The Bitcoin ETF is being the talk of the town in crypto day in day out lately and the many ETF proposals that are out there keep everyone excited. For a great part anticipation of a potential approval prices were going up significantly and where the altcoins sometimes were losing ground, Bitcoin kept holding strong. The next few weeks until decisions are being published by the SEC will probably be quite volatile and we need to be prepared for a buy the hype, sell the news effect, whatever the final outcomes may be. Anyway, all these different ETF proposals and discussions might add to a lot of confusion, so what about trying to bring the information together and getting some clarity on what is going on. First some background information.
What is an ETF?
ETF stands for Exchange Traded Fund, which is a security in the form of shares that can be traded on an exchange. An ETF represents a share in an underlying asset or multiple assets. It doesn't provide direct ownership of the asset, nor, in case of company stock for example, voting rights. Underlying assets are often baskets of stocks, like indexes as the S&P500 or for example commodities like gold (and in our case: Bitcoin, if a BTC ETF gets approved). A regular holder of an ETF will not be able to redeem the ETF for the underlying asset(s), this is only allowed by certain Authorized Participants. A regular holder of an ETF can just buy, hold and sell the ETF against the price for which it is trading. An ETF has much similarities with a mutual fund or an investment fund, but the big difference is that unlike mutual funds and investment funds (in best case scenario these can only be redeemed at the fund by a shareholder against the so-called Net Asset Value at the end of the day), with an ETF its shares can be created and redeemed continuously throughout the whole trading day, which means that there are more arbitrage opportunities which lead to a price for the ETF that much closer follows the price of the underlying asset than other types of investment funds do (those often have a larger premium or discount in relation to the assets that they are invested in, because those can either only be redeemed once a day or not at all).
Examples of arbitrage
If demand increases for an ETF the price may go up more than the price of the underlying asset. In that case an Authorized Participant could buy the asset cheaper on the market and then deliver the asset to the ETF, which will issue new shares to the Authorized Participant. The ETF supply has now increased to meet demand and the Authorized Participant can sell the ETF on the ETF exchange for a higher price than he paid for the underlying asset initially.
If the price of the ETF falls because the demand for it decreases, an Authorized Participant may decide to buy the ETF for a lower price, redeem it from the ETF provider (which decreases the supply of outstanding shares) and receiving the underlying asset, then sell the underlying asset for a higher price on the regular market for the asset.
This mechanism of arbitrage allowed for Authorized Participants is what keeps the price of an ETF near the price of the underlying asset.
There are 3 main types of ETFs:
An ETF for Bitcoin has the advantage that it opens up a whole new market for institutional investors, because with an ETF they can simply buy and sell Bitcoin through regulated brokers and even they can then be used for 401k's. Many have already tried to apply for an ETF with the SEC and so far all of them have been rejected or are still pending. Is that going to change anytime soon?
Isn't there already an Bitcoin Investment Fund listed in the US?
Yes, there is! GBTC is an investment fund that can already be bought in the US by investors. However main disadvantage of this fund is that it regularly trades against high premiums and discounts in relation to Bitcoin and therefore not adequately tracks Bitcoin's price.
The 3 main Bitcoin ETFs that are being discussed and in the news lately:
NYSE ETF: The New York Stock Exchange has applied for 5 ETFs that are all leveraged ETFs and 2 of those are Inverse leveraged ETFs. As we have learned these are only interesting for speculative trading. According to the filing, the spot price (the price that is used to calculate the total value of the ETF's holdings) will track the existing Futures markets prices only (CME and CBOE) and will invest in those Futures contracts only as well. This means that no trading nor arbitrage between real Bitcoin and the ETF needs to take place. Not surprisingly, this ETF filing doesn't have so much mainstream interest from the cryptocommunity. The NYSE is a very established financial institution and does have a lot of experience with ETFs so that is definitely a pre for their chance of getting approved. Last week the SEC announced that they have postponed the decision on the 5 ETFs to September 21.
Winklevoss ETF: the Winklevoss brothers are well known in the crypto industry as early investors, and they operate the crypto exchange Gemini. They had filed and got rejected last year already and this year they tried again. They would be managing the ETF, they would be the custodians of the Bitcoins that would back the ETF and it would be traded on their own platform. At least for the custodian aspect, the Winklevoss brothers could expected to be experts, as their exchange Gemini is about the only exchange that hasn't been hacked (yet). Unfortunately last week their ETF got rejected again for multiple reasons, including not providing enough proof that their custody would be secure enough and lack of oversight in the prevention of fraud and illegal manipulation. Another major reason for rejection was the fact that the ETF would use the Winklevoss' brothers own exchange Gemini as spot price for calculating the value of the ETF holdings. This was a concern for manipulation and does not reflect the entire Bitcoin market enough, as Gemini only accounts for 0.1% of total Bitcoin trading volume ($7.5million daily volume), which would not be representative enough. More notable however was the fact that the SEC pointed out that it actually did not have enough faith in the entire Bitcoin market, because most exchanges are unregulated and without oversight and not enough liquidity. For example they would also like to see higher trading volume in the Futures market as one of the factors of maturity. These statements could be very important, because that would in fact imply that per definition they wouldn't approve the other ETF proposals either until the market is better regulated and has higher liquidity on regulated exchanges and Futures Markets.
