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A beginner’s guide to cryptocurrency ETFs
The 101 on bitcoin and cryptocurrency ETFs (exchange-traded funds)
Cryptocurrency has become quite a prominent asset that many investors are considering adding to their portfolio. That said, the blockchain market is associated with wild swings and extreme volatility.
If you want to speculate on the price of Bitcoin and other cryptocurrencies without actually buying any digital coins, cryptocurrency ETFs offer one way to do this. ETFs allow you to track the price of an underlying asset or index. This can be appealing, as investors are able to invest in a regulated stock company while still gaining exposure to assets like Bitcoin.
Though some options exist, as of 2021 cryptocurrency ETFs are yet to receive the official seal of approval from important global regulators such as the U.S. Securities and Exchange Commission (SEC). Keep reading to find out why.
Compare cryptocurrency ETFs
|ETF name||Offered by||Symbol||Type||Retail or wholesale?||Minimum investment||SEC-approved?|
|Bitcoin Tracker One||XBT Provider||COINXBT||Exchange-traded note||Retail||1 share||No|
|Bitcoin Tracker Euro||XBT Provider||COINXBE||Exchange-traded note||Retail||1 share||No|
|Ether Tracker One||XBT Provider||COINETH||Exchange-traded note||Retail||1 share||No|
|Ether Tracker Euro||XBT Provider||COINETHE||Exchange-traded note||Retail||1 share||No|
|HB10||Huobi Global||HB10||Index fund||Retail||~US$100||No|
|CoinJar Digital Currency Fund - Bitcoin Class||CoinJar||-||Index fund||Wholesale||AU$50,000||No|
|CoinJar Digital Currency Fund - Mixed Class||CoinJar||-||Index fund||Wholesale||AU$50,000||No|
|Coinbase Index Fund||Coinbase||CBIFS||Index fund||Wholesale||US$250,000||No|
|Bitcoin Investment Trust||Grayscale Investments||GBTC||Investment trust||Wholesale||US$50,000||No|
|Bitcoin Cash Investment Trust||Grayscale Investments||BCHFUND||Investment trust||Wholesale||US$25,000||No|
|Ethereum Investment Trust||Grayscale Investments||ETHFUND||Investment trust||Wholesale||US$25,000||No|
|Ethereum Classic Investment Trust||Grayscale Investments||ETCG||Investment trust||Wholesale||US$25,000||No|
|Litecoin Investment Trust||Grayscale Investments||LTCFUND||Investment trust||Wholesale||US$25,000||No|
|XRP Investment Trust||Grayscale Investments||XRPFUND||Investment trust||Wholesale||US$25,000||No|
|Zcash Investment Trust||Grayscale Investments||ZECFUND||Investment trust||Wholesale||US$25,000||No|
|Digital Large Cap Fund||Grayscale Investments||DLCFUND||Investment trust||Wholesale||US$50,000||No|
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 ASX200, 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.
As you might have already predicted, a cryptocurrency ETF designed to give investors exposure to the cryptocurrency market. Commonly referred to as blockchain ETFs, they track the price of one 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.
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 Bitcoin futures.Back to top
How do cryptocurrency ETFs work?
While buying and selling cryptocurrency is a lot easier today than it was just a couple of years ago, it can still be complicated and confusing for new users. Setting up and maintaining one or more digital wallets, understanding the difference between public and private keys, and dealing with the threats of hacking and theft are all significant barriers that crypto newcomers are faced with.
But cryptocurrency ETFs offer a way around these obstacles. When you invest in a crypto ETF, you don’t actually buy any cryptocurrency – instead, the ETF will be based on one of two approaches:
- Physical-backed crypto ETFs. Any digital coins the ETF is designed to track are owned by the fund itself, and you buy units or shares in the ETF. If the value of the digital coins owned by the ETF rises, the value of your investment unit also increases.
- Futures-backed crypto ETFs. With this type of ETF, shares in the fund aren’t based on actual coins but on Bitcoin 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 either bearish or bullish markets, while also eliminating the fund’s risk of having their crypto assets stolen or hacked.
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.
You’ll also need to pay a management fee to the ETF issuer, but ETFs generally have lower fees compared to traditional managed funds (like a hedge fund).
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 five 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 five cryptocurrencies individually, you would have needed to create one 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.
The history of crypto ETFs
The history of cryptocurrency ETFs has been brief but controversial. Throughout 2021 there’s been a fair bit of media coverage focused on the efforts of multiple ETF providers to get the U.S. Securities and Exchange Commission (SEC) to approve their proposals for a crypto-based ETF.
As of August 2021, the SEC is yet 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.
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.
The SEC ruled against a further crypto ETF application, a joint venture between investment firm VanEck and fintech company SolidX, on 29 December 2018. VanEck still hasn’t given up hope though, and it seems in 2021 that regulators in the SEC are finally beginning to change their tune and demonstrate a willingness to accept blockchain-based ETFs. At this point it seems not a matter of “if”, but “when” such funds will be legalised. If crypto ETFs can receive approval from the SEC and are launched in the US, this could mean a step forward in cryptocurrency’s battle for widespread 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
What are my Bitcoin ETF options?
If the right ETF isn’t available on your stock exchange, there are several options available from the following providers:
How to invest in a cryptocurrency ETF
ETFs are traditionally designed to be bought and sold on securities exchanges, which means you can trade them via your regular online brokerage account. You may wish to sign up for an online trading account through your regular financial institution, or open an account with a specialist broker.
However, with exchanges like Huobi and OKEx launching their own index funds, you may need to register for an account on the relevant crypto exchange in order to access them.
Finally, if you’re interested in the potential of the technology behind blockchain, you may also want to consider ETFs focused on blockchain companies. Blockchain technology is one of the key innovations introduced by Bitcoin and closely associated with the wider cryptocurrency industry, so it may be worth researching tech-focused ETFs and whether they provide any exposure to blockchain-related investments.
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 confusing and daunting process. ETFs make it simple to gain exposure to digital currencies without going through the hassle of owning any coins.
- Create a diverse portfolio. The compartmentalised nature of the crypto industry means that acquiring and holding a large collection of currencies all at once is complicated and time-consuming. You may have to open several wallets and maintain accounts on multiple crypto exchanges. However, cryptocurrency ETFs allow you to track multiple digital coins and tokens all at once, saving you a whole lot of time and effort.
- Avoid the risk of hacking. 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.
- Lower fees. ETFs generally have lower fees than traditional managed funds, making it possible to build a diversified portfolio at reduced expense.
- Limited choice. There’s currently limited choice available for anyone wanting to invest in cryptocurrency-related ETFs. However, if the SEC approves any of the crypto ETF applications currently under consideration, that could soon change.
- 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 of risk. 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 (such as XBT Provider’s funds), be aware that foreign tax may apply.
Disclosure: At the time of writing the author holds ADA, ICX, IOTA and XLM.
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