Understanding bitcoin ETFs

While bitcoin continues to make financial headlines, the difficulty of buying and storing bitcoin makes it a complex investment to manage. With new bitcoin ETFs, investors can easily gain exposure to this asset class without buying bitcoin itself. Here’s how it works.

A bitcoin ETF is a fund that tracks the price of bitcoin. Instead of buying, selling, and storing bitcoins directly, investors can trade a bitcoin ETF that reflects the price of bitcoin as it goes up or down in value. These ETFs are traded on the major stock exchanges, giving investors the liquidity and ease of access they need to enter and exit a bitcoin-related investment without going through the hassle of trading bitcoin itself.

There are two main types of bitcoin ETFs:

• Spot bitcoin ETFs: These more recently introduced ETFs hold actual bitcoin as the underlying asset. The fund buys bitcoin and stores it securely, and the ETF’s value fluctuates with the market price of bitcoin. Different spot bitcoin funds may calculate the price of bitcoin slightly differently depending on their methodology, creating differences in pricing between ETFs. There are currently 12 spot bitcoin ETFs available to invest in, representing more than $54 billion in asset value.
• Futures-based bitcoin ETFs: These ETFs – which have been around for some time -  invest in bitcoin futures contracts instead of holding bitcoin. Unlike spot bitcoin ETFs that are passively managed, a futures-based bitcoin ETF is typically actively managed, which can increase fees. There are currently 22 futures-based bitcoin ETFs available to invest in, with a collective asset value of over $4 billion.

Investing in bitcoin directly takes a bit more work than investing in stocks or funds. Managing bitcoin directly involves:

• Owning a digital wallet to store cryptocurrency, requiring a certain level of technological understanding.
• Securing your bitcoin and related passwords to keep it safe from hackers.
• Managing your bitcoin using a crypto exchange, which is separate from your main brokerage account.

A bitcoin ETF removes this complexity by allowing you to invest in bitcoin through a publicly traded fund. This fund can be bought and sold through your brokerage account, making it simple to track and trade.

Think of a bitcoin ETF as similar to a gold ETF. Instead of buying and storing bitcoin or gold bars, an ETF gives you exposure to the asset directly from your brokerage account: no safe required.

Investing in a bitcoin ETF has both benefits and drawbacks compared to investing in bitcoin directly.

The benefits of investing in a bitcoin ETF vs. bitcoin directly includes:

• Easier access: You can invest in a bitcoin ETF right from your brokerage account without worrying about things like cryptocurrency exchanges or wallets.
• Greater security: You outsource security to the ETF manager who can leverage institutional-grade security to protect the bitcoin.
• More protection:A bitcoin ETF has the same level of regulatory scrutiny as other securities traded on a stock market, which can provide more confidence when compared to the largely unregulated crypto market. While bitcoin ETFs are not FDIC-insured, Securities Investor Protection Corporation (SIPC) insurance protects against the loss of cash and securities held by a customer at a financially-troubled SIPC-member brokerage firm up to $500,000. SIPC does not protect against the decline in value in your securities. Learn more about what SIPC protects and doesn’t protect.

The drawbacks of a bitcoin ETF include:

• Higher fees: A bitcoin ETF charges a management fee, which can erode your returns compared to owning bitcoin directly. Some brokerages don’t charge to trade a bitcoin ETF, while a cryptocurrency trading platform may charge a commission for each transaction, so you’ll want to calculate both the fees and commissions for each option to know the true cost.
• Tracking error: Depending on how the ETF calculates the price of bitcoin, there can sometimes be a difference between the actual cost of bitcoin and the price of the ETF. There can also be a difference between the performance of the fund and the performance of bitcoin itself.
• Regulatory risk: Investors should expect regulations to continue to evolve, which may impact how these ETFs are taxed and managed.
• Limited track record: While futures-based bitcoin ETFs have been around since 2021, spot bitcoin ETFs were only approved in January 2024. The limited time these ETFs have been in existence can make it hard for investors to evaluate their performance or anticipate how they will react in the event of a major market event.

Comparing your bitcoin investment options

Trading bitcoin–whether owning bitcoin directly or through an ETF–is not for everyone. Investing in bitcoin has the potential for significant volatility. Investors should educate themselves about the unique aspects of bitcoin terminology, use cases, investment arguments, valuation regimes, ETF options, and the overall risks of bitcoin as an asset class before they consider adding bitcoin to their portfolio.

Investors who are ready can use bitcoin ETFs to add bitcoin to their portfolio. You can invest in bitcoin ETFs through E*TRADE to add exposure to bitcoin directly from your brokerage or IRA account–no crypto wallet or storage required. Bear in mind however that the potential for significant volatility still exists by investing in bitcoin ETFs.

Use our ETF screener to find a bitcoin ETF that is right for your investment goals.

The source of this article is the report, ‘Bitcoin ETFs: Helping Investors Understand an Important Development in the ETF industry’ by Morgan Stanley Wealth Management’s Global Investment Office, July 2024.