Demystifying Bitcoin: a closer look at Cryptocurrency ETFs

Cryptocurrency is digital money secured by a specific type of public ledger called blockchain. Without a governing body like a government, a public digital ledger transparently records peer-to-peer transactions.

Bitcoin was launched in 2009 and became the first widely adopted cryptocurrency. Because the number of coins is limited, Bitcoin has gained popularity as a speculative investment.

Speculative investments are usually high-risk assets that are typically bought with the express purpose of selling when their value rises. The appeal is that these investment can appreciate significantly in a short space of time, but they’re considered risky because they can also experience dramatic downturns.

Bitcoin as an ETF

On 10 January 2024, the US Securities and Exchange Commission (SEC) marked a significant milestone in the crypto world by approving 11 spot Bitcoin Exchange-Traded Funds (ETFs), with offerings from fund titans like BlackRock and Fidelity. This move could potentially transform the landscape of cryptocurrency investing and open new opportunities for traders.

To understand the impact of this development, you’ll need to know what spot ETFs are. They’re a type of fund that directly tracks the current, or ‘spot,’ price of an asset – in this case, Bitcoin (BTC). Unlike futures-based ETFs, which are tied to contracts betting on the future price of an asset, spot ETFs are backed by the actual price of the asset itself.

This means that when you invest in a spot Bitcoin ETF, the fund purchases actual Bitcoin, and the value of your investment fluctuates with the real-time price of the cryptocurrency in the market. These are held by a custodian. Coinbase is the custodian for eight of the 11 spot Bitcoin ETFs.

The introduction of these products is a game changer because it provides a bridge between the traditional financial world and the burgeoning crypto market. For traders, this means easier access to Bitcoin investments without the complexities and security concerns of managing a digital wallet or trading on a cryptocurrency exchange.

One of the most significant advantages of these ETFs is the potential for increased liquidity and price stability. As more institutional and retail investors gain exposure to Bitcoin through these funds, trading volumes are expected to rise. This could lead to a more stabilised market with less price volatility, which is beneficial for traders who seek to capitalise on incremental price movements.

Moreover, spot Bitcoin ETFs could also lead to broader adoption and acceptance of the virtual money as a legitimate asset class. With the SEC's stamp of approval, investor confidence could grow, potentially leading to increased demand and, consequently, higher prices.

This parallels the journey of gold ETFs, which increased gold demand substantially and reduced volatility long-term.

How the ETF is different from other Bitcoin derivative products

Bitcoin ETFs make investing in the cryptocurrency much more accessible to casual traders and retail investors. While futures contracts based on the asset’s price require oversight of settlement dates and delivery complexities, an ETF trades like a stock. It simply tracks an underlying index price – in this case, Bitcoin’s spot price.

So the ETF offers simple exposure tied to Bitcoin's price swings without needing to directly buy crypto from an exchange or wallet and take on the hassles of storage and security. You can buy and sell the ETF seamlessly like stocks from a standard brokerage account.

The ETF coincides with another important moment for Bitcoin prices: halving day.

Bitcoin halving day

Bitcoin mining is how new coins are created and verified transactions are added to the blockchain ledger. Miners compete to solve complex maths puzzles and earn rewards for each block added. Originally, successful miners were rewarded 50 BTC per block, an incentive for mining activity. However, Bitcoin has a hard cap of 21 million total coins that can exist.

To ensure controlled supply until the cap is reached, mining rewards decrease by 50% every 210,000 blocks mined. This pre-set halving of mining rewards happens approximately every four years, with the last halving day occurring in April 2024.

When halving days reduce the supply of new Bitcoins flowing in, simple economics kicks in. All else being equal, when supply drops but demand keeps growing, prices tend to rise. The anticipation of this can spur speculative investing leading up to the halving day.

Even without the ETF news, Bitcoin's next halving day expected in 2028 suggests this built-in increasing scarcity could drive prices up in the coming years.