What is a Cryptocurrency ETF and How Does it Work?

Cryptocurrency ETF track a single crypto or a basket of different digital tokens and currencies

A cryptocurrency exchange traded fund is a fund made up of cryptocurrencies. A cryptocurrency ETF measures the price of one or more digital tokens, whereas the majority of ETFs track an index or a basket of assets. The share price of Bitcoin ETFs varies every day based on investor sales and purchases. They are also exchanged every day, just like conventional stocks.

Investors can gain from Bitcoin ETFs in several ways, including dramatically reduced ownership costs and the outsourcing of the challenging learning curve associated with cryptocurrency trading.

Two different types of cryptocurrency ETFs exist:

The first kind is supported by actual cryptocurrency. The cryptocurrency purchases are made by the investment company running the fund, and shares are used to indicate ownership of the coins. Investors who purchase shares in the ETF will subsequently acquire cryptocurrencies. Owners can thus become exposed to cryptocurrencies without the cost and danger of outright ownership.

The second form is a synthetic variation that follows derivatives for cryptocurrencies, such as futures contracts and cryptocurrency exchange-traded products (ETPs). The values of Bitcoin futures contracts traded at the Chicago Mercantile Exchange (CME), for instance, are tracked by several ETFs that have been suggested to the U.S. Securities and Exchange Commission (SEC).

The ProShares Bitcoin Strategy ETF (BITO), the first cryptocurrency ETF, began trading in October 2021. This ETF monitors the cost of Bitcoin futures.

Instead of reflecting the values of actual cryptocurrencies, the ETF share price imitates the price fluctuations of derivatives. As a result, the cost of shares in a particular cryptocurrency ETF increases in tandem with rising futures contract values. It decreases in step with the decrease. Synthetic cryptocurrency ETFs pose an additional risk, just like other derivatives, because it's possible that they don't always operate transparently.

ETFs are seen by supporters of cryptocurrencies as the holy grail that will increase Bitcoin acceptance and liquidity. The Winklevoss twins submitted an ETF proposal for Bitcoin (BTCUSD) to the SEC as early as 2014, or almost five years after the cryptocurrency first started trading at an exchange.

The organization turned down its application. Since then, there has been a rush of applications from different financial organizations looking to capitalize on the price fluctuation of Bitcoin, including one founded by the Winklevoss twins who reapplied this year. The SEC noted receiving at least 12 petitions in 2021 alone.

In a letter from January 2018 outlining its concerns, the SEC also justified the denial of ETF applications. The lack of transparency at cryptocurrency exchanges, which determine the price of individual tokens, the possibility of market manipulation, and the low liquidity levels in cryptocurrency markets are some of its main worries.

In the time since the agency's letter was issued, the situation in the cryptocurrency markets has altered. Exchange trading volumes have increased. The total market value of cryptocurrencies has topped US$2 trillion as of April 2022.

As previously indicated, the first cryptocurrency ETF began trading in October 2021, and Coinbase Global Inc. (COIN), the largest cryptocurrency exchange in North America, is now a publicly traded company.

Also, there has been a change of leadership at the agency's helm. Jay Clayton, a former SEC chairman who was well-known in the industry, was seen negatively against cryptocurrencies. He was succeeded in 2021 by Gary Gensler, a former commissioner of the Commodities Futures Trading Commission (CFTC), who also instructed a blockchain and cryptocurrency course at MIT. The arrival of Gensler has revived expectations for the establishment of a Bitcoin ETF; however, he has stated that he shares his predecessor's evaluation and opinions on the cryptocurrency markets.