With regulatory bodies rumored to soon accept a pure Bitcoin (BTC)-backed exchange-traded fund, it is important to understand the journey of some of the first crypto-based ETFs that have recently been approved by government agencies.

The United States Securities and Exchange Commission approved a Bitcoin-adjacent ETF, giving investors the opportunity to gain exposure to Bitcoin through the stock markets, and the most recent acceptance was that of the ProShares Bitcoin Strategy ETF, which started trading on NYSE Arca on Oct. 19.

It's important to note that the aforementioned exchange-traded funds are not pure-crypto ETFs and merely track either crypto-related company stocks or futures contracts.

The SEC has yet to approve a pure-crypto ETF, unlike Canada back in the spring when regulators approved three Ether (ETH)-based ETFs from three different firms: Purpose Investments, Evolve ETFs and CI Global Asset Management.

Despite the good news of regulators beginning to accept crypto ETFs, many questions remain about why there have been so many challenges in listing them. This fall, there has been a lot of anticipation and speculation around what ETFs are exactly and how they can boost — or hinder — the crypto market as a whole. Here are the issues, challenges and possible future of crypto-backed exchange-traded funds.

Regulatory mismatch

Exchange-traded funds, in general, are investment funds that track a basket of assets on the stock market and can be traded in the same manner as regular stocks.

While there are ETFs for just about any asset, the problem with crypto is that there is still uncertainty among regulators about how to define Bitcoin and other cryptocurrencies, and how to protect consumers against risk exposure. Those issues could present a challenge as pure-crypto ETFs begin to appear on stock markets, as not having regulatory clarity could cause problems with regulation across various national bodies and around the world.

The various financial regulatory agencies of the United States, for example, all have different — sometimes conflicting — views on what cryptocurrencies are, especially when it comes to taxation and trading.

In 2020, France’s principal financial regulator, the Autorite des Marches Financiers (AMF), responded to the European Commission’s guidance on so-called “crypto assets,” stating that it is still too early to explicitly define them. A spokesperson told Cointelegraph at the time:

“The AMF considers that giving a precise classification applied to crypto-assets could be premature at this stage. It is only after solid feedback that we will be able to judge the relevance of a precise classification (e.g. ‘utility tokens’, ‘security tokens’, ‘payment tokens’, ‘stablecoins’ etc.).”

French fund manager Melanion had its Bitcoin-adjacent ETF recently approved, with hopes to have its shares track the price of Bitcoin, first in the French market and soon in many other markets around Europe.

Cointelegraph reached out to Jad Comair, founder and chief inv officer of Melanion, who mentioned that because it is not possible in the European market to directly expose investors to Bitcoin via the Undertakings for Collective Investment in Transferable Securities (UCITS) framework — which is “a format used by 99% of the ETFs listed in Europe” — the firm had to get smart and create “a world unique index construction methodology that measures companies’ Bitcoin exposure.”

This means that the ETF tracks the stocks of companies that invest in Bitcoin, mine Bitcoin or are otherwise involved in the crypto market, but it doesn’t contain Bitcoin itself. “The index selects the most exposed companies to Bitcoin, and weighs them according to their historical correlation (beta) to Bitcoin’s performance,” said Comair.

Fears vs. risks?

There still could be risks involved with highly volatile assets like cryptocurrencies, especially with a futures-backed Bitcoin ETF.

Bitcoin futures ETFs track a basket of futures contracts rather than Bitcoin itself. Since the futures price of Bitcoin may differ from the spot price, there is a possibility that the ETF may not accurately track the price of Bitcoin, exposing the ETF holder to some risk.

The term “contango” refers to when the futures price is higher than the spot price, while “backwardation” is when the futures price is lower than the spot price.

Related: Crypto breaks Wall Street’s ETF barrier: A watershed moment or stopgap?

Moreover, this high volatility means that regulators could move to implement more investor protection, especially after seeing the jumps that the crypto market has experienced in the past six months. This brings forth the question:

Could an exchange-traded fund help mitigate the risks that come with volatility?

With the fresh acceptance and implementation of crypto futures ETFs — the most recent model now trading on the New York Stock Exchange — this could “open the doors for the ‘real’ money to step in, as, for the time being, the existing Bitcoin products are eligible for small investment pockets, and Bitcoin itself is very complicated to put in a regular portfolio,” Comair stated. More serious exposure to the markets, even if via companies investing in Bitcoin, could push the market into explosion and/or stability.

It is possible that the changes in the crypto market could push for more ETF acceptance as the stock market learns how to interact with the crypto market — and vice versa. With ETFs tracking companies investing in crypto and the onset of futures-based crypto ETFs, could this lead to more widespread adoption of crypto investing as a whole?