Yellow Capital Blog/Investments/Bitcoin ETF vs Bitcoin ETN: What is Bitcoin ETN?

Bitcoin ETF vs Bitcoin ETN: What is Bitcoin ETN?

Friday, March 29, 2024

In March 2024, the London Stock Exchange (LSE) announced its plan to commence trading Bitcoin and Ethereum exchange-traded notes (ETNs) from May 28. Applications for trading will be available starting April 8.
Now, let's examine Bitcoin ETNs more closely and compare the two main investment products that have emerged in this area—Bitcoin Exchange Traded Funds (ETFs) and Bitcoin Exchange Traded Notes (ETNs). Although both products aim to expose investors to Bitcoin's price movements, their structure, underlying holdings, and associated risks differ.

What is a Bitcoin ETF?

An Exchange Traded Fund (ETF) is an investment fund that operates on an exchange, similar to a stock, and holds a basket of underlying assets. A Bitcoin ETF would be a regulated investment product directly holding Bitcoin as its underlying asset.
The main feature of a Bitcoin ETF is that it would own and hold actual Bitcoin on behalf of its investors. When investors buy shares of a Bitcoin ETF, they are essentially gaining exposure to the price movements of the underlying Bitcoin held by the fund.

Bitcoin ETFs are regulated investment vehicles, subject to the same rules and oversight as traditional ETFs. Regulatory oversight provides investors greater transparency, liquidity, and protection than investing directly in Bitcoin.

Bitcoin ETF vs Bitcoin ETN

What is a Bitcoin ETN?

A Bitcoin Exchange Traded Note (ETN) is a type of unsecured debt security that tracks Bitcoin's price movements. While an ETF holds the underlying asset directly, an ETN is a debt instrument issued by a financial institution.
When investors buy a Bitcoin ETN, they lend money to the issuing institution, which promises to pay returns based on Bitcoin's price performance. The issuer doesn't hold Bitcoin directly but replicates the cryptocurrency's price movements using derivatives or other financial instruments.
Bitcoin ETNs are traded on exchanges, similar to stocks or ETFs. This exposes investors to Bitcoin's price movements without needing to own or manage the underlying cryptocurrency directly.

Key Differences: ETF vs ETN

ETF: Direct Ownership of Bitcoin

An exchange-traded fund (ETF) that invests in Bitcoin would possess and hold it as its underlying asset. This implies that investors who buy shares in a Bitcoin ETF would have indirect ownership of the Bitcoin that the fund owns in proportion to their share of the ETF.

ETN: Debt Instrument Tracking Bitcoin Price

A Bitcoin ETN is a type of debt instrument a financial institution offers. This instrument promises to provide returns based on Bitcoin's price performance. Unlike owning Bitcoin, investors who purchase a Bitcoin ETN do not have any direct ownership of Bitcoin. Instead, they hold a debt obligation from the issuing institution.

Counterparty Risk in ETNs

Regarding counterparty risk, there is a significant difference between ETFs (Exchange-Traded Funds) and ETNs (Exchange-Traded Notes). An ETN is a debt obligation, which means that its value and performance are dependent on the creditworthiness and ability of the issuing institution to meet its obligations. If the issuer defaults or becomes insolvent, investors in the ETN may lose their entire investment.
On the other hand, a Bitcoin ETF does not carry the same level of counterparty risk because the fund directly holds the underlying Bitcoin assets.

Pros and Cons of Bitcoin ETNs

Bitcoin ETNs are exposed to price movements but have advantages and disadvantages.

Pros of Bitcoin ETNs

Regulated Investment Vehicle
Unlike direct Bitcoin investment, Bitcoin ETNs are financial instruments regulated by governing bodies, providing investors with transparency and protection.
Bitcoin ETNs are traded on exchanges like ETFs, providing investors with liquidity and the ability to buy and sell shares throughout the trading day.
Bitcoin Price Exposure
Bitcoin ETNs track Bitcoin's price movements, giving investors exposure without direct ownership.

Cons of Bitcoin ETNs

Credit Risk
Bitcoin exchange-traded notes (ETNs) carry counterparty risk, meaning their value depends on the issuer's creditworthiness. If the issuer becomes insolvent or defaults, the investor's entire investment could be at risk.
Tracking Error
Bitcoin ETNs may not perfectly track Bitcoin's price due to fees, expenses, and the issuer's ability to replicate its performance.
Lack of Direct Bitcoin Ownership
Investors in Bitcoin ETNs do not directly own the underlying Bitcoin; instead, they hold a debt obligation from the issuing institution. This may be less desirable for some investors seeking direct exposure to the cryptocurrency.
Tax Treatment
The tax treatment of Bitcoin ETNs differs from that of ETFs or direct Bitcoin investments, which could impact overall investor returns.