Interestingly enough even an SEC commissioner went as far as publicly publishing a post that she thought the SEC was stifling innovation by rejecting the Winklevoss ETF and she felt that the SEC's argument about potential market manipulation in the Bitcoin market is invalid, because that happens just as much in markets of other commodities that have ETFs already approved. She also argued that it is not the SEC's responsibility to make judgments about the state of a commodity's international market, but only if the market in which the ETF shares are traded is well enough regulated and with sufficient oversight in prevention of fraud and manipulation. She thought the Winklevoss ETF should have been approved. Not sure if her rebelling action would help the process for the remaining pending ETFs, but she did get a lot of new followers on social media from crypto enthusiasts for her supporting comments.
CBOE ETF: this ETF is a proposal by a partnership between the CBOE exchange (where already Bitcoin Futures are listed), SolidX and VanEck (that already has issued various ETFs in the past). By far this ETF proposal is the most anticipated, most popular and by experts seen as the most probable to be approved by the SEC. The SEC received more than 200 comments from people for this proposal (the NYSE proposal only got 2). The partnership itself between these established firms in traditional finance boost a lot of confidence for a favorable view from the SEC and besides that this ETF will be backed by actual Bitcoins that will be acquired by the fund and, on the issuance of new shares, more real Bitcoin needs to be purchased to be held in custody. So this should eventually have an impact on the market for Bitcoin itself as well. Another very positive feature is the fact that this ETF will have the Bitcoin in custody fully insured against hacking or theft, which would add extra to investor's security. For the spot price calculation, indexes of regulated OTC brokers will be used, as well as the Futures markets (CME and CBOE) and of a number of licensed cryptocurrency exchanges..... (read further in comments)
What is an ETF?
ETF stands for Exchange Traded Fund, which is a security in the form of shares that can be traded on an exchange. An ETF represents a share in an underlying asset or multiple assets. It doesn't provide direct ownership of the asset, nor, in case of company stock for example, voting rights. Underlying assets are often baskets of stocks, like indexes as the S&P500 or for example commodities like gold (and in our case: Bitcoin, if a BTC ETF gets approved). A regular holder of an ETF will not be able to redeem the ETF for the underlying asset(s), this is only allowed by certain Authorized Participants. A regular holder of an ETF can just buy, hold and sell the ETF against the price for which it is trading. An ETF has much similarities with a mutual fund or an investment fund, but the big difference is that unlike mutual funds and investment funds (in best case scenario these can only be redeemed at the fund by a shareholder against the so-called Net Asset Value at the end of the day), with an ETF its shares can be created and redeemed continuously throughout the whole trading day, which means that there are more arbitrage opportunities which lead to a price for the ETF that much closer follows the price of the underlying asset than other types of investment funds do (those often have a larger premium or discount in relation to the assets that they are invested in, because those can either only be redeemed once a day or not at all).
Examples of arbitrage
If demand increases for an ETF the price may go up more than the price of the underlying asset. In that case an Authorized Participant could buy the asset cheaper on the market and then deliver the asset to the ETF, which will issue new shares to the Authorized Participant. The ETF supply has now increased to meet demand and the Authorized Participant can sell the ETF on the ETF exchange for a higher price than he paid for the underlying asset initially.
If the price of the ETF falls because the demand for it decreases, an Authorized Participant may decide to buy the ETF for a lower price, redeem it from the ETF provider (which decreases the supply of outstanding shares) and receiving the underlying asset, then sell the underlying asset for a higher price on the regular market for the asset.
This mechanism of arbitrage allowed for Authorized Participants is what keeps the price of an ETF near the price of the underlying asset.
There are 3 main types of ETFs:
- regular ETF: these are as described above and these usually hold the assets directly and the price of the ETF tracks the price of the underlying asset closely. This type of ETF is suited for longer term hodling.
- leveraged ETF: these ETFs might not hold the asset itself, but rather invest in derivatives and/or with margin trading, creating a leverage. For example with a 2:1 leveraged ETF, 1 price point change in the referenced asset, creates 2 price points change in the ETF, but only on an intraday basis, because they are re-balanced every day. This ETF is only for speculative short term trading.
