More than 10 years after the first filing, the U.S. Securities and Exchange Commission finally approved a spot bitcoin exchange-traded fund. In fact, the SEC approved 11 spot bitcoin ETFs, giving investors options right off the bat. Trading should start in the US on Jan. 11.

Spot bitcoin ETFs are the best option on the fund market for bitcoin investors.

What is a spot Bitcoin ETF?

“Spot bitcoin ETF” is just the official name for an ETF that holds bitcoin. The performance of these ETFs should follow bitcoin prices closely, minus fees and the fund’s trading costs.

A spot price is the immediately available price of a security. Futures prices, on the other hand, represent prices at a future date. Stocks and bonds trade at spot prices (that is, current prices), while products like commodities trade at future prices (which allows buyers to lock in a specific price and complete the transaction at a future date).

The only reason we call the newly approved ETFs “spot bitcoin” is because bitcoin futures ETFs made their debut first. Bitcoin futures ETFs entered the US market in October 2021. 

If a spot bitcoin ETF had been approved first, we may well have simply called them “bitcoin ETFs.”

Should you invest in spot Bitcoin ETFs?

Investors don’t need to take a stance on bitcoin. Fear of missing out is a poor investment strategy, and investors should only invest in these ETFs if they see value in doing so.
Below are a few considerations when deciding whether to invest in spot bitcoin ETFs.

Spot Bitcoin ETFs are a better option than alternatives

Fees

The SEC’s decision to approve multiple filings at the same time created fierce fee competition between issuers during the application process, which is good for investors. Lower fees and costs become paramount to attracting new assets, leading issuers to come to market with competitive fees.

A similar situation could play out in Australia with multiple providers likely to launch local products.

Futures drag on performance

While the SEC dragged its feet on spot bitcoin ETFs, it approved the first bitcoin futures ETF more than two years ago. ProShares Bitcoin Strategy ETF (BITO) was the most heavily traded ETF debut ever. But as we said at that time, “These aren’t the bitcoin ETFs you’re looking for.”

Bitcoin futures ETF investors pay an extra fee to roll from one futures contract to the next, something spot bitcoin ETFs don’t need to worry about.

Spot Bitcoin ETFs aren’t as efficient as most ETFs

Although spot bitcoin ETFs are overall a better option for investors than bitcoin futures ETFs, they don’t yet offer the efficiency that investors have come to expect from other ETFs.
ETFs have become hugely popular because of their low costs. In-kind creations and redemptions allow ETF portfolio managers to limit trading and avoid transaction costs.

Spot bitcoin ETFs won’t benefit from these in-kind creations or redemptions (at least, not yet). The SEC only approved cash creations and redemptions, meaning the ETF will need to bear the costs of buying and selling bitcoin when ETF shares are created or redeemed.

Trading costs could eat away at the edges of spot bitcoin ETF performance. The extent of these costs remains to be seen. Investors on the fence about whether to buy a spot bitcoin ETF may prefer to stick with traditional ETFs until this inefficiency is resolved.

The unique risks of Bitcoin

The average ETF investor likely hasn’t experienced volatility like bitcoin. Over the past five years, bitcoin’s standard deviation or dispersion of returns is nearly 4 times that of the U.S. stock market, as proxied by the Morningstar US Market Index. That said, much of bitcoin’s volatility was to the upside.

But that’s not always the case. Bitcoin prices have had drawdowns of at least 45 percentage points four times in the past five years, and the current price remains 37 percentage points below all-time highs.

Risks don’t stop at price swings. There’s little precedent for the myriad dangers facing bitcoin investors, such as the manipulation and fraud that have been rampant in cryptocurrencies. A bitcoin ETF doesn’t directly inherit that past, but the price of bitcoin is connected to other potentially affected entities.

Spot bitcoin ETFs are particularly exposed to counterparty risk regarding cryptocurrency exchange Coinbase COIN, which spot bitcoin ETF issuers rely on heavily.

Coinbase is the named “bitcoin custodian” on most of the US ETF filings, meaning Coinbase will be responsible for the security of all the private keys of bitcoin held by these ETFs.

Coinbase is also likely the exchange where bitcoin trading will occur for the ETFs when creations and redemptions require it. And Coinbase is the entity responsible for surveillance-sharing agreements with the ETFs’ listing exchanges—an SEC mandate for a better line of sight into crypto markets where trading could affect ETF prices. Much relies on Coinbase’s safe passage.

Bitcoin is difficult to value

Bitcoin is a speculative investment. There is no fundamental reason why it is priced where it is today. It is at the whims of supply and demand, making future prices hard to predict.

Morningstar's Madeline Hume, took a look at four valuation methodologies for pricing bitcoin. Her conclusion? Each is flawed in its own way, and there doesn’t seem to be much appetite for improving them. Investors must understand that bitcoin prices, and therefore these ETFs, are untethered from a fundamental value. Don’t buy these ETFs if that makes you uneasy.