What is a spot bitcoin ETF and why it has sparked a crypto rally?

Since the approval of multiple spot bitcoin exchange-traded funds (ETFs) by the US Securities and Exchange Commission (SEC) in January, the price of bitcoin has followed a mostly steady upward trajectory.

On 14 March, bitcoin hit a record high of $73,580, according to CoinGecko data, its price bolstered by increased inflows from fund managers such as BlackRock (BLK) and Franklin Templeton (BEN), via spot bitcoin ETFs.

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But what exactly are spot bitcoin ETFs, and why have they caused such a surge in the price of the world's largest digital asset by market capitalisation?

What is a spot bitcoin ETF?

Spot bitcoin ETFs function similarly to traditional ETFs but with a distinct focus on tracking the current price of bitcoin (BTC-USD).

These financial products directly invest in bitcoin as the underlying asset, unlike derivatives-based bitcoin ETFs, that use financial instruments like futures contracts to replicate bitcoin's prices. This distinction allows investors in spot bitcoin ETFs to have direct exposure to the price movements of bitcoin itself.

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Each share of the ETF sold corresponds directly to an equivalent amount of bitcoin held in reserve by the fund. These ETFs make it easier and safer for regular investors to invest in bitcoin, and they follow rules set by financial regulators, making them more reliable. However, management fees and brokerage commissions still apply.

Currently, there are 11 spot bitcoin ETFs in existence, offered by fund managers such as BlackRock, Fidelity, WisdomTree and Franklin Templeton. These managers collaborate with authorised participants who purchase bitcoin for the ETF. The acquired bitcoin is then securely stored in digital wallets by trusted custodians, such as Coinbase (COIN).

How spot bitcoin ETFs influence the market

The issuance of shares by these funds represent purchased bitcoin, mirroring the current spot price of the digital asset.

These shares are traded on traditional stock exchanges, providing both individual and institutional investors with a convenient avenue to invest in bitcoin without the complexities associated with direct ownership, such as operating private keys and digital wallets.

For example, BlackRock's iShares Bitcoin Trust ETF (IBIT) is listed on the Nasdaq (^IXIC), while Fidelity's Fidelity Wise Origin Bitcoin BTC fund (FBTC) is listed on the New York Stock Exchange (^NYA).

The introduction of spot bitcoin ETFs has significantly impacted the price of bitcoin. In the short term, the influx of institutional investment facilitated by these ETFs has bolstered demand for the digital asset, leading to a surge in its price.

Furthermore, the SEC's approval of spot bitcoin ETFs signals a significant shift in regulatory sentiment towards cryptocurrencies, legitimising bitcoin as an asset class and enhancing liquidity in the bitcoin market.

Global adoption and regulatory landscape

Following the footsteps of the SEC in the US, the UK's Financial Conduct Authority (FCA) has expressed intentions to permit bitcoin-backed exchange-traded notes (ETNs), specifically targeting professional investors.

This global acceptance and adoption of bitcoin-backed financial products indicate a growing recognition of the cryptocurrency's potential within the traditional financial ecosystem.

Risks and considerations

Despite the allure of spot bitcoin ETFs, it's crucial to acknowledge the inherent risks associated with investing in bitcoin.

The volatility of bitcoin remains a significant concern, and investors should exercise caution and assess their risk tolerance before venturing into these newly-approved investment products. Additionally, reliance on third-party custodians that hold the underlying asset introduces another layer of risk, emphasising the importance of thorough due diligence before investing.

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The approval of these ETFs by regulatory bodies like the SEC and potential adoption by others like the FCA underscore a growing acceptance of bitcoin within the traditional financial landscape.

However, investors must remain vigilant, understanding the risks involved and conducting thorough research before diving into this evolving market.

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