What are ETFs?
An ETF is a type of fund, traded on stock exchanges, that hold assets tracking the value of an index. Authorized participants, which are generally large financial institutions, buy and sell large creation units of the ETF to break up and distribute in smaller quantities. ETFs were created in 1993 as a tool for investors to track the value of market sectors, niches, and trading strategies.
Why ETFs? Why Bitcoin?
Financial professionals are racing to be first to market with an ETF for emerging market sectors. Bitcoin has grown to the point of receiving this attention. Leading the charge are the Winklevoss brothers, who introduced Bitcoin ETFs to the SEC in 2014. If readers are interested in the prospectus, it’s available on the SEC website.
Drawbacks of a Bitcoin ETF
Although the benefits of ETFs have contributed to their rising popularity, ETFs have drawbacks that can be exaggerated in their developmental stages. In 2011, Fidelity published a piece on the drawbacks of ETFs. Of those that Fidelity listed, buying high and selling low, management fee creep, and tracking error seem as though they could be particularly pronounced when evaluating a Bitcoin ETF.
Buying high and selling low describes the spread between bid and asking prices for ETFs. If this spread is
high, the cost of purchasing (or the benefit of selling) may not accurately reflect the value of the ETF. In an ETF with few transactions, it’s likely that the spread will be greater than in an ETF with regular, or practically constant transactions as the curve of people’s willingness to sell/buy will be smoother.
Management fee creep describes the administrative costs of ETFs. In a developing fund, the costs of marketing could be reflected in the management fees. Given the uncertainty and slow adoption of Bitcoin across traditional financial markets, marketing costs could be higher for a Bitcoin fund.
Tracking error describes the deviations in a fund’s investment performance from the index that it tracks. Given the volatility of Bitcoin, it could prove difficult to accurately align with the indexes of choice. This can be a cost to investors.
Broader Implications for Bitcoin
If the Winklevoss Bitcoin ETF is approved, it would signal faith in Bitcoin from the U.S. federal government. This faith could improve investor confidence and the value of Bitcoin itself. As a byproduct of a legitimizing a cryptocurrency investment vehicle, Bitcoin investment would likely be subject to a greater degree of scrutiny from the federal government and regulatory agencies. This could incentivize greater transparency for other methods of Bitcoin investment, improving access to the Bitcoin market.