The United States capital markets regulator — the U.S. Securities and Exchange Commission (SEC) — approved 11 spot Bitcoin exchange-traded funds (ETFs) from BlackRock, Vanguard, Franklin Templeton, Valkyre, Fidelity Investments, Invesco Galaxy, ARK Invest, Bitwise, Grayscale, Hashdex and VanEck on Jan. 10, 2024. The approvals ended a decade-long regulatory pursuit since the initial application in 2013 was rejected by the SEC.
The approval opened doors, offering investors a regulated and potentially more accessible route to gain exposure to the world’s leading cryptocurrency through regulated products. ETFs are investment vehicles that provide exposure to a basket of investments such as equities or bonds.
ETF providers such as BlackRock, Fidelity and others consider a diverse range of assets, including stocks, bonds, commodities or currencies, and build baskets of the assets, each with its own ticker. The ETF monitors the price of an underlying asset or index and blends the characteristics, risks, returns and other potential benefits of the assets in the basket.
Investors can buy a share in that basket like they would buy stock in a firm. Like a stock, investors may trade the ETF on an exchange such as the New York Stock Exchange (NYSE) during trading hours.
This provides a more straightforward way of investing in Bitcoin (BTC) for those without a crypto wallet or who do not wish to trade via decentralized and centralized crypto exchanges.
As Bitcoin ETFs gain popularity, understanding the nuances becomes important for investors seeking to navigate the evolving landscape. This article specifically focuses on the market tracking analysis, tracking differences, tracking errors and other performance metrics within Bitcoin ETFs.
Understanding Bitcoin ETFs
Bitcoin ETFs are investment funds that track the price performance of BTC. These ETFs operate similarly to traditional ETFs, with shares traded on stock exchanges. Each share represents ownership of underlying Bitcoin assets or derivatives thereof.
A Bitcoin ETF operates similarly to traditional ETFs, whereby the value of a single share of the ETF correlates directly with the price movements of BTC. As the value of Bitcoin rises, the ETF’s share price increases accordingly, and conversely, if Bitcoin’s value decreases, the ETF’s share price follows suit.
However, unlike trading on a cryptocurrency exchange, transactions for the Bitcoin ETF occur on traditional market exchanges such as the NYSE or Nasdaq. By investing in Bitcoin ETFs, investors can participate in the potential upside of Bitcoin’s price appreciation without the complexities of directly purchasing and storing BTC.
Why do Bitcoin ETFs matter to investors?
Investing in a Bitcoin ETF offers investors the opportunity to capitalize on the price movements of Bitcoin without distancing themselves from the intricacies of Bitcoin’s functionality or navigating the complexities of the Bitcoin blockchain and cryptocurrency exchanges.
The direct ownership of Bitcoin includes securing a wallet and safeguarding passwords, managing associated risks of scams and hacks or simply human errors like lost funds or passwords. Investing in a Bitcoin ETF streamlines these hassles.
For instance, the risk of permanently losing Bitcoin due to forgotten wallet passwords or lost seed phrases is mitigated as investors hold shares in the ETF rather than managing their individual cryptocurrency holdings. A Bitcoin ETF simplifies the investment journey by providing more accessible and user-friendly exposure to Bitcoin’s price dynamics.
Additionally, they offer the potential for diversification within investment portfolios by providing exposure to Bitcoin and other assets like stocks, bonds or commodities. This diversification can help mitigate risk and enhance overall portfolio stability.
Bitcoin ETFs may also offer tax efficiency benefits and fund management efficiency, as they trade on traditional exchanges and are subject to regulatory oversight. This could make them more attractive to institutional investors and those seeking compliance with tax regulations.
Tracking difference and tracking error in Bitcoin ETFs
Determining whether an ETF effectively fulfills its intended role can be crucial for investors. While evaluating past year’s performance may seem intuitive, market cycles, price fluctuations and volatilities can obscure an ETF’s true performance. Bitcoin ETF’s relative newness in the market makes it important for investors to learn tracking analysis and gauge ETF tracking differences between various provider offerings.
Tracking difference and tracking error are two key metrics used to evaluate the performance of Bitcoin ETFs relative to their underlying benchmarks.
Tracking difference in Bitcoin ETF
Tracking difference measures portfolio tracking accuracy by calculating the annualized difference between ETF and index returns. An ETF aims to track an index, meaning it tries to deliver the same returns as a particular index; likewise, a Bitcoin ETF aims to track the BTC index and deliver the same result as the BTC price. Tracking difference is the discrepancy between ETF performance and index performance.
It highlights ETF performance metrics by indicating whether the ETF is meeting its objectives. A positive tracking difference means the ETF outperformed its index, while a negative value indicates it underperformed. Tracking difference is rarely nil as several factors prevent the ETF from perfectly mirroring its index, and ETFs usually trail their index.
For instance, if the BTC price experiences a 30% increase in a quarter, ideally, the value of the BTC ETF should also rise by 30% during the same period. Any deviation from this alignment could result in missed investment opportunities.
For example, hypothetically, in the table below, one may assume a certain percentage increase in the price of Bitcoin for each quarter. The “Expected ETF Performance” column represents the anticipated performance of the Bitcoin ETF, mirroring the price increase of Bitcoin. The “Actual ETF Performance” column indicates the ETF’s real performance during each quarter.
The “Tracking Difference” column calculates the deviation between the expected and actual ETF performance, highlighting whether the ETF outperformed (+) or underperformed (-) compared to the Bitcoin index.
Therefore, by monitoring Bitcoin ETF tracking differences, investors can better align their investment objectives with the performance expectations of the ETF relative to their benchmark indexes.
Tracking error in Bitcoin ETF
Tracking error is typically expressed as a percentage representing the standard deviation difference between an investor’s portfolio’s returns and those of the benchmark it aims to replicate. It measures the extent to which the portfolio’s performance deviates from the benchmark’s.
Thus, tracking error analysis evaluates ETF tracking risk by quantifying the volatility of this difference. Factors like intraday pricing deviations, market price variations and fund management efficiency contribute to tracking errors.
For Bitcoin ETFs, several factors can influence tracking error, which is the deviation between the fund’s returns and the performance of the underlying Bitcoin index or benchmark. Firstly, the fund’s expense ratio plays a pivotal role, as higher fees can significantly impact the fund’s performance, potentially leading to a wider tracking error.
However, adept portfolio management strategies, such as efficient rebalancing, dividend management and securities lending, can help mitigate the negative effects of fees and even allow the fund to outperform the index.
Moreover, the degree of alignment between the fund’s holdings and those of the underlying index is crucial. While some funds closely replicate the index, others may employ a representative sample approach, introducing differences in asset composition and weighting that can contribute to tracking errors.
Additionally, the liquidity of Bitcoin and its underlying securities can affect tracking error, particularly if the ETF trades illiquid or thinly traded assets, leading to discrepancies between the fund’s market price and the actual market price of Bitcoin.
Furthermore, net asset value (NAV) tracking is another critical aspect. Any deviation between the ETF’s NAV and the value of its underlying assets can contribute to tracking error, especially during periods of market volatility or when liquidity issues arise.
Finally, the inherent volatility of the Bitcoin market can also impact tracking error, with higher volatility potentially exacerbating deviations from the index. Overall, factors such as expense ratios, portfolio composition, liquidity and market volatility collectively influence the tracking error of Bitcoin ETFs, highlighting the importance of diligent fund management and strategy implementation for investors seeking accurate index replication and performance.
Thus, understanding and monitoring these tracking metrics are essential for investors to make informed decisions regarding their Bitcoin ETF investments.
Written by: Shailey Singh