Regulatory Landscape

Regulatory Landscape of BTC ETN

The rules and regulations surrounding Bitcoin investment products have been changing, with different regions adopting varying approaches. In the United States, before approving, the Securities and Exchange Commission (SEC) was hesitant to approve a Bitcoin ETF as it was concerned about potential market manipulation, liquidity, and custody issues. Despite this, several Bitcoin ETN products have been approved and are trading on European exchanges.
Approval of a Bitcoin ETF in the United States is a significant milestone for the cryptocurrency industry, as it introduces wider institutional adoption and investment opportunities.
Regulators are more receptive to Bitcoin ETNs than ETFs because ETNs are seen as less risky due to their structure as debt instruments. This is related to custody and potential market manipulation concerns.
However, the continuing regulatory discussions and scrutiny around Bitcoin investment products emphasize the need for strong oversight and investor protection measures, regardless of the specific product structure.​

Which is Better for Investors?

An investor's specific goals, risk tolerance, and investment preferences should guide their decision between a Bitcoin ETF and a Bitcoin ETN.
Bitcoin ETF: Direct Exposure and Ownership
Investors looking for direct exposure to Bitcoin and the possibility of long-term capital appreciation may find a Bitcoin ETF a more appealing option. By holding Bitcoin as the underlying asset, a Bitcoin ETF can offer investors indirect ownership of the cryptocurrency, enabling them to take advantage of its potential price appreciation.
Additionally, Bitcoin ETFs have an advantage over ETNs because they do not have the counterparty risk associated with the latter. The fund that issues the ETF directly holds the underlying assets. For investors concerned about the issuing institution's creditworthiness, this can be a significant advantage.
However, it's important to note that Bitcoin ETFs are still subject to regulatory approval in many jurisdictions, and their availability may be limited or nonexistent in certain markets.

Bitcoin ETN: Accessible Exposure with Risks
Bitcoin Exchange-Traded Notes (ETNs) are a more convenient option for investors who want to invest in Bitcoin's price movements without directly owning or managing the cryptocurrency. ETNs are ideal for investors who want to diversify their portfolios with Bitcoin exposure but need to be more comfortable with the complexities of holding the digital asset.
Moreover, ETNs offer the convenience of being traded on exchanges, making buying and selling shares easy throughout the trading day.
However, investors in Bitcoin ETNs need to be aware of the counterparty risk associated with these debt instruments. The value of an ETN is linked to the creditworthiness of the issuing institution, and a default or insolvency could result in a total loss of investment.
Furthermore, Bitcoin ETNs may not accurately track Bitcoin's price movements due to fees, expenses, and the issuer's ability to replicate the cryptocurrency's performance effectively.

Role of ETNs as a Stopgap
Bitcoin ETFs are highly sought after by investors who want regulated and direct exposure to Bitcoin. However, in certain markets where these ETFs are not yet approved, Bitcoin ETNs have played an important role as a temporary solution.
In these jurisdictions, Bitcoin ETNs offer investors a regulated alternative for gaining exposure to the price movements of Bitcoin within the existing regulatory framework.
However, it's important to note that the availability and acceptance of Bitcoin ETNs can vary across different jurisdictions. Investors should consider the specific risks and regulatory environment of these products in their respective markets.

Yellow Capital

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The Bitcoin investment landscape is constantly evolving, with the debate between Bitcoin ETFs and Bitcoin ETNs being one of the highlights. While both investment products aim to expose investors to Bitcoin's price movements, they differ in structure, underlying holdings, and associated risks.
Bitcoin ETFs offer direct ownership of the underlying Bitcoin, making them more attractive for investors who seek long-term capital appreciation and direct exposure to the cryptocurrency. However, the approval and availability of Bitcoin ETFs still need to be improved in many jurisdictions.
On the other hand, Bitcoin ETNs provide a more accessible way to gain exposure to Bitcoin's price movements through a regulated debt instrument. However, they carry counterparty risk, and their performance may not perfectly track the underlying cryptocurrency.
Ultimately, the choice between a Bitcoin ETF and a Bitcoin ETN will depend on an investor's specific goals, risk tolerance, investment preferences, and the regulatory environment in their respective jurisdictions.

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