What is a Spot Bitcoin ETP?

What you need to know about these unique assets.

For much of 2023, crypto enthusiasts hoped for the approval of a spot bitcoin exchange-traded product (ETP). Some believed it would bring enough new money to the crypto industry to save it from 2022's bitter bear market.

Now they're here and available to trade. But what are spot bitcoin ETPs, exactly? And how are they different from spot trading bitcoin and other crypto assets? Let's explore the key differences and what to consider from an investing standpoint.

What are spot bitcoin ETPs?

Spot bitcoin ETPs are investments that track the price of bitcoin. They're the first exchange-traded products that hold actual bitcoin (i.e., "spot") as their underlying asset. Other bitcoin-related exchange-traded products exist, but their underlying assets are typically bitcoin futures, which are derivatives of bitcoin, as opposed to the real thing.

You may already be familiar with the concept of ETFs and crypto-related ETFs. All ETFs are part of a broader category called exchange-traded products (ETPs), which are listed on an exchange and can be bought and sold during market hours like a stock.

ETFs, the most common type of ETP, are governed by the Investment Company Act of 1940 and are pooled investment opportunities that typically include baskets of stocks, bonds, and other asset groups based on fund objectives. ETPs, however, are not subject to this Act, and as such, generally don't have diversified holdings like traditional ETFs.

Potential pros of spot bitcoin ETPs

May make crypto more accessible to the public.

Those new to crypto can find it hard to understand the details behind buying bitcoin and other cryptocurrencies. Which platform can be used to buy crypto? Is a purchase recorded on the blockchain? Where are the coins that are bought stored? These questions can be daunting for first-timers.

Then, once a purchase has been made, there are financial planning considerations that differ from those of traditional assets. For example, when it comes to reporting taxes for traditional assets, gains and losses can often be synced to tax preparation software with a single click through brokerage platform. Reporting crypto taxes, however, may require uploading documents to the tax preparation software, as the ability to sync seamlessly with platforms offering crypto may not yet exist. Apart from taxes, there are also unique steps necessary for fitting crypto into an estate plan.

These factors may make those who are unfamiliar with crypto's nuances hesitant to invest. They can also make it harder for financial advisors to incorporate crypto into an investment plan for clients.

Buying spot bitcoin ETPs, however, operates much like buying an index fund or sector ETF. Investors can complete everything through more traditional routes, including brokerage accounts, IRAs, and trusts, which simplifies many of the questions above. Tax and estate planning considerations may also be simpler to manage through this route.

Note: Despite the potential advantages, remember that spot bitcoin ETPs hold bitcoin as their underlying asset. Bitcoin and other cryptocurrencies are highly volatile and may be more susceptible to market manipulation than other securities.

Nevertheless, in general, the ETPs remove significant hurdles for investors who want exposure to bitcoin.

May have fewer security considerations compared to buying bitcoin

Those who aren't familiar with the nuances of crypto cybersecurity may also find it confusing to learn how to keep their bitcoin secure. Protecting bitcoin requires knowing the difference between hot and cold wallets, ways to avoid scams, features of reliable custodians, and other best practices.

These aspects are critical knowledge for bitcoin owners because there is no central customer service team in crypto. If a person is hacked or scammed, or if the crypto exchange where the person is storing their coins on collapses, they may lose access to their investments forever.

For those who have been hesitant about buying crypto because of these risks, spot bitcoin ETPs are an alternative that potentially comes with fewer of these risks. With the ETP, they only need to protect the login to their financial platform, rather than learn and manage multiple cybersecurity nuances. However, note that they are still trusting that the ETP issuer is managing these cybersecurity nuances effectively.

Additionally, ETPs in general are subject to certain regulatory oversight from government agencies. This contrasts with the crypto market, which is currently less regulated. Some investors may feel more confident buying an asset that is subject to regulation.

Potential cons of spot bitcoin ETPs

Doesn't give direct ownership of bitcoin but still has security risks

An investor will miss out on several aspects of Bitcoin's true purpose if they only buy an ETP. For example, consider decentralization. Pseudonymous Bitcoin creator Satoshi Nakamoto's original vision was to create a currency that isn't controlled by or dependent upon a central authority. In contrast, ETPs are dependent on issuing financial institutions. In contrast, the existence of bitcoin isn't dependent on institutions.

Owning bitcoin also means a person can send the bitcoin to others through the blockchain, or pay for goods and services from vendors who accept it. But ETPs can't be used to pay for goods and services. And while a person can technically gift shares to someone else, it's not as practical as simply sending friends or family some bitcoin.

Another potential downside of spot bitcoin ETPs is that even though a person can't access many of bitcoin's core value props, they're still exposed to some of bitcoin's underlying security risks. While they no longer have to manage their own security risks for the underlying bitcoin, they do have to trust that the underlying bitcoin custodian will properly manage theirs.

Comes with trading limitations and investment risks

Both long-term and short-term investors should note that spot bitcoin ETPs can only be bought or sold during traditional market hours. Bitcoin, however, trades 24/7.

In the past, bitcoin has sometimes made significant double-digit moves on weekends. As an ETP holder, the investor will have to wait until the market opens to enter or exit their positions, which means they may miss these moves. Depending on their strategy, this may present challenges—especially if there's a big drop in price.

Similarly, investors should note that spot bitcoin ETPs are new, and it remains to be seen whether they will achieve widespread adoption. If they don't, there may be liquidity issues; i.e., their buys may only get filled at higher prices than what they're looking for, and their sells may be filled at lower prices.

There are also tracking errors to consider. Like with other ETPs, spot bitcoin ETPs won't reflect bitcoin's price perfectly. This can be due to factors like management fees and rebalancing costs and delays, which don't exist if a person buys bitcoin directly. So while buying an ETP may give the investor's portfolio exposure to bitcoin's macro movements, it won't track it on a precise 1:1 basis.

Finally, note that buying the ETP does not shield investors from bitcoin's volatility, which has been substantial at times throughout its history. Unlike many other ETFs and ETPs, which diversify their risk across several stocks or commodities within a specific sector, spot bitcoin ETP holdings are concentrated in bitcoin. Investors should keep this in mind when deciding how to allocate their portfolios.

Buying bitcoin directly vs. buying a spot bitcoin ETP

If the investor understands the risks and are deciding between buying bitcoin directly or a spot bitcoin ETP, the differences might be best summed up as functionality versus convenience. Buying bitcoin will give access to the features Nakamoto envisioned, but the investor must be willing to learn the nuances of crypto cybersecurity and management.

Buying a spot bitcoin ETP allows to quickly enter the crypto market without necessarily learning the technical details. In return, however, holdings aren't truly decentralized, can't be used to pay for goods and services, could be exposed to tracking errors, and come with trading limitations detailed in the section above.

Ultimately, no matter which route is taken, remember that bitcoin and other cryptocurrencies are highly volatile, and may be more susceptible to market manipulation than other securities. Note that crypto holders do not benefit from the same regulatory protections applicable to registered securities, and the future regulatory environment for crypto is currently uncertain. Crypto is not insured by the Federal Deposit Insurance Corporation or protected by the Securities Investor Protection Corporation, meaning the investor should only buy bitcoin with an amount they're willing to lose.