- Inverse ETF: These can be leverage as well as non-leveraged. Key feature is that they move in the opposite direction of the underlying asset and are therefore another form of shorting the asset. If the price of the represented asset goes down, the inverse ETF goes up in value. This ETF uses derivatives and margin trading to achieve this and also this ETF is only suitable for short term, intraday, speculative trading.
An ETF for Bitcoin has the advantage that it opens up a whole new market for institutional investors, because with an ETF they can simply buy and sell Bitcoin through regulated brokers and even they can then be used for 401k's. Many have already tried to apply for an ETF with the SEC and so far all of them have been rejected or are still pending. Is that going to change anytime soon?
Isn't there already an Bitcoin Investment Fund listed in the US?
Yes, there is! GBTC is an investment fund that can already be bought in the US by investors. However main disadvantage of this fund is that it regularly trades against high premiums and discounts in relation to Bitcoin and therefore not adequately tracks Bitcoin's price.
The 3 main Bitcoin ETFs that are being discussed and in the news lately:
NYSE ETF: The New York Stock Exchange has applied for 5 ETFs that are all leveraged ETFs and 2 of those are Inverse leveraged ETFs. As we have learned these are only interesting for speculative trading. According to the filing, the spot price (the price that is used to calculate the total value of the ETF's holdings) will track the existing Futures markets prices only (CME and CBOE) and will invest in those Futures contracts only as well. This means that no trading nor arbitrage between real Bitcoin and the ETF needs to take place. Not surprisingly, this ETF filing doesn't have so much mainstream interest from the cryptocommunity. The NYSE is a very established financial institution and does have a lot of experience with ETFs so that is definitely a pre for their chance of getting approved. Last week the SEC announced that they have postponed the decision on the 5 ETFs to September 21.
Winklevoss ETF: the Winklevoss brothers are well known in the crypto industry as early investors, and they operate the crypto exchange Gemini. They had filed and got rejected last year already and this year they tried again. They would be managing the ETF, they would be the custodians of the Bitcoins that would back the ETF and it would be traded on their own platform. At least for the custodian aspect, the Winklevoss brothers could expected to be experts, as their exchange Gemini is about the only exchange that hasn't been hacked (yet). Unfortunately last week their ETF got rejected again for multiple reasons, including not providing enough proof that their custody would be secure enough and lack of oversight in the prevention of fraud and illegal manipulation. Another major reason for rejection was the fact that the ETF would use the Winklevoss' brothers own exchange Gemini as spot price for calculating the value of the ETF holdings. This was a concern for manipulation and does not reflect the entire Bitcoin market enough, as Gemini only accounts for 0.1% of total Bitcoin trading volume ($7.5million daily volume), which would not be representative enough. More notable however was the fact that the SEC pointed out that it actually did not have enough faith in the entire Bitcoin market, because most exchanges are unregulated and without oversight and not enough liquidity. For example they would also like to see higher trading volume in the Futures market as one of the factors of maturity. These statements could be very important, because that would in fact imply that per definition they wouldn't approve the other ETF proposals either until the market is better regulated and has higher liquidity on regulated exchanges and Futures Markets.
Interestingly enough even an SEC commissioner went as far as publicly publishing a post that she thought the SEC was stifling innovation by rejecting the Winklevoss ETF and she felt that the SEC's argument about potential market manipulation in the Bitcoin market is invalid, because that happens just as much in markets of other commodities that have ETFs already approved. She also argued that it is not the SEC's responsibility to make judgments about the state of a commodity's international market, but only if the market in which the ETF shares are traded is well enough regulated and with sufficient oversight in prevention of fraud and manipulation. She thought the Winklevoss ETF should have been approved. Not sure if her rebelling action would help the process for the remaining pending ETFs, but she did get a lot of new followers on social media from crypto enthusiasts for her supporting comments.
CBOE ETF: this ETF is a proposal by a partnership between the CBOE exchange (where already Bitcoin Futures are listed), SolidX and VanEck (that already has issued various ETFs in the past). By far this ETF proposal is the most anticipated, most popular and by experts seen as the most probable to be approved by the SEC. The SEC received more than 200 comments from people for this proposal (the NYSE proposal only got 2). The partnership itself between these established firms in traditional finance boost a lot of confidence for a favorable view from the SEC and besides that this ETF will be backed by actual Bitcoins that will be acquired by the fund and, on the issuance of new shares, more real Bitcoin needs to be purchased to be held in custody. So this should eventually have an impact on the market for Bitcoin itself as well. Another very positive feature is the fact that this ETF will have the Bitcoin in custody fully insured against hacking or theft, which would add extra to investor's security. For the spot price calculation, indexes of regulated OTC brokers will be used, as well as the Futures markets (CME and CBOE) and of a number of licensed cryptocurrency exchanges..... (read further in comments)
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