Bitcoin ETFs: What Are They and How Do They Work

Bitcoin ETFs (Exchange-traded Funds) are the hot topic of the financial world. Over the past year, they have attracted billions in net inflows, with a handful of major funds dominating the market.

In this guide, we’ll explain what Bitcoin ETFs are, how they work, their benefits and risks, and the leading Bitcoin ETFs investors are watching today.

What is a 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.

How does a Bitcoin ETF work?

Bitcoin ETFs track the price of Bitcoin, allowing investors to buy and sell shares on traditional stock exchanges. They provide a regulated and straightforward way to gain exposure to Bitcoin's market performance without directly purchasing or storing the cryptocurrency. Many of the popular Bitcoin ETFs trade under a ticker symbol, which helps them to more accurately track the price.

What are the different types of Bitcoin ETFs?

There are several types of crypto ETFs, each catering to different investment objectives. Broadly, ETFs can be categorized into:

Spot Bitcoin 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.

Bitcoin Futures 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. 

Bitcoin Leveraged ETFs

Leveraged Bitcoin ETFs also rely on derivatives, such as futures contracts, and reset daily to attempt to deliver 2x or 3x the daily performance of Bitcoin.

This process makes them highly volatile: if Bitcoin’s price fluctuates significantly, a leveraged Bitcoin ETF can quickly lose value.

The SEC's approval of Bitcoin ETFs

On January 10, 2024, the SEC released a statement, letting investors know a number of spot Bitcoin exchange-traded products (ETP) shares had been approved for listing. Prior to this, the SEC only allowed Bitcoin futures ETFs, which were approved in late 2021.

These approvals laid the foundation for Ethereum ETFs and Solana ETFs to begin trading on the U.S. market.

What are the benefits of Bitcoin ETFs?

Bitcoin ETFs come with unique advantages, including:

• Accessibility: Trade Bitcoin through standard brokerage accounts on stock exchanges.

• Regulation: Benefit from oversight and regulation in traditional financial markets.

• Diversification: Add a cryptocurrency asset class to diversify your investment portfolio.

• Simplicity: Gain exposure to Bitcoin's value without the need to manage and secure the actual digital coins.

• Liquidity: Bitcoin ETFs offer liquidity, making it easier to buy and sell shares on the stock market.

What are the risks of Bitcoin ETFs?

Like all financial investments, Bitcoin ETFs also come with risks including:

• Market volatility: Bitcoin is known for its significant price fluctuations, which can lead to substantial losses.

• Regulatory changes: Future regulatory changes could impact the legality and operations of Bitcoin ETFs.

• Counterparty risk: Dependence on the ETF provider to manage and secure underlying assets effectively.

• Tracking error: The ETF might not perfectly track the price of Bitcoin due to management fees and operational costs.

What is the best Bitcoin ETF?

Choosing the best Bitcoin ETF depends on your preference as an investor, and the fees associated with each one. For example, a spot Bitcoin ETF is an easier fund to get into and can be seen as more transparent, whereas futures contracts are effected by more than just Bitcoin's price and can be less clear.

Here are a few of the most popular Bitcoin ETFs, their type, and the fees associated with them.

How to buy a Bitcoin ETF

The easiest way to buy a Bitcoin ETF is through a reliable centralized exchange. Similar to purchasing other ETFs, you can follow these steps:

1. Choose a brokerage: Select a reputable brokerage or trading platform that offers Bitcoin ETFs.

2. Open an account: If you don’t already have one, open a brokerage account and complete any necessary verification processes.

3. Fund your account: Deposit funds into your brokerage account.

4. Search for Bitcoin ETF: Look up the Bitcoin ETF on the platform using its ticker symbol.

5. Place an order: Decide how many shares you want to buy and place your order through the brokerage.

What is the Bitcoin ETF token?

Bitcoin ETF (ETF) is a token that is not affiliated with real Bitcoin ETFs. The Bitcoin ETF Token is a cryptocurrency project designed to benefit from the potential approval of a Bitcoin Exchange-Traded Fund (ETF). Key features the project mentions include sustainable tokenomics, an engaged community, and staking opportunities. It's worth noting much of the information reported to price listings like CoinMarketCap is self-reported and the project is still in very early development.

Don't forget the tax bill

Like other financial investments, Bitcoin ETFs are subject to taxation. Generally, you will pay Capital Gains Tax on any gain from spot ETFs.

Koinly is a Bitcoin ETF calculator. We've got a dedicated guide to crypto ETF taxes where you can learn more about how Bitcoin ETFs are taxed.