With the advancement of blockchain in finance, cryptocurrencies have paved their way to the world of finance quite easily, and now is one of the most discussed topics of financial analytics.
The most popular cryptocurrency to be used and discussed is Bitcoin, as it is the largest cryptocurrency available in the market by market capitalization.
Anyone interested in financial exchanges already has an idea about Exchange-Traded Funds (ETFs). Exchange-traded funds are regulated financial instruments that can hold a variety of assets.
The potential of an ETF that follows bitcoin is the biggest chance for this sort of link for cryptocurrency fans and investors wanting to profit on the rising popularity of exchange-traded funds (ETFs).
Investors can buy and sell ETF shares in the same way they would equities. But, ETF shares can be purchased and sold at any time during market trading hours, unlike mutual funds.
(Related read: 14 Types of Trading)
In this article, we will discuss everything about the Bitcoin Futures ETF including its definition, working, its approval, and the risks that come along with it.
But, before we understand what Bitcoin Futures ETF is, it is important to clear out this given question:
What are bitcoin futures?
Bitcoin futures are a form of derivative trading contract in which two parties agree to purchase or sell bitcoin at a predetermined price at a future date, usually on a currency market.
So, the actual market price of bitcoin at the time of buying or selling does not play a huge role in this exchange, and the contract settlement date or the expiry date is the agreed-upon date by which both parties must satisfy their commitments. Although, there remains some dependency on the market price.
When a bitcoin futures contract expires, whoever committed to acquire bitcoin must do so at a premium or a discount, since it's extremely improbable that bitcoin would be the same price when the contract expires as it was when it was negotiated. The amount that individuals must pay is determined by the current market price (commonly known as the spot price) and the value of each futures contract in their possession.
There are few things to note about bitcoin futures since it is a contract that is signed by two sides if one side is experiencing profit, the other is bound to incur a loss. Contracts for futures always have an expiration date. Investors can opt to sell their contracts before they expire to another party or wait until they expire to settle them. Based on the current settlement of futures traders, the prices of bitcoin futures and the market price of bitcoin tend to differ.
If more individuals are betting on bitcoin's price rising, the contract's value will naturally be higher than bitcoin's current market price. When more traders predict that the price of bitcoin will decline in the future, the situation is the inverse.
As the expiration date of contracts approaches, the values of bitcoin futures contracts and bitcoin on spot markets tend to converge.
(Also read: Difference between Bitcoin and Bitcoin Cash)
What is the Bitcoin Future ETF?
According to coindesk, a bitcoin futures ETF is an exchange-traded fund that allows investors to acquire exposure to bitcoin values without actually purchasing the cryptocurrency. An exchange-traded fund (ETF) follows the price of an underlying asset. And, in the case of a bitcoin ETF, the investment instrument's underlying asset is bitcoin.
Because investors might hypothetically arbitrage away the spread between the ETF and the underlying asset if it were too wide, the price of an ETF will generally retain a high correlation with the price movement of the underlying asset.
Similarly, tying the price of a bitcoin ETF to a bitcoin hoard is a common strategy. All the business needs to do now is make sure it has enough bitcoin on hand to back up the value of its bitcoin ETF.
Although this is a very common and effective method, the notion of a physically-backed bitcoin ETF has been met with skepticism by the Securities and Exchange Commission in the United States. The decision was based on the fact that bitcoin is traded on mostly unregulated exchanges, making it vulnerable to fraud and manipulation.
As per ETF Trends, the VanEck SolidX Bitcoin Trust ETF was introduced earlier this year by VanEck and SolidX, a fintech business with bitcoin-related initiatives. This ETF would be aimed at institutional investors, with a share price of $200,000 at the start.
XBTC is a cryptocurrency that is used to track an index that is linked to a group of bitcoin trading desks. 5 The assumption is that by broadening the scope of the ETF's emphasis, XBTC will be able to address the SEC's concerns about funds connected to bitcoin.
(Related read: What is FinTech?)
How is bitcoin ETF different from Bitcoin future ETF?
Bitcoin ETFs are backed by actual bitcoin, whereas bitcoin futures ETFs are backed by bitcoin derivatives (futures contracts).
Due to market sentiment, the price of bitcoin futures may differ from the current price of bitcoin, therefore bitcoin futures ETFs may occasionally follow the price of bitcoin incorrectly.
Because the ETF is backed by actual bitcoin, there is no risk of price divergence in the case of a bitcoin ETF.
How does Bitcoin ETF work?
As we know by now, an exchange-traded fund (ETF) is a type of investment instrument that follows the performance of a certain asset or group of assets. ETFs allow investors to diversify their portfolios without having to hold the assets. ETFs are a simpler option to buying and selling individual assets for those who want to focus just on profits and losses.
Traditional ETFs allow investors to readily diversify their holdings since they target larger baskets of names with something in common—for example, a focus on sustainability or equities representing the video game industry and associated industries.
A bitcoin ETF is a fund that tracks the price of the world's most popular digital currency. This allows investors to invest in the ETF without having to go through the time-consuming process of trading bitcoin.
Furthermore, because the ETF would not be directly invested in bitcoin, holders will not have to worry about the complicated storage and security protocols that cryptocurrency investors must follow. With bitcoin future ETF, the price mimicked is that of bitcoin futures, and not the actual bitcoins.
The ETF's value is derived, in essence, from the price fluctuations of bitcoin futures. In this case, the ETF's issuer must have holdings in the bitcoin futures market and tie the ETF's price to those bitcoin futures contracts. So, it is better to invest in Bitcoin Futures ETF as it is safer and more predictable.
(Also read: Bitcoin mining)
Risks of Bitcoin Futures ETF:
The following are the downsides of Bitcoin futures ETF:
The price trackers can also act as one of the biggest risks of the Bitcoin Futures ETF, as all the ETFs are dependent on the accuracy of these price trackers. When the price of bitcoin futures is greater than the spot price, we may claim the ETF is following the price of bitcoin incorrectly.
This is referred to as "contango," and it is harmful to investors who hold bitcoin futures ETFs. Backwardation, on the other hand, happens when the futures price is lower than the current price of bitcoin.
When the bitcoin futures contracts expire, the business issuing the bitcoin futures ETF must roll them over (that is, the process of renewing contracts by selling the almost expired ones and using the revenue to purchase new contracts with a farther expiration date).
When the price of a bitcoin futures contract is lower than the price of a new contract, the money from selling contracts that are about to expire will not be enough to buy the same number of contracts that will expire later. The ETF's performance will be harmed as a result of this scenario.
(Must click: Top Companies Adopting Bitcoins)
Although the risks are something that might make someone hesitate before investing in Bitcoin futures, as a bitcoin futures ETF is another form of regulated financial product that allows investors to indirectly engage in the bitcoin market.
The emergence of bitcoin ETFs and bitcoin futures ETFs might assist to accelerate bitcoin increases, as well as gains across the cryptocurrency market because many other digital currencies are closely connected to bitcoin's performance.
(Must Read: What is the Future of Cryptocurrency?)
In this article, we have briefly discussed bitcoin futures and bitcoin futures ETF, the difference between bitcoin ETF and bitcoin futures ETF, and the risks that come along with bitcoin future ETF.