A beginner’s guide to Bitcoin and cryptocurrency ETFs
ETFs give you a convenient way of investing in cryptocurrency, but they may not be the most cost-effective.
If you want to invest or speculate on the price of cryptocurrencies without actually buying any digital coins, buying units in cryptocurrency ETFs offer a way to do this.
ETFs allow you to track the price of an underlying asset or index, such as the price of a single cryptocurrency or a "basket" of several tokens – a convenient way of diversifying your portfolio. They also remove some of the barriers to entry, such as using a cryptocurrency exchange or learning how to store crypto safely. Another appeal is that ETFs are tightly regulated and offered through traditional platforms such as stock exchanges, including NASDAQ and the Toronto Stock Exchange.
Throughout cryptocurrency's history, ETFs have had a difficult time, with little support from regulatory bodies around the world. The US Securities and Exchange Commission (SEC) and other government regulators have typically rejected applications for Bitcoin-based ETFs. Because of this, there hasn't been a breadth of options for investing in such an index.
However, after years of lobbying, the SEC finally greenlighted official Bitcoin exchange-traded funds in October 2021. This was a significant development due to the globally available nature of US markets, which are typically accessible to investors in most parts of the world, while other local markets are not. The approval by the SEC has triggered a wave of applications for new cryptocurrency ETFs which are likely to expand beyond Bitcoin into other cryptocurrencies.
What is a cryptocurrency ETF?
An ETF is a collection (often called a "basket") of assets that can be bought and sold on a stock market the same way investors can trade ordinary shares in a company. ETFs are investment funds designed to track the performance of a particular index, such as the NASDAQ 100's QQQ, or a specific commodity or asset.
For example, a gold ETF allows you to invest in the value of gold without ever having to own any gold or find somewhere to store it.
Cryptocurrency ETFs are designed to give investors exposure to the cryptocurrency market. These indexes track the price of 1 or more digital coins or tokens. This lets investors add the value of crypto to their portfolio without some of the risks associated with actually owning any digital currency. Some of these risks include:
- Custody. While the vast majority of cryptocurrency exchanges hold funds on your behalf, some users are still nervous about the storage of cryptocurrencies. This may be due to the long history of exchange hacks, or a misunderstanding that they need to manage the coins themselves.
- Regulation. Most cryptocurrency exchanges are unregulated, although an increasing number are choosing to obtain relevant licensing. Despite this, user funds in most countries are not protected by the same protections as money in a bank account or stock trading platform.
- Mistakes. Cryptocurrencies are unforgiving – send funds to the wrong address and they are likely lost forever. While investors don't need to move cryptocurrencies from one address to another, the reputation for difficulty is still off-putting.
Cryptocurrency ETFs largely avoid most of these risks by taking custody of funds on behalf of investors and packaging them into a highly-regulated investment, which is served through traditional outlets, such as stock brokers.
The simplest way for a crypto ETF to track the price of a digital currency is for the ETF company to purchase and store that crypto, and then divide shares in the ownership of those coins between stakeholders. However, another model is for the fund to own futures contracts. These contracts allow investors to essentially "bet" on whether they think the price of a given cryptocurrency will rise or fall in a set period of time. Futures-based cryptocurrency ETFs were the first type to be approved by the SEC.Back to top
How do cryptocurrency ETFs work?
Broadly speaking, there are 3 types of cryptocurrency ETFs:
Physical-backed crypto ETFs
These hold actual coins and tokens which underpin the value of the ETF. If the value of the digital coins owned by the ETF rises, the value of your investment unit also increases.
- Pros. The most direct way of investing in crypto via an ETF, as the fund essentially just holds coins on your behalf. A good proxy for people who cannot or do not want to own actual coins.
- Cons. Still not as good as the real thing, with the ETF prices frequently lagging behind the market and trading restricted to market hours (unlike actual crypto which trades 24/7). Availability is also limited depending on what markets you have access to. For instance, in Canada retail customers can purchase physical ETFs, but in the US they are regulated to accredited investors.
Futures-backed crypto ETFs
With this type of ETF, shares in the fund aren't based on actual coins but on futures contracts. A futures contract is an agreement that sets a fixed price and date for buying or selling an asset. As a result, they potentially allow investors to profit in both bearish or bullish markets (depending on the specifics of the fund). Futures-backed ETFs are typically used when holding the underlying asset would be problematic, such as storing barrels of oil, or safely securing cryptocurrency.
- Pros. This type of ETF is the first to receive approval for retail customers in the US. The fund is not directly exposed to the risks associated with storing cryptocurrency.
- Cons. Expensive compared to a physical ETF or real crypto. On top of the ETF management fees is the risk of contango, where futures contracts cost more than the underlying asset. This can cause futures-based ETFs to trade at a premium compared to the spot market, making them worse value for money than purchasing actual coins.
