The dreams of Bitcoin ETFs are now a reality following SEC approval, but here’s what investors need to know

For so long, the concept of bitcoin ETFs has been little more than a pipedream, until the SEC finally gave the concept regulatory approval.

Cryptocurrencies have seen a surge in popularity over the past decade, with Bitcoin being the most well-known and dominant player in the market – it is just over half of crypto’s US$1.7tn market capialisation. Despite its success, there are still many barriers preventing widespread adoption of Bitcoin as a mainstream form of currency. One major hurdle is the lack of regulated investment vehicles for cryptocurrencies was one of them. The approval of bitcoin ETFs could go a long way towards overcoming this hurdle.

Bitcoin ETFs…how would they work?

First of all, it is important to recap what ETFs are generally. An ETF is an investment vehicle that tracks the performance of a particular asset or group of assets. It allows investors to buy and sell shares of the ETF, providing them with exposure to the underlying assets without actually owning them. This makes it easier for investors to diversify their portfolios and gain access to markets that would otherwise be difficult to enter.

So you could imagine bitcoin ETFs would be a good way to overcome the hurdle of liquidity. Invest in a bitcoin ETF, and you would effectively own shares with direct exposure to bitcoin. We’re not talking ownership in companies that invest in bitcoin while still owning the asset itself (like DigitalX (ASX:DCC)) or even bitcoin miners. We’re talking investors buying an ETF and having exposure to bitcoin, along with all the upside and downsides coming with it. It isn’t quite the same as holding it directly, but it is held via existing financial instruments.

The lack of bitcoin ETFs up till now is almost exclusively because of regulatory concerns. Regulators have been reluctant to approve such a concept for several reasons, most notably the volatile nature of cryptocurrencies and the potential for fraud and manipulation in the market. However, hopes were always becoming higher and higher that it could become reality, especially as the market was maturing and becoming more regulated.

Now approved

The SEC announced last week it was approved. In a statement written by Chair Gary Gensler, the regulator said the approval and listing of the relevant bitcoin ETFs was ‘the most sustainable path forward’, noting things were different from 2018 when the first proposal was disapproved.

At the same time, the SEC noted that it was not endorsing bitcoin, or crypto generally, as an asset class. It even noted that bitcoin was ‘primarily a speculative, volatile asset that is also used for illicit activity including ransomware, money laundering, sanction evasion, and terrorist financing’.

Ultimately, it did give approval and noted this would mean a few things

• Sponsors of bitcoin ETFs would be required to provide full, fair and truthful disclosure about the products
• Bitcoin ETFs would be listed and traded on exchanges
• Existing rules and standards of conduct to purchases and sales.

The SEC also stressed that it was not an endorsement of crypto trading platforms or intermediaries, noting they tend to be non-compliant with federal securities laws and often had conflicts of interest.

Implications

The SEC itself highlighted many of these. One thing it neglected to mention (and we understand why) was that it would open up access to Bitcoin for a wider range of investors, including institutional ones who may have previously been hesitant to enter the market. This influx of new investors could potentially drive up demand and increase the value of Bitcoin.

In addition, the introduction of a Bitcoin ETF would also contribute to the overall mainstream adoption of cryptocurrencies. As more investors gain access to Bitcoin through an ETF, it will become more widely recognized and accepted as a legitimate asset class.

While there is still uncertainty surrounding the future of Bitcoin and other cryptocurrencies, the SEC’s blessing is show that progress is being made towards a different future to the tortured past it has had.

So will this mean bitcoin will rise? Possibly, although this is just one of many factors influencing the market. Bitcoin had a great year in 2023 for a number of reasons even in absence of the ETF. One could conclude either that a bitcoin ETF would make this asset class perform even better, that it will do well regardless of whether or not there’s an ETF, or that perhaps it has come too late to have an impact to the market. In our view, the determinant of this question will occur between now and May – any movement after May could be attributed primarily to the scheduled halving of bitcoin.

Bitcoin price in USD, log scale (Source: TradingView)

So should I invest in bitcoin ETFs?

First of all we note that there will be some time before we can see bitcoin ETFs easily tradeable. Even then, we are not so sure. It is unlikely to be listed in Australia, requiring investors to turn to foreign exchanges and be subject to all the difficulties associated with that.

Investors already invested in crypto may find this a more appealing avenue to invest, although of course not if they’ve lost money already. For investors not in crypto, this too will be an easier way, but always be aware that it is a volatile asset class that can cause substantial losses just as easily as substantial gains.

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