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Demystifying bitcoin: a closer look at cryptocurrency ETFs


MongiIG

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Explore how the approval of Bitcoin ETFs by the US SEC opened unprecedented doors for investors and how this pivotal change is set to revolutionise cryptocurrency investing.

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Source: Bloomberg

IG Analyst  

Let's peel back some of the mystery around the recent news propelling bitcoin into the spotlight - the new crypto exchange-traded funds (ETFs).

Cryptocurrency is digital money secured by a specific type of public ledger called blockchain. Without a governing body like a government, a public digital ledger transparently records peer-to-peer transactions. Bitcoin, launched in 2009, became the first widely adopted cryptocurrency. Because the number of coins is limited, bitcoin has become a tempting speculative investment.

A historic milestone: the approval of bitcoin ETFs by the SEC
On January 10th 2024, the U.S. Securities and Exchange Commission (SEC) marked a significant milestone in the cryptocurrency world with the approval of 11 spot bitcoin exchange traded funds (ETFs). This includes offerings from fund titans BlackRock and Fidelity. This move is set to potentially transform the landscape of cryptocurrency investing and open new opportunities for traders.

To understand the impact of this development, it is essential to grasp what spot ETFs are. A spot ETF is a type of fund that directly tracks the current, or 'spot', price of an asset and in this case, bitcoin (BTC). Unlike futures-based ETFs, which are tied to contracts betting on the future price of an asset, spot ETFs are backed by the actual price of the asset itself.

Boosting confidence in Bitcoin investments
This means that when you invest in a spot bitcoin ETF, the fund purchases actual bitcoin, and the value of your investment fluctuates with the real-time price of bitcoin in the market. These bitcoins are held by a custodian. Coinbase is the custodian for eight of the 11 spot bitcoin ETFs.

The introduction of spot bitcoin ETFs is a game-changer because it provides a bridge between the traditional financial world and the burgeoning crypto market. For traders, this means easier access to bitcoin investments without the complexities and security concerns of managing a digital wallet or trading on a cryptocurrency exchange.

Liquidity, price stability and broader adoption
One of the most significant advantages of these ETFs is the potential for increased liquidity and price stability. As more institutional and retail investors gain exposure to bitcoin through these funds, trading volumes are expected to rise. This could lead to a more stabilised market with less price volatility, which is beneficial for traders who seek to capitalise on incremental price movements.

Moreover, spot bitcoin ETFs could also lead to broader adoption and acceptance of bitcoin as a legitimate asset class. With the SEC's stamp of approval, investor confidence in bitcoin could grow, potentially leading to increased demand and, consequently, higher prices.

This parallels the journey of gold ETFs, which increased gold demand substantially and reduced volatility long term.

Bitcoin ETFs vs. futures contracts
Bitcoin ETFs make investing in bitcoin much more accessible to casual traders and retail investors. While futures contracts based on the price of bitcoin require oversight of settlement dates and delivery complexities, an ETF trades like a stock. It simply tracks an underlying index price -- in this case, bitcoin spot price.

The bitcoin ETF offers simple exposure tied to bitcoin's price swings without needing to directly buy crypto from an exchange or wallet and take on the hassles of storage and security. You can buy and sell the ETF seamlessly like stocks from a standard brokerage account.

The ETF format opens the door to mainstream investment funds, retirement accounts like 401ks, and amateur stock dabblers -- not just specialised futures traders. This instantly widens the pool of potential bitcoin investors dramatically.

The ETF coincides with another important moment for bitcoin prices: halving day.

Bitcoin halving day explained
Bitcoin mining is how new coins are created and verified transactions are added to the blockchain ledger. Miners compete to solve complex maths puzzles and earn rewards for each block added. Originally, successful bitcoin miners were rewarded 50 BTC per block, an incentive for mining activity. However, bitcoin has a hard cap of 21 million total coins that can exist.

To ensure controlled supply until the cap is reached, mining rewards decrease by 50% every 210,000 blocks mined. This pre-set halving of mining rewards happens approximately every four years, with the next halving day estimated to be in April 2024.

When halving days reduce the supply of new bitcoins flowing in, simple economics kicks in. All else being equal, when supply drops but demand keeps growing, prices tend to rise. The anticipation of this can spur speculative investing leading up to the halving day.

Impact of halving day on supply and prices
Even without the ETF news, bitcoin's next 'halving day' in April 2024 suggests this built-in increasing scarcity could drive prices up in the coming years.

Of course, cryptocurrencies still come with plenty of risk and uncertainty. But the possibility of more investors and financial giants embracing bitcoin and its derivatives indicates prices could continue climbing. For intrepid investors, crypto ETFs offer a simpler way to stake your claim!

This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

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