How ETFs are Created
ETFs are made through a creation and redemption process that takes place in the primary market - a market where all securities are created.
When a fund company decides to launch ETFs, they will work with a designated broker, which is typically a bank or securities dealer.
The designated broker facilitates the creation of ETFs by delivering, to the fund company that's managing the ETF, a basket of the underlying securities that make up the ETF. In return, the fund company will issue ETF units to the broker that can be sold to investors through the stock market (i.e. the secondary market).
The designated broker will also act as a Market Maker by buying and selling units on the stock exchanges as needed to help keep the trading prices close to the net asset value (NAV), and to keep a reasonable spread for the units (the difference between the bid and ask price, explained below).
If the designated broker runs out of ETF units, they can get more by delivering the basket of securities to the fund company and receiving additional ETF units. This happens when there's more demand for the ETF than supply.
But if there's more supply, a designated broker can "redeem" units by delivering ETF units to the fund company and receiving a basket of securities in return. This process reduces the number of units outstanding.
In practice, there's typically more than one designated broker for an ETF which helps to ensure the units are trading close to their true value (i.e. NAV).