Bitcoin’s recent rally in October 2021 was by the launch of the Bitcoin ETF on Oct 19th, 2021. But what exactly does this launch mean for this cryptocurrency? When there are so many other crypto funds already present today, what is so special about this ETF?
Before we ponder these questions, let’s first understand what ETFs and Future Contracts are and why this particular Bitcoin ETF (ProShare Bitcoin Strategy ETF – BITO) is unique.
Exchange Traded Funds (ETFs) are essentially a single fund consisting of a basket of stocks/commodities. To explain in simple terms, suppose you invest INR 1000 in an imaginary ETF called ‘ProMoney’. Let’s assume this fund contains five different stocks under its belt. The money you (and lakhs of others) invest into the fund is used to buy and hold those five stocks. The more money you put in the ETF, the more stocks the fund buys, and the higher the price of those stocks go.
You essentially hold a diverse set of stocks by buying into the fund without owning any of these stocks directly. So those who are not comfortable buying/selling stocks on the exchange can use ETFs to invest indirectly in stocks.
The same can be said about crypto ETFs as well. The value of the ETF will reflect the value of all the crypto coins present in its basket. There are several advantages here:
But the topic of the conversation is a Bitcoin Futures ETF! A futures ETF is entirely different from an ETF that I explained above. How? For that, let me first brief another crucial concept.
Simply put, futures contracts allow investors to bet on the future price of an asset on a future date without actually buying the asset. On that date, the profit/loss exchanges hands between the buyer and seller. As a simple example, suppose you buy a futures contract on an imaginary stock BITC at $100 in one month in the future. After that one month, if BITC is $110, only the $10 is exchanged between you and the seller. No actual BITC is being bought or sold.
The price of the stock is not affected when it is not actually traded (in the case of a futures contract)
One can trade Bitcoin futures (where the underlying asset is Bitcoins) on exchanges just like the stock market (in this case, the Chicago Mercantile Exchange).
Now putting together ETFs & Futures contracts, let’s see what Bitcoin Futures ETF means.
It may get a little tricky here.
The Bitcoin Futures ETF is a fund that holds Futures contracts of bitcoins rather than holding Bitcoins themselves. This way, when you buy into this ETF, it does not use that money to buy bitcoins and hence does not affect its price directly.
Take the example of when Tesla was added to the S&P 500 Index in Dec ’20, Tesla’s stock price rocketed up immediately. An important reason for this (apart from the hype it created) was that the S&P 500 had to buy Tesla stocks now to add them into its fund. This buying of Tesla stocks rallied its price high up.
Unlike that example, the Bitcoin ETF would not buy bitcoin to add it into its fund by holding Bitcoin futures contracts instead, making it safer as an investment, hence approved by the SEC.
Nonetheless, the hype it created was enough to surge Bitcoin prices to all-time highs.
To understand more about what this means for the future of Bitcoin, read my full post here!
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