Bitcoin ETFs might be the next derivative instruments to be launched using the cryptocurrency after CBOE’s futures launch on December 10. According to reports, the Securities and Exchange Commission (SEC) has already received 15 applications for bitcoin ETFs.

The proposed ETFs range from coin-based (or, based on the actual price of bitcoins at an index) to futures-based (or, based on the price of bitcoin futures at a regulated institution) to an inverse bitcoin ETF or an ETF that shorts bitcoin.

Some commentators say that the chances of SEC approving a fund based on a price index for bitcoin is highly unlikely. The Winklevoss twins, who submitted the first application for a bitcoin ETF in 2013, had proposed such a fund but their application was rejected by the SEC. The application is being reconsidered after an appeal. (See also: Why Is SEC Afraid Of Bitcoin ETFs?)

Estimates for launch dates for the first bitcoin-based ETF range from next quarter to next summer. The launch of a bitcoin ETF could offer a convenient opportunity to investors to profit from bitcoin without experiencing its underlying volatility. In addition, they could provide much-needed liquidity to bitcoin trading markets and help in price discovery for the cryptocurrency in futures markets.    

How Regulation Makes a Difference

The current market for ETFs based on bitcoin is sparse and fragmented. Bitcoin ETFs are available in the OTC market, which is not subject to stringent SEC regulations. While they produce outsized returns, such instruments often mirror bitcoin’s whipsaw price movements. 

For example, Grayscale’s Bitcoin Investment Trust (GBTC) produced returns of 2,084% this year on an average premium of 48.09% over bitcoin’s price. Within a three-day period between December 5 to December 8, its price swung from a high of $1,825 to a low of $1,573.88 the next day and, subsequently, another upward movement to $1,820 the following day. Including it in a portfolio would require constant rebalancing in order to produce targeted returns. (See also: Why Buy This Bitcoin ETF Instead Of Actual Bitcoin.) 

On the other hand, XBT Provider by CoinShares has listed two ETNs on Nordic Nasdaq in Sweden. One of them produced returns of $1,480.16% in the last year on an average 52-week premium of 0.54% over bitcoin’s price.

According to Ryan Radloff, co-founder of CoinShares, there has been a significant “volume tick up” since the launch of bitcoin futures on CBOE and inquiries from investors regarding their product. 

Bitcoin ETFs Pose Problems As Well

But concerns still abound about the effect of bitcoin ETFs based on another derivatives on the overall ecosystem. For example, Joe Saluzzi, partner at Themis Trading, pointed out in a tweet that a bitcoin ETF was the derivative of a derivative. The systemic risk might also be amplified by volatility in bitcoin prices and outages at the exchanges that serve as inputs to indexes. 

Bitcoin ETFs might also not provide the tax benefits that accrue from conventional ETFs. Because bitcoin is a digital currency, ETFs may settle redemptions in cash by selling securities in the markets. To avoid capital gains tax on their sales, the fund will immediately pass on the benefits to shareholders, which may cause them to be subject to taxation. 

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