What Are Bitcoin ETFs: A Plea for Clarity Amidst All the Commotion and Confusion

Today, Bitcoin ETFs are discussed at length by many in the media, yet surprisingly, very few actually have a deep understanding of these ETFs, with many of the subject’s details being hidden beneath the surface of the all-too-often unintelligible highfalutin jargon and Einstein-level financial gobbledygook.

So, what on earth are Bitcoin ETFs, why are they so hot, and why is it that the notion of Bitcoin ETFs does not sit well with the US Securities and Exchange Commission (SEC) despite the ongoing efforts by those with a vested interest to get these ETFs approved?

Well, let’s pause here for a second. First, let’s briefly talk about ETFs in general. ETF stands for Exchange Traded Fund, which is a type of investment fund comprised of multiple tradable assets or groups of assets, with the sole purpose of allowing investors to diversify their presence without actually directly owning every one of those assets.

In layman’s terms, if I want to have my finger in every pie, this is exactly what I do as an investor, as opposed to putting my money into just one company or stock and owning it wholeheartedly.

This way, the risks are comparatively lower, and the earning potential is higher. ETFs track the performance of their corresponding assets and then adjust their portfolios and conduct business accordingly: don’t go all in but instead take what’s best when it’s best and simply dump your star player when you no longer need him.

To some, it sounds like good old speculation. The reason being is that, of course, it is. What’s more, if you’ve ever looked into the prelude of the 2008 financial crisis, seen The Big Short (2015), and happen to know what a Collateral Debt Obligation (CDO) is, this lays out a solid foundation for understanding the world of ETFs.

While some detest this CDO to ETF comparison, others, including Michael Burry (played by Christian Bale in the aforementioned film), claim that there’s an unsettling resemblance between the two, with a potentially similar disastrous outcome on the horizon.

Incidentally, for those unfamiliar with this name, Burry is a former hedge-fund manager who against all odds accurately predicted the subprime mortgage crisis and the collapse of the US housing market, which rapidly turned into a global financial catastrophe.

So yes, his credentials are intact.

What’s the problem then, with them ETFs exactly? To put it bluntly, just like CDOs, ETFs are basically full of garbage most of the time, according to Burry.

Back then, CDOs consisted of subprime mortgage loans that could never be repaid but we were nonetheless put together with the others of the kind to form portfolios that were labelled “prime” and were, in turn, sold to investors who looked to diversify and multiply their profits.

Likewise, ETFs today often consist of the same mediocre assets, but which, when combined, suddenly become highly valued packages, explains Burry. In other words, we’re talking about derivatives: not a face value of the product, but it’s derived value, a value which is the result of repackaging and, for lack of a better term, rebranding, i.e. a shiny new wrapper on the outside, with a stale candy gone sour on the inside. 

As Burry told Bloomberg earlier this fall, ETFs lack accurate pricing mechanisms and crucially “do not require the security-level analysis that is required for true price discovery”, which, of course, results in a bubble. Consequently, there’s a major liquidity problem, as these ETFs are indexed at one price, while their constituent parts do not reflect and cannot live up to those prices, individually or even combined.

Whereas these ETFs are traded at trillions of dollars globally, their core face-value insides are often valued at mere millions, not even billions. In other words, the sums that are being exchanged and assigned to the ETFs cannot be backed up by the assets themselves, because when all is said and done, when these products are sold in the non-ETF, non-derivative fashion, they will never fill up the tank.

And, admittedly, the longer it goes on for, the worse it gets, courtesy of the snowball effect: “the theater keeps getting more crowded, but the exit door is the same as it always was,” says Burry.

This is a worst-case scenario, of course. It’s probably true that not all ETFs spell trouble all across, necessarily or always. Certainly, SEC doesn’t consider many mainstream finance ETFs especially dangerous, even though the regulators are supposedly aware of any possible risks; in fact, most such ETFs today are considered business as usual.

Moreover, in addition to the more traditional ETFs, there is also more than one ETF type within the realm of alternative finance. This is precisely why one should not confuse Bitcoin with Blockchain ETFs: whilst the former has to do with cryptocurrencies (or more specifically Bitcoin and its clones), the latter has to do with Blockchain technology and DLT, often without tying them to altcoins in any way.

As Christian Magoon, CEO of Amplify (reportedly one of the most successful Blockchain ETFs) recently stated, “Bitcoin needs Blockchain, but Blockchain doesn’t need Bitcoin”.

