Bitcoin ETFs: Types and Taxes
Bitcoin ETFs (exchange-traded funds) are the hot topic of the financial world given the SEC's recent approval, but what is a Bitcoin ETF and how are ETFs taxed?
What is a crypto or Bitcoin ETF?
Exchange-traded funds (ETFs) are investment funds that are traded on stock exchanges, much like individual stocks.
They are designed to track the performance of a specific index, commodity, or basket of assets.
ETFs provide investors with the diversification of a mutual fund and the flexibility of a stock, making them a popular choice for various investment strategies.
A Bitcoin ETF allows investors to gain exposure to crypto without needing to consider a digital wallet, exchange, or self-custody. This allows investors to access crypto in a simple way that may be familiar to them.
What are the different types of ETFs?
There are several types of crypto ETFs, each catering to different investment objectives. Broadly, ETFs can be categorized into:
Spot crypto ETFs
ETF directly holds the underlying asset which reflects the overall value of the ETF. The price of the underlying holdings (e.g. Bitcoin) will generally reflect in the value of the ETF.
Futures crypto ETFs
Unlike spot ETFs, futures ETFs do not hold underlying assets directly. Instead, the fund engages in futures contracts to gain exposure to the asset's price movements. These contracts are commitments to buy or sell the asset at a predetermined price at a specified time in the future.
Whilst crypto-related ETFs currently exist as futures ETFs, they do not have any direct exposure to crypto markets and therefore the spot ETFs are highly anticipated within the crypto industry.
Does the SEC regulate Bitcoin ETFs?
Read next: Does the SEC regulate crypto?
Bitcoin ETF taxes
The fundamental tax treatment of a Bitcoin ETF will be similar to holding Bitcoin directly. In most countries such as the USA, UK, Canada, and Australia - ETFs that invest in capital assets or property such as crypto will be taxed as such. This means you need to consider whether you’ve made a capital gain or loss when you sell holdings in the ETF. If you’ve made a capital gain, you’ll be liable for Capital Gains Tax.
You can read more about crypto and Capital Gains Tax in your country in our guides:
ETFs are commonly referred to as being ‘tax efficient’ for their ability to influence when capital gains are distributed to investors. However, with a spot Bitcoin ETF, it’s worth noting that dividend distributions won’t be applicable even though you may be used to receiving these in ETFs such as those that track an index such as NASDAQ where underlying companies regularly issue dividends.
It’s important to know that holding an ETF generally does not adversely affect investors for tax purposes when cash redemptions occur. This was a point of confusion during the application process for Bitcoin spot ETFs and Greyscale issued clarification on this matter. In the USA, the spot ETFs are typically structured as ‘grantor trusts’, meaning that the acquiring of assets (or “carrying value) held by the underlying ETF does not lead to a taxable event for ETF investors.
Imagine a spot Bitcoin ETF where 500 units correspond to one underlying Bitcoin. An investor buys 100 Bitcoin ETF shares for $10,000. The next month, the total value increases to $18,500, prompting the investor to redeem for cash.
Taxable Capital Gain: In this scenario, the investor incurs a taxable capital gain, calculated as the difference between the purchase and redemption prices ($10,000 - $18,500 = $8,500).
IRS Reporting: The taxable capital gain from the redemption is reported to the IRS on an IRS Form 1099-B.