Blockchain and its related technologies have burst onto scene this year, but it’s understandable if you’ve found yourself confusing crypto acronyms.
From NFT to ETH, it can feel as though new variants of blockchain technology are in the news each day. Notably last month renowned cryptocurrency bitcoin took to the stock market in the form of an ETF, or an “exchange-traded fund”. But what is it? What does it do? And why should you care?
What is an ETF?
The acronym ETF stands for Exchange Traded Fund.
Yes ok, but what is that?
It’s a type of investment fund that is traded on the stock exchange.
ETFs gather money from investors into a basket of different investments including stocks, bonds and other securities. And now, bitcoin too it seems. Creating a fund like this enables diversification of investment assets, which can help to balance risk, an important goal in the world of investment.
There are a variety of ETFs, each with different goals:
• Some ETFs contain a variety of stocks and bonds (and now digital assets too);
• Some track the performance of a stock market index (such as the FTSE 100) ; and
• Some track the performance of a particular market sector like Energy or Healthcare.
• Let’s run through an example!
So imagine, Jess is an investor.
Jess wants to make a diversified investment designed to replicate the performance of a major stock index like the FTSE 100. Jess carries out some research into ETFs and settles on one, which meets her objectives. She then purchases shares in the ETF through her broker. Jess is therefore able to participate in the exposure to a wide range of assets with a single purchase instead of multiple purchases, saving her from the burden of timely research and analysis. Handy.
How can Jess make money from her ETF?
Similar to a stock, Jess can earn a return in two ways: if the value of the ETF increases, and in dividends. If the value of the ETF investment increases, so does it’s price. If Jess purchased an ETF at £100 a share and a year later it was selling at £200 a share, then Jess could profit £100 per share if she sold (although she would likely have to pay some capital gains tax too). Similarly, if the ETF dropped in price and Jess sold at a lower price then she would lose money.
So, what does an ETF have to do with Bitcoin’s skyrocketing price?
On 19th October 2021, American provider of specialised exchange-traded products, ProShares began trading the Bitcoin Strategy Fund, which is an ETF linked to Bitcoin. Putting it lightly, it did particularly well, topping $1 billion in trading volume on day one.
What is really exciting is that all new ETFs must register with the Securities and Exchange Commission under the Investment Company Act 1940, so this approval of a Bitcoin ETF suggests that the Commission are open to allowing more products tied to cryptocurrency to be traded. Which, for the cryptocurrency community is big, big news.
Up until now, the Commission has never considered cryptocurrencies to be securities, although they have taken a very broad view with anything resembling a cryptoasset, classing almost all of those as securities. Regulators have been avoiding bringing cryptocurrencies within the regulatory perimeter for years, instead focussing on what people do with them (such as fundraising) but this decision bridges traditional funding with new-age funding and could further accelerate Bitcoin’s journey into the mainstream.
The fund will trade under the ticker BITO, so anyone with a brokerage account will be able to buy and sell a Bitcoin-backed financial product on the stock market.
It is worth noting that the new ETF is futures-based, which means the fund doesn’t contain Bitcoin itself, but it bets on the future price of Bitcoin.