Stocks-based crypto ETFs
This type of ETF is quite different to the others as it is based on stocks of cryptocurrency or blockchain-related companies. The idea is to give exposure to the wider blockchain industry (the technology behind most cryptocurrencies) through a basket of stocks. For instance, the Bitwise Crypto Industry Innovators ETF is made up of publicly traded exchanges (Coinbase, Robinhood), hedge funds (Galaxy Digital), mining firms (Hut 8) and companies that hold crypto in their treasury (MicroStrategy, Tesla).
- Pros. A convenient way of gaining exposure to the wider industry through a mixture of companies. Likely less volatile than ETFs that track cryptocurrency prices and less overall risk.
- Cons. Less volatility also means less room for growth, compared to cryptocurrency-based ETFs. The cryptocurrency industry is still in the midst of regulation around the globe, which could negatively impact the prospects of some of the companies listed in these ETFs.
ETF units can be bought and sold on securities exchange markets, but brokerage fees apply. Just like shares traded on an exchange, the price of an ETF fluctuates throughout the day as investors buy and sell units. Keep in mind that ETFs only trade during market hours, while cryptocurrency trades 24/7. This can lead to a discrepancy between the price of the fund and the spot market.
You'll also need to pay a management fee to the ETF issuer, but this is included in the unit price. ETFs generally have lower fees compared to traditional managed funds (like a hedge fund), but higher than the cryptocurrency spot market.
Case study: How crypto ETFs work
To help you understand ETFs a little better, let's take a look at a hypothetical example.
The company that issues the ETF owns a specified amount of each of the 5 currencies, and the ownership of these tokens is divided into shares. Investors then buy and sell those ETF shares on stock exchanges in the hope of benefiting from price increases to the underlying digital currencies.
Let's assume that the value of 1 unit of XYZ ETF is $50, and you decide to purchase 10 units for a total of $500. After 12 months of growth for global crypto markets, the XYZ ETF unit price has risen to $100, meaning your total investment is now valued at $1,000.
Had you taken a more traditional approach and decided to buy each of the 5 cryptocurrencies individually, you would have needed to create 1 or more wallets, registered for an account on a crypto exchange, paid brokerage fees for each individual crypto trade, and then tracked the price movements of each coin across the past year.
But with a cryptocurrency ETF, it's easier and far less time-consuming to gain access to a diverse portfolio of crypto assets.
Benefits vs risks of Bitcoin ETFs
Just like any other type of investment, cryptocurrency ETFs have a range of pros and cons. It's essential that you weigh up the potential benefits against the risks involved before deciding whether you should invest in any crypto ETF.
- Simplicity. Learning how to buy and store cryptocurrency can be a difficult or nerve-racking process for some. ETFs make it simple to gain exposure to digital currencies without going through the hassle of owning any coins.
- Accessibility. An increasing number of cryptocurrency ETFs are available through traditional stock brokers and exchanges. In addition to making them easy to access, they also come with the legal and regulatory protections associated with such services.
- Diversification. Some ETFs offer a basket of various cryptocurrencies which streamlines the process of building a diverse portfolio. It prevents the need to purchase several currencies, which could involve multiple exchange accounts, wallets and technical understanding.
- Security. Cryptocurrency exchanges and wallets are susceptible to hacking attacks and theft. Buying units in a crypto ETF protects you against these risks as you don't actually own any digital coins.
- Limited choice. There's currently limited choice available for anyone wanting to invest in cryptocurrency-related ETFs, although this is rapidly changing. The world's most accessible ETF market, the United States, finally approved cryptocurrency-based ETFs in late 2021. It is likely that more ETF options will follow, but in globally accessible US markets as well as more local options.
- Volatility. Cryptocurrencies are famous for their volatility and can experience substantial price fluctuations in a short space of time. If the market moves against you, the value of your crypto ETF units could take a sharp dive.
- Lack of risk diversification. Traditional ETFs often include an extensive range of securities to help achieve diversification. They sometimes include government bonds and debt to mitigate market risk. However, most versions of crypto ETFs only provide access to a limited range of digital currencies. When you also consider the correlation between the performance of Bitcoin and the value of altcoins, this only increases the level of risk.
- Crypto-specific risks still apply. Just because you don't have to deal with any of the risks of owning digital currency, that doesn't mean these risks cease to exist. Issues such as hacking will still need to be managed by the ETF provider.
- Fees apply. On top of an annual management fee, you'll need to consider brokerage fees that apply when you buy or sell ETF units.
- International taxes. If you buy ETF units located in another country be aware that foreign tax may apply.
Should you invest in an ETF or real crypto?
Cryptocurrency ETFs are best suited to people who want exposure to cryptocurrency markets, but do not want to or cannot own real cryptocurrency for various reasons.
