What is a Bitcoin ETF?

An ETF is an exchange-traded fund that follows a strategy of investing in assets with relatively low entry costs.

Typically, ETFs were designed either to track baskets of instruments, certain strategies, or assets that are difficult to hold physically.

Why do you need an ETF?
A huge amount of investor capital circulates on exchanges not directly, but through institutional investors.

These institutional investors are not individuals with college degrees — they are legally regulated collective investment funds that pool money from smaller investors for further investment.

The legal regulation of these funds strictly determines where and through which structures they can invest.

And since the legal status of BTC is still not fully regulated, these institutions had no legal way to invest in BTC by buying coins directly.

But they could invest in registered ETFs.

This is exactly what explains the hype around the launch of BTC ETFs.

So how does a BTC ETF work?

Let’s start with the name.

ETF literally means "exchange-traded fund."

Any trader, during a trading session, can buy or sell ETF shares.

Buying ETF shares does not give you the right to own any amount of BTC. You are buying shares in the fund — you are investing in the ETF, not in BTC directly.

Sometimes, the fund’s share price may not correlate exactly with the BTC price. The deviation is usually minor and infrequent, but it can happen.

As an ETF shareholder, you’ll always lag behind BTC price growth slightly, because the ETF’s operating costs are passed on to you proportionally to your share in the fund.

It’s not as predatory as what investors suffered in The Wolf of Wall Street, but still.
Now, let’s talk about the inner workings of an ETF.

By law, the money received from selling its own shares must be invested in the assets specified in its registration documents — in our case, Bitcoin.

But obviously, no fund will perform multiple BTC transactions throughout the day to match ETF share trades — this happens periodically.

A fund typically keeps a balance of both cash and the investment asset.

If there's a short-term cash deficit during the day, it can be easily covered by borrowing from a parent company, a bank, or by shifting the shortfall to a market maker temporarily.

But doing the same with the investment asset (BTC) isn’t so simple — as far as I know, no regulated financial institutions provide BTC loans.

Still, it’s not hopeless.

For quite some time now, BTC futures have been trading on the CME.

If the fund temporarily lacks BTC, a trader can hedge exposure by buying BTC futures in an amount proportional to the missing BTC.

Once the situation balances out — or even simultaneously — the future can be sold.
And yes, some additional “games” with derivatives are likely.

Let’s be honest — it would be silly for a fund holding a pile of BTC not to earn some extra income by selling distant call options on part of the stash.

Or, knowing they’ll be buying BTC anyway at a certain time, why not try to buy cheaper via selling put options?

There’s no proof the ETF itself does this, but some not-so-directly affiliated party almost certainly is.

These are the realities of the exchange world.