The prospect of a Bitcoin ETF keeps popping up in the news lately. One Bitcoin ETF proposed by the Winklevoss brothers of Gemini fame was recently rejected, but spurred excitement anyway, due to the fact that one outspoken SEC commissioner, Hester Peirce, surprisingly supported it enthusiastically.
So what is an ETF, why does it matter, and what’s the big deal if one gets approved or rejected?
Let’s start with a basic nutshell explanation of what an ETF is. Firstly, it stands for “exchange-traded fund”, meaning, it’s a fund that represents something of value with shares that can be traded on an exchange. This is a derivative market, meaning, when trading an ETF, you aren’t trading the actual asset it represents. Instead, you’re trading shares that represent the asset.
Take the example of gold. I could buy and sell an actual chunk or wafer of gold, and its price is based on its weight, assuming it is of an agreed purity standard. But instead, more conveniently, I can trade a gold ETF, which is a share that represents a certain quantity of gold and is therefore worth as much as the same quantity of gold when traded. This way, I avoid the hassles of physically running around trading chunks of gold with random people and instead trade, essentially, a note or share that entitles me to that much value in gold, while the gold is held securely in one place.
So what’s the big deal then? After all, Bitcoin futures are derivatives that were launched back in December and that hasn’t exactly gone well for Bitcoin, has it?
This is a good point. Many observers point to the launch of CBOE (Chicago Board of Exchange) futures (this is also a derivative market since it involves trading without an exchange of the actual asset) as the point at which Bitcoin began its precipitous decline in value, finally arriving at depressing lows earlier this year. It’s possible that the ability to use Bitcoin futures to bet on a price drop did put a damper on the momentum that the cryptocurrency market was experiencing at the time. Having said that, it has been possible to “short” Bitcoin on exchanges like BitFinex for a long time already, so it’s pretty debatable as to whether institutional futures really had a significant impact on the market.
But there is a really important difference between these CBOE futures and the impending CBOE Bitcoin ETF, backed by VanEck and SolidX, that is gaining more prominence in the news again.
Bitcoin futures, unlike ETFs, do not require any custody of an actual asset. A Bitcoin future contract is really nothing more than a bet, with USD or whatever other agreed currency, placed on the future price of Bitcoin. The exchange providing the facilitation of futures contracts has no need to hold any Bitcoin because the contracts are paid out, most often, in USD. This means no Bitcoin actually changes hands in the event of a future contract’s issuance or expiration.
Futures then, only have a psychological effect on the market, but do not have any impact on the supply and demand of the Bitcoin assets in question.
And this is where ETFs are so crucially different. An ETF must hold, in its own custody, a quantity of an asset based on which it issues shares to traders. So if a million USD of Bitcoin are issued as shares on a given ETF, that ETF must hold a million USD of Bitcoin in some kind of (hopefully) secure storage. If the ETF is an index ETF, meaning it represents a number of assets, the provider would have to physically hold the assets of whatever index it selects (say, for example, like the top ten crypto ETF proposed by Bitwise Asset Management that is also seeking approval from the SEC).
So if the CBOE Bitcoin ETF is approved by the SEC, this would then require the CBOE to have, in its custody, whatever quantity of Bitcoin it will issue via representative shares to institutional, accredited investors. These large-scale investments might eventually involve funds like pensions, for example. This could involve a substantial purchase of Bitcoin on a fairly large scale, unlike the CBOE futures, which required no purchase of actual Bitcoin.
Such a large purchase of Bitcoin would create supply constraints, increasing demand and thereby increasing the price of Bitcoin. This is why ETFs are a much bigger deal than futures ever were (it needs to be noted: this is not financial advice. Do your own research before any kind of investment, but especially in crypto! It’s also worth noting that you’re probably better off holding the actual Bitcoin asset than a derivative like an ETF, so you can maximize your control and the benefit of holding the asset in the event of increased interest, without any intermediary — again, this is just my opinion!).
Now, I’m not going to throw around a bunch of speculative numbers — and anyone that does is doing exactly that — speculating — but this should cause a considerable influx of funds into Bitcoin if such an ETF gets approved.
And that is a gigantic if. The SEC has seen and rejected many Bitcoin ETF proposals in the past, including the most recent one presented by the Winklevoss brothers. They have also frequently delayed decisions on ETF approvals, waiting to see how the market behaves over time and hoping for more regulatory controls to be in place before making a decision.
The reason this CBOE ETF might succeed where others have failed? The CBOE has many connections with the SEC and has worked closely with them in the past with their futures exchange, which in their view, has succeeded in calming the volatile waters of the cryptocurrency market. Additionally, to minimize risk, the CBOE is offering insurance coverage to clients to protect against loss or theft of Bitcoin assets. Of course, the SEC could easily decide to delay their decision — a highly likely scenario — giving them more time to ensure all the pieces are in place to minimize money-laundering, insider-trading, wash-trading, pump and dumps, and other manipulative behaviours that have been prevalent in the crypto space (that’s not to say that they aren’t prevalent elsewhere!).
In August (the exact date is up in the air, but should be somewhere around August 10), the SEC will have to make a decision on whether to reject, delay, or approve the CBOE Bitcoin ETF. This is part of the reason that Bitcoin’s dominance has surged to nearly 50% in the market over the past couple months as some are speculating on the hopes of ETF approval. This upcoming decision could be a pivotal moment in the history of Bitcoin, or it could be underwhelmingly disappointing. All we can do is wait, on the edge of our seats, to see what might unfold in the coming weeks and months.