Bitcoin ETF: Definition, How It Works, and How to Invest

Bitcoin exchange-traded funds (ETFs) are pools of bitcoin-related assets offered on traditional exchanges by brokerages to be traded as ETFs. The intent behind these ETFs is to give retail investors and investors not comfortable investing in cryptocurrencies access to them without actually owning them.

Learn more about Bitcoin ETFs, how they work, and what's available.

What Is a Bitcoin ETF?

A Bitcoin ETF is an exchange-traded fund comprised of bitcoin or assets related to Bitcoin's price. They are traded on a traditional exchange instead of a cryptocurrency exchange. Theoretically, bitcoin is purchased by the company, securitized, and sold or traded on an exchange. However, the Security and Exchange Commission continues to reject these proposals; there is no cryptocurrency ETF directly representing an underlying coin.

Currently, the underlying assets within Bitcoin ETFs are linked to Bitcoin futures contracts traded on the Chicago Mercantile Exchange.

The first concept for a Bitcoin ETF emerged shortly after investors and brokers noticed that bitcoin prices were trending upward and the cryptocurrency was becoming more popular. Most importantly, there appeared to be an opportunity to generate returns from buying and selling bitcoin.

As Bitcoin's price rose above several thousand dollars, retail and average investors lost the opportunity to invest in Bitcoin directly. Brokerages, responding to demand for investor access to Bitcoin, began to design Bitcoin exchange-traded funds. Applications with the Securities and Exchange Commission (SEC) for approval started in 2013 with the Winklevoss brothers.

Understanding Bitcoin ETFs

In an exchange-traded fund that tracks stocks, the stocks are purchased by the fund. These are the fund's holdings, and the company that bought them offers fractionalized shares on exchanges, which trade nearly 24 hours per day, seven days per week.

A Bitcoin ETF, following this structure, would need to purchase and hold bitcoin. It would then offer fractionalized shares of its holdings on an exchange, which could be traded similar to a traditional ETF.

A futures contract is a standardized contract where two parties agree to exchange a specific quantity of assets on a specific day for a particular price. A Bitcoin futures contract is an agreement between two parties for the exchange of a contract unit of bitcoin—in this case, one contract unit is 5 BTC.

The fund creates shares with prices based on the current price of one contract unit and offers it on an exchange for trade. The first official Bitcoin-linked ETF was the Proshares Bitcoin Strategy ETF (BITO), approved by the SEC in October 2021 and listed on the New York Stock Exchange.

Goals of Bitcoin ETFs

In their current form—and the form desired by many investors—Bitcoin ETFs are designed to allow more people to invest in Bitcoin without the necessary expenses and hassles of buying them. They eliminate the need for security procedures and excessive funds while providing a familiar investment type.

Security

While you don't technically have cryptocurrency in your wallet, you have security keys that you need to safeguard. If you buy your cryptocurrency through an exchange, you can choose to have your keys stored on that exchange if it offers that service.

However, wallets and exchanges can be hacked and keys stolen—which means your cryptocurrency can be stolen. You can store your keys offline using several methods, but none of these methods are 100% secure or guaranteed. An ETF doesn't require you to own any cryptocurrency, store keys safely, or move the keys back and forth between different types of storage—you own shares of the fund, which takes the risks of storing keys for you.

High Prices

One of the most significant obstacles for average investors is price. Bitcoin (BTC) set a record high of close to $69,000 per BTC shortly after the Proshares Bitcoin ETF was listed on the NYSE. Over the new few months, its price began to drop, hitting close to $35,000. So, even at low prices, retail investors may not have the assets to purchase 1 BTC. An ETF allows you to gain exposure to BTC within your budget, risk tolerance, and investing goals.

ETFs are Better Understood

Perhaps most importantly, ETFs are much better understood across the investment world than cryptocurrencies. Even as digital coins and tokens become increasingly popular, they are becoming more complex. So if you're only interested in becoming involved in digital currency investing, an ETF lets you focus on trading an asset you already understand rather than learning about blockchain, mining, decentralized exchanges, distributed ledgers, key storage, and cryptocurrency.

How to Invest in Bitcoin ETFs

If you're looking to invest in Bitcoin ETFs, you can purchase them through your broker or advisor if they offer them. There are several Bitcoin ETFs that trade on exchanges such as the New York Stock Exchange ARCA and Nasdaq:

• Proshares Bitcoin Strategy ETF (BITO)
• Valkyrie Bitcoin Strategy ETF (BTF)
• VanEck Bitcoin Strategy ETF (XBTF)
• Global X Blockchain & Bitcoin Strategy ETF (BITS)

It's important to note that these ETFs are not entirely comprised of Bitcoin futures. For the most part, they invest in traditional securities, holding Bitcoin futures contracts when it meets the fund's strategy. For example, the Proshares Bitcoin Strategy Fund is designed to hold Bitcoin futures contracts only when positions are profitable. Otherwise, it can hold securities of Bitcoin-related companies and money market instruments. It can also borrow using reverse repurchase agreements.

Investing in cryptocurrencies and other Initial Coin Offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author does not own Bitcoin ETFs.