on the owner, requiring them to safeguard their private keys, either by purchasing a hardware wallet or storing them securely. Furthermore, investors must navigate the complexities of reporting Bitcoin sales that result in capital gains for tax purposes.
With a Bitcoin ETF, however, investors do not have to worry about managing private keys, storage, or security. Instead, they own shares in the ETF just like they would with traditional stocks, gaining access to the crypto market without the hurdles associated with buying and holding crypto. This simplified approach holds great appeal for countless individuals and sophisticated institutional investors alike. As a result, numerous hedge funds and investment firms have applied to the U.S. Securities and Exchange Commission (SEC) for approval to launch Bitcoin ETFs.
When contemplating investing in gold or Bitcoin, investors can choose between direct ownership and investing in an ETF that tracks the price of the underlying asset. Each option presents its own set of advantages and disadvantages. Direct ownership of assets, such as gold coins or bars, offers a tangible sense of ownership, but also comes with security risks associated with storing valuable items at home, including the possibility of theft or damage due to fire. Additionally, there are extra costs and inconveniences related to acquiring, maintaining, and safeguarding the asset. On the other hand, investing in an ETF eliminates the need for physical storage, reduces security risks, and simplifies the trading process, allowing for easy buying and selling on traditional stock exchanges. However, this option lacks the physical possession of the asset, which may be important to some investors. Ultimately, the choice between direct ownership and ETF investment depends on an investor's preferences, risk tolerance, and desired level of involvement in managing the asset.
The case for a Bitcoin ETF is particularly strong due to the numerous challenges associated with direct ownership of digital assets. These challenges include setting up an account on a brokerage platform, navigating bank approval processes for transactions, deciding whether to store Bitcoin on an exchange or a hot or cold wallet, understanding the differences between various wallets and seed phrases, and learning how to send crypto between different platforms. Furthermore, direct investment in Bitcoin may bring additional risks, such as the potential for lost or forgotten passwords, and vulnerability to hacking attacks. For these reasons, many casual investors may find a Bitcoin ETF to be a more accessible and manageable option compared to direct ownership of Bitcoin.
Potential Future
It is difficult to project Bitcoin ETFs’ future impact. Predicting the future impact of Bitcoin ETFs on the crypto market using historical examples is challenging due to several reasons. Unlike gold ETFs, which experienced similar hype in the early 2000s, Bitcoin has a finite supply, greater volatility, and fewer controls over the underlying asset's usage. In the short term, Bitcoin ETFs could affect major crypto exchanges, whose margin and trade volumes may decline as customers opt for the lower cost and easier access provided by Bitcoin ETFs instead of creating digital wallets on platforms like Coinbase.
Regarding future regulations, the SEC's stance remains uncertain. Commissioner Pierce expressed hope for a change in course from the current "one market in the U.S. and another in the world" scenario due to regulatory ambiguity. However, not all SEC commissioners share the same viewpoint. In his statement regarding the Bitcoin ETF approval, SEC Chair Gary Gensler emphasized that the agency did not approve or endorse Bitcoin and that the approval should not be interpreted as a reflection of their perspective on other crypto assets.
Analyzing historical patterns in Bitcoin's price movements suggests that the digital assets tends to reach new all-time highs approximately a year before its cycle peaks. Top analysts believe this pattern indicates that BTC's value could surge beyond existing records, possibly exceeding $80,000 by the end of 2024. Nonetheless, the journey is likely to be complicated, with market volatility playing a significant role, influenced by macroeconomic factors and institutional investors' perceptions of BTC as a risk asset.
Institutional investors will play a crucial role in shaping Bitcoin's future. Their perception of BTC as a 'digital gold' and a safe-haven asset is anticipated to drive considerable inflows into the Bitcoin ETF. If BTC continues to be perceived mainly as a risk asset, its growth trajectory might be more restricted, particularly amid challenging macroeconomic conditions.
Although the Bitcoin ETF is a significant milestone, it is merely one aspect of the evolving crypto ecosystem. Numerous key developments are on the horizon, poised to influence the future of the crypto market.
The approval of a Bitcoin ETF signifies a new era of maturity and acceptance for the crypto market. However, this is only the beginning of a more intricate journey. A complex interaction of regulatory decisions, technological advancements, market dynamics, and global economic factors will determine the fate of Bitcoin and the broader crypto ecosystem. As the crypto market continues to evolve, it offers both challenges and opportunities for investors, innovators, and regulators. The future remains uncertain, but one thing is certain: the digital assets’ world is embarking on an exciting new chapter, with all attention focused on what comes next.
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