Cryptocurrency exchange traded funds (ETFs) are a type of investment fund that tracks the performance of one or a basket of cryptocurrencies. Similar to traditional ETFs, a crypto ETF is traded on exchanges and offers a convenient way to get exposure to the crypto market without holding cryptocurrencies directly.
Both traditional stock ETFs and crypto ETFs are designed to track the performance of an underlying asset. In the case of stock ETFs, they track the price movements of a basket of company shares, while crypto ETFs track the performance of various cