One of the interesting aspects of any early stage innovation is that it is incredibly difficult to distinguish a breakthrough idea from a dud. At one point Twitter (TWTR) was considered a mere Internet curiosity, while the Segway was expected to revolutionize urban transportation. The proposed Bitcoin ETF is a classic case in point: If successful, it could make virtual currency trading more mainstream, which would be a breakthrough development. However, that success is currently not assured.

Nevertheless, the Bitcoin ETF is an important concept, so rather than speculating on its potential adoption, this article focuses on understanding the product itself. We address five fundamental questions about the proposed Bitcoin ETF:

1. What is the asset underlying the ETF?

Bitcoin is a virtual currency that can be stored and traded electronically. It is stored in a digital wallet and can be traded using a downloadable software (Bitcoin client) or through a third party provider. It is important to distinguish Bitcoin from payment systems like Paypal (EBAY) or Apple Pay (AAPL), which are ways to transfer a traditional currency (such as the US Dollar) electronically.

An important reason for the adoption for Bitcoin is that it is decentralized i.e. there is no central Bitcoin issuing or monitoring authority. Instead, every time a Bitcoin transaction is initiated, it must be validated by a Bitcoin miner. These miners are entities within the Bitcoin network that validate the transaction by solving a mathematical proof. Once the transaction is validated, the miner adds it to the record of previous Bitcoin transactions. This updated chain of completed Bitcoin transactions is called a Blockchain, which is publicly transmitted across the entire Bitcoin network. This system prevents double counting of existing Bitcoins and enables record keeping of all Bitcoin transactions.

In return for validating transactions, miners are rewarded with a transaction fee and new Bitcoins. So miners are effectively performing a dual function: they are validating transactions and facilitating the creation of new Bitcoins in a systematic manner. (A detailed explanation of Bitcoin mechanics is available on the Khan academy website)

The goal of the proposed ETF is to provide exposure to this asset and reflect Bitcoin price changes.

2. Who is launching the ETF and what is the current status?

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Understanding The Proposed Bitcoin ETF: 5 Key Questions