This is because purchasing cryptocurrency directly, through a specialised cryptocurrency exchange or broker, is more cost-effective than investing via an ETF.
- In addition to brokerage fees, which are typically higher than cryptocurrency exchanges, ETFs charge a management fee on top which is included in the unit price of the ETF.
- They can only be traded during market hours – unlike crypto exchanges which operate 24/7. This means that the ETF will always lag behind the market, and prevent traders from capitalising on price swings outside market hours.
As such, ETFs are more suited to people looking for a long-term buy and hold investment rather than something to actively trade.
That being said, if you want to invest in cryptocurrency markets without the responsibility of owning the actual coins or dealing with multiple exchanges or wallets, then ETFs are one option.
If you simply want to invest in coins in the hope the price rises, then a physically-backed ETF is likely what you want.
Alternatively, if you are a more experienced investor with a deeper understanding of markets, including futures, then you may want to explore a futures-backed ETF.
Lastly, if you are not interested in any specific coins, but are bullish on the sector in general, then a stocks-backed ETF could be a great way to diversify your investments across the whole market. Stocks-backed ETFs are also a way for the most die-hard of cryptocurrency investors to diversify their portfolio and gain exposure to sectors such as mining.
Compare cryptocurrency ETFs
How to invest in a cryptocurrency ETF
You essentially have 3 main avenues for investing in a crypto ETF, each with their own pros and cons. Keep in mind various ETFs are spread out over a number of providers, from brokers to privately managed funds. As such you will need to consider which markets you have access to when deciding on an ETF, in addition to the assets you actually want exposure to.
Other ways to invest in cryptocurrency without buying coins
There are several other ways to invest in cryptocurrency without purchasing the actual coins and tokens.
Contracts for Difference (CFDs) are a popular way of investing in almost any asset, as they simply track the price of the underlying asset, rather than representing ownership of the real thing. CFDs allow you to go long or short, with many CFD platforms also offering leverage.Where to trade cryptocurrency CFDs
Derivatives include things like futures contracts, options and CFDs which track the price of an underlying asset, such as Bitcoin or Ethereum. Futures and options are typically used to speculate on the future price of an asset. As such, they are better utilised in the hands of experienced traders rather than novice investors.How to trade cryptocurrency futures
There is a wide range of publicly traded companies with exposure to cryptocurrency. These range from dedicated services such as cryptocurrency exchanges and mining companies, to investment funds, right through to loosely affiliated companies that use blockchain technology or have part of their treasury in cryptocurrencies.
Some of the more popular cryptocurrency stocks that are also included in stock-based ETFs include:
- Coinbase (exchange)
- Robinhood (trading platform)
- Galaxy Digital (hedge fund)
- Riot Blockchain (mining)
- Hut 8 (mining)
- MicroStrategy (holds a portion of its treasury in Bitcoin)
- Tesla (holds a portion of its treasury in Bitcoin)
The history of cryptocurrency and Bitcoin ETFs
The history of cryptocurrency ETFs really depends on where in the world you are looking, although much of the hype is concentrated around the US market.
The first wave of cryptocurrency ETFs came out of Europe, with the CoinShares Bitcoin Tracker One in 2015 becoming the first publicly traded Bitcoin ETF. More recently, Canada became the first market in the Americas to launch a physical Bitcoin ETF, with the launch of the Purpose Bitcoin ETF (BTCC) on the Toronto Stock Exchange in February 2021.
Despite dozens of applications over the years, the US Securities and Exchange Commission (SEC) refused to approve Bitcoin or cryptocurrency ETFs, citing security concerns. It has rejected several crypto ETF proposals in the past, notably shutting down applications from the Winklevoss twins in 2017 and 2018, and a venture between VanEck and fintech company SolidX, in late 2018.
The following statement has been included in the vast majority of SEC rejections:
...the Commission is disapproving this proposed rule change because, as discussed below, the exchange has not met its burden under the Exchange Act and the Commission's Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange's rules be designed to prevent fraudulent and manipulative acts and practices.
In 2021, regulators in the SEC finally began to change their tune and demonstrate a willingness to accept crypto-based ETFs. This culminated in the SEC approving and listing BITO – ProShares' Bitcoin Strategy ETF – on public stock exchanges in October 2021. This was the first ever SEC-accepted Bitcoin ETF in America. Speaking with Finder, Sarah Bergstrand, COO of Bitbull Capital, said the long-awaited approval will "give BTC the additional validation and regulatory support it needs as an alternative investment asset class".
Achieving regulatory success is a big step forward for the cryptocurrency industry and may have an impact on wider adoption. Properly regulated and professionally managed ETFs could represent a safer option for investors concerned about the risks of buying digital currency, plus help bridge the gap between the world of crypto exchanges and more traditional investment tools.Back to top
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