What is a Bitcoin bond ETF, and how does it work?

Bitcoin ETFs, explained

An ETF is one Bitcoin investment option for retail investors; it lets them track Bitcoin’s price without the hassle of owning the crypto directly.

In January 2024, the US Securities and Exchange Commission (SEC) regulators approved the first spot Bitcoin (BTC) exchange-traded fund (ETF). It sparked a rise in Bitcoin investments, confirming the cryptocurrency’s popularity.

It paved the way to more accessible digital asset-backed ETFs for all, including retail investors. Instead of going through the technical hassle of creating and holding a Bitcoin wallet, investors may now use a brokerage account to invest indirectly in Bitcoin. 

There are two types of Bitcoin ETFs: spot Bitcoin ETFs and Bitcoin futures ETFs.

Investors mean a “spot Bitcoin ETF” when they say “Bitcoin ETF.” It is an investment vehicle that seeks to track Bitcoin’s price. Bitcoin ETFs are traded on regulated securities exchanges, not on crypto exchanges. 

A spot Bitcoin ETF issues shares corresponding to the amount of Bitcoin it holds and is indeed backed by Bitcoin. If the coins’ value rises, then the ETF’s value is expected to increase in tandem. The Bitcoin is secured in a digital vault, and registered custodians manage it. They use various security layers — online and offline — to reduce hacking risks.

The other type of Bitcoin ETF, the Bitcoin futures, is to track Bitcoin’s future performance. It uses futures contracts between two parties who agree to buy or sell a set amount of Bitcoin at a set price on a specific future date. 

Did you know? As of Jan. 24, Bitcoin ETFs have a total volume of $10.11 billion, a market cap of $122.80 billion, and assets under management of $124.19 billion, highlighting growing investor interest.

Bitcoin bonds, explained

Bitcoin bonds offer a new way to invest in crypto. They combine the benefits of a stable, reliable financial tool with the high returns of a volatile industry.

A bond can be defined as an IOU (I Owe You), a certificate that proves the existence of a debt with different entities:

• Government-issued bonds — low risk. Investors get repaid the initial amount plus interest.
• Corporate-issued bonds — higher risk. These are funds that companies must generate with the intent of refinancing or growing.
• Municipal bonds — low risk and generally tax-exempt interest rates. Bonds are used to raise capital to fund infrastructure projects.

Investing in Bitcoin bonds comes with higher risks compared to other types of bonds. Their value depends on the volatile digital currency. However, higher risks mean a better chance of high returns, which is what appeals to the new generation of investors.

What is a Bitcoin bond ETF?

Bitcoin bond ETFs blend traditional finance with crypto-focused ETF strategies. They offer investors a new way to diversify their portfolios while engaging with the crypto market indirectly.

ETF investment strategies are a more accessible and regulated way to invest in Bitcoin, in addition to its inexpensive formula compared to other types of investments. It promises a low-risk investment, creating a steady source of income for the investors.

Bond ETFs are funds invested in various convertible fixed-income securities, such as government or corporate bonds. A Bitcoin bond ETF is an investment in bonds issued by companies that use the bonds’ proceeds to purchase Bitcoin. 

These are crypto-backed bonds and function on blockchain technology. They are, therefore, issued and maintained in borderless and decentralized smart contracts. They are programmed to handle interest and repayment terms, thus eliminating the need for intermediaries like banks. The terms can be varied and offer a fixed or variable interest rate. 

Let’s identify the benefits and drawbacks of holding a Bitcoin bond ETF.

Benefits

• Diversification and exposure to Bitcoin without the tech issues.
• Investing in a regulated asset like an ETF offers protection. This can give peace of mind to the conservative investors.
• The bond offers consistent interest payments that can be appreciated during times of volatility and prolonged bear markets.
• The open ledger’s transparency means everything can be tracked on the blockchain. This includes your investment’s performance and your payout timings.

Drawbacks

• Volatility. While ETFs are tools different from Bitcoin, they are still strictly linked to its price and can therefore be more volatile compared to other ETFs.
• Bond issuer risk. After a dramatic drop in Bitcoin’s price, a bond issuer may struggle to repay the bond or maintain its value.

Did you know? El Salvador was the first country to issue Bitcoin bonds, also known as “Volcano Bonds.” These innovative bonds are designed to raise funds for Bitcoin mining powered by volcanic energy and the development of Bitcoin City, blending blockchain technology with renewable energy initiatives.

How Bitcoin bond ETFs work

Ultimately, the success of such ETFs depends on both the performance of Bitcoin (BTC) and the bond-issuing companies’ financial health.

When investors buy ETF shares, their money is used to buy these bonds or similar securities. A bond ETF generates returns primarily from the interest paid by the bonds it holds. An ETF’s share price will fluctuate based on the following:

• Bitcoin’s price
• The market value of the bond
• The viability of the issuing company
• Market interest rate
• State of the overall bond market.

Here’s how this type of investment works: 

The investment focus of Bitcoin bond ETFs is to gain exposure to bonds like the ones issued by MicroStrategy, which is heavily invested in Bitcoin. It uses the capital raised from these bonds to buy more Bitcoin, which links the bond’s value directly to the digital currency’s price.

Companies like MicroStrategy issue fixed-interest securities in the form of convertible bonds or notes. These can be converted into the company’s stock under specific terms. 

The ETF’s managers engage in active work on the bond and similar securities. They make investment decisions based on market conditions to maximize returns from the bonds and the underlying Bitcoin exposure.

Traditional bonds vs. Bitcoin bonds

Traditional bonds are reliable, as they are backed by governments or corporations and offer steady returns. Bitcoin bonds, on the other hand, expose investors to cryptocurrency.

The Bitcoin bond ETF is backed by the issuing company and not by the cryptocurrency itself. Bitcoin will, indirectly, set the bond’s price, but the issuer’s financial health is key to this investment’s success.

Riskier than traditional bonds, Bitcoin bonds are generally more flexible. They are still available in the traditional financial markets and can be traded on stock exchanges, unlike most financial tools, which must be held until maturity.

Liquidity is also an element that sets traditional and Bitcoin bonds apart. Traditional bonds are conventional in offering reliable access for investors to trade in established, highly regulated markets. On the other hand, Bitcoin bonds depend on the ETF trading volume, which may vary considerably.

Traditional bonds suit risk-averse investors who prefer stability and predictable returns. Bitcoin bonds, however, add risk and complexity to the mix. This is something investors should take into account when deciding which tool is better for them.