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Simplifying Bitcoin ETF (Exchange-Traded Fund) and the Hype Around it

The Current Bitcoin ETF proposal if approved by US-SEC will allow institutional investors to buy or sell Bitcoin easily without the technical requirements and security risks like holding actual bitcoin in wallets. Not just that, the Bitcoin investment will be fully insured. While a functionally similar ETN is already available in European markets, this will be the first for America and can kick-start the next market uptrend.

Bitcoin ETF is the talk of the town, the town being the United states of America. The US Securities and Exchange Commission (SEC), or America’s SEBI as we Indians can call it, will make a ruling on a proposal for Bitcoin ETF. There are market level arguments that this proposal, if approved can moonshot the price of Bitcoin. Everyone wants that to happen, but does everyone know what an ETF is and how it works?

For this article, I will try to simplify ETFs and Bitcoin ETFs as much as I can. But given that ETFs is a vast topic to explore, I will leave some sources to learn more about ETFs at the end of the post.

Exchange-Traded Fund (ETF)

Exchange-Traded Fund is a pooled investment vehicle like mutual funds. A bunch of investors pool money together to buy a bunch of assets. Simple. But there is a difference between Mutual Funds and ETFs.

Both funds allow you to have a diversified index – a combination of multiple assets, but mutual funds are not traded on stock exchanges and they have a net asset value fixed for the whole day – you can only buy or sell mutual funds once in a day at the NAV of the day. 

Unlike Mutual funds, ETF can be traded on exchanges just like other stocks and the price changes throughout the day based on the trading volume.

In simple words, let us say you want to invest Rs. 10 crore in all the stocks that are part of the Nifty index on the NSE. Nifty tracks 50 stocks. You have 2 options:

  1. You buy all the 50 shares individually. Each for Rs. 20 lakhs.
  2. Or if Nifty index value is Rs. 10000, you buy One lakh units of the Nifty ETF.

In both cases you would have invested Rs. 10 Crore on all 50 shares comprising the Nifty index. Obviously, buying one fund is easier than buying 50, so you will go for option 2 and ETFs can be traded just like stocks on the exchange.

A key difference in terms of investments between the two is that mutual funds are generally targeted at retail investors while ETFs begin with an investment from institutional investors called the authorised participants (AP). Shares/Baskets are created and sold to APs by the ETF sponsors. These APs then trade their baskets in secondary markets where the retail investors can buy and sell the ETF. Basically APs are the market makers that provide the liquidity and earn from the arbitrage available with a small price difference in other markets V/s the ETF market.

One Bitcoin ETF share will be equal to $200,000 according to the proposal. We will get there in a bit.

Another difference between MF and ETF – typically in mutual funds, the fund managers do not disclose where the funds are being invested, it is a trade secret. But in ETF, the investment is declared. Hence many ETFs track Indexes like Sensex/Nifty or commodities.

Commodity ETF

There are several kinds of ETFs like Equity funds, currency funds, commodity funds, real estate funds and many more. But let us stick to Commodity ETFs for this article. As the name suggests it is an ETF for commodities.

A commodity ETF allows you to buy and sell commodities on the stock exchange without physically holding the commodities. But then you can ask, why would I buy ETFs when I can trade commodity on commodity exchanges?

  • Commodity markets run from 10 AM to 11:30 PM on Weekdays in India
  • You cannot trade commodities on stock exchanges like BSE and NSE

So, what if someone invests your money into commodities and then gives you equivalent share units of it that you can buy or sell on stock exchanges? That is a commodity ETF. Commodity ETFs can be a combination of more than one commodities or just one single commodity. The most popular ETF for a single commodity are the Gold ETFs.

man holding gold
Gold ETFs are being traded on both BSE and NSE in India

There are mainly three types of Commodity ETFs –

  • Physically backed funds – A fund manager holds equivalent amount of physical commodity
  • Equity based Funds – A fund that invests in stocks of companies that produce the commodity
  • Futures Backed Funds – A fund that invests in future contracts of the commodities.

Bitcoin ETF will be a physically backed fund. 

Bitcoin ETF

The goal behind Bitcoin ETF is simple, get institutional investors on board to trade bitcoin without them having to bother about the technicalities associated with buying and storing the cryptocurrency. VanEck and SolidX have come together to create the current Bitcoin ETF proposal. No other cryptocurrency will be part of the ETF except Bitcoin.

The SEC, has rejected two Bitcoin ETFs to date, one submitted by SolidX and the other filed by the Winklevoss twins, who operate a major US-based crypto exchange Gemini. The reason was lack of regulations globally and the lack of insurance on funds.

The regulatory air is clearing up as developed countries like Japan and South Korea are leading the charge in regulating their markets. The current ETF filing by Chicago Board Options Exchange (Cboe) with the SEC for a Bitcoin ETF is equipped with proper insurance, with a condition to reimburse any losses due to loss of Bitcoin by theft, hack or any other means.

The proposal ‘Notice of Filing of Proposed Rule Change to List and Trade Shares of SolidX Bitcoin Shares Issued by the VanEck SolidX Bitcoin Trust’ was published on July 2, and SEC typically has 45 days to make a ruling on a proposed rule change, which makes the likely date of decision August 16.

ETF Share Price

According to the filing, assuming the Bitcoin price at $8000 and 25 BTC per share, each share will cost approximately $200,000 and there will be a total of 100 shares in the market. Although Bitcoin is traded 24/7, the trust has plans to fix an NAV of the share based on MVBTCO index.

MVBTCO index will be used to determine the NAV of the ETF on each day. The index ‘calculates the intra-day price of bitcoin every 15 seconds, including the closing price as of 4:00 p.m. E.T’. According to the release, ‘The bitcoin OTC platforms included in the MVBTCO are U.S.-based entities’.

Acquiring and Storing Bitcoin

The trust (sponsors) have to actually own and store the Bitcoin that are offered in the ETF shares. For 100 shares, a total of 2500 BTC should be purchased.

The trust plans to buy Bitcoin from OTC markets and from certain domestic or international exchanges. Bitcoin will be stored in “multi-signature cold storage wallets.” Additionally, “For backup and disaster recovery purposes, the Trust will maintain cold storage wallet backups in locations geographically distributed throughout the United States, including in the Northeast and Midwest.”

Bitcoin Purchase will be easier for institutional investors with Bitcoin ETF

Market Reaction to Bitcoin ETF

Market action can never be truly determined but experts believe if ETF gets a green signal it could be the new trigger to increase in Cryptocurrency prices. The ETF is targeted at bringing institutional money into the Crypto market by making it easier to invest in Bitcoin. If institutional investors enter the market, it could start an uptrend.

Additionally, the proposal would require the VanEck SolidX Bitcoin Trust to purchase Bitcoin in bulk to back the ETF triggering a much needed volume boost in the market. All in all the market sentiments are hoping for an approval of Bitcoin ETF to kick off a new Bull run, but the hype around it already seems to be working as Bitcoin has climbed upto $7500 in the past week.

Side Note – Blockchain ETF

While the debate on Bitcoin ETF is on, the blockchain ETFs are doing tremendously well in the US stock markets. Blockchain ETF invest in public companies that have announced a significant investment in the blockchain technology and are working towards a blockchain based system.

There are about six blockchain ETFs currently available in the market.

Learn More About ETF

As I said before, ETF is a vast topic and cannot be covered in one post. Please go through some of the sources below to learn more.

Update: Commodity market timings were corrected. 

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