But what about Bitcoin ETFs then? What’s the deal with them? Well, on the plus side, because of the nature of all ETF, they will allow investors to work with Bitcoin without owning any of it. Also, as is the case with all ETFs, they will allow investors to short-sell Bitcoin assets when necessary, that is speculate on declines swiftly and lucratively.

And finally and crucially, they will allow investors to trade these assets in a form acceptable by most mainstream brokers and traders, who are familiar and comfortable with ETFs as a financial tool, but not necessarily with cryptocurrency as a more recent phenomenon.

Be that as it may, despite these advantages for eager capitalists, Bitcoin ETFs invite essentially all of the criticisms of their traditional counterparts, plus all of the confusion, financial hanky-panky, and questionable reputation associated with the still to this day dubious world of cryptocoins. 

This is probably why SEC seems to be OK with a typical ETF, which to the federal regulator―to use a simple analogy―is like a private buffet consisting of various items on the menu whose origins can be easily traced.

Compare it to a much more obscure Bitcoin ETF, which probably appears to SEC much the same, except that this private (to the point of being clandestine) buffet―to continue the analogy―consists of extremely exotic items on the menu, whose origins often cannot be traced, whose manufacturers often lack the required documentation to back their products (i.e. “nutritional information”), and whose key people are sometimes even on the run.

Naturally, any regulator would be wary to lend its stamp of approval to folks like that and then have to face the music and be held accountable for any resulting calamities.

Rather predictably, SEC has rejected proposals to create a Bitcoin-backed ETF several times already this year alone, citing manipulation concerns among its primary reasons for disapproval. Some crypto veterans, including those running crypto exchanges like Ras Vasilisin, are in line with SEC’s reckoning and claim that a Bitcoin ETF is on par with a tail wagging the dog: how the system is set up is fundamentally flawed and fraudulent, and it cannot possibly lead to prosperity in the long run; however, it can and will lead to giant deficits, tumultuous crises, and inevitably court hearings.

This is claimed to be the case for the ever same reason: the indexed values of these funds will not accurately reflect the values of the individual assets contained within them.

Nevertheless, there are understandably others who have a lot to gain when it comes to Bitcoin ETFs. Among them are the (in)famous Winklevoss twins who initially emerged in the limelight following the much publicized 2008 lawsuit against Facebook and Mark Zuckerberg, which was examined at length in another critically acclaimed film, The Social Network from 2010. After the twins accepted $65 million as a settlement from Zuckerberg, their lives became intimately intertwined with the life of their winning ticket, Bitcoin.

This proved to be especially so during the 2017 bubble, when they had invested heavily in the first ever cryptocurrency and later opened Gemini, their own crypto exchange with a cheeky name.

Of late, quite expectedly, most of the Winklevoss efforts have been concentrated on the next big step: getting a Bitcoin ETF approved by SEC, in order to turn their combined net worth of a billion and a half USD into a more impressive figure yet. 

Bitwise, a venture fund, are pushing for a Bitcoin ETF for the same reason: they want to increase their profits and claim that their proposal is solid and foolproof; what’s more, the global markets are purportedly ready to welcome them.

Cboe Global Markets (CBOE), who popularized Bitcoin futures, also want to see the same novelties introduced. At the same time, crypto insiders like Weisberger stipulate that SEC’s judgement is clouded by their bias against the asset itself and their lack of jurisdiction over Bitcoin: in reality, a Bitcoin ETF is no more risky than, say, a precious metals ETF (that SEC did approve), with the dangers of inadequate price discovery and possible price manipulation―if there are any―being the same or worse with precious metals. Go figure!

Granted, most players who are speaking in favor of Bitcoin ETFs, or are actively campaigning and anticipating their approval, have a serious personal interest in seeing these new trading practices take hold.

As of right now, SEC is still very sceptical and refusing to take the bait. Will Bitcoin ETFs be approved in the end? Probably. Eventually. How soon, what’s going to happen between now and then, and what exactly are we going to see post-approval?

Well, nobody really knows for certain. One thing is dang clear though: it won’t be smooth sailing.

While the benefits of Blockchain technology and cryptocurrency are evident, whether we’re going to use them to our advantage, or abuse them, as was and still is the case in mainstream finance, remains to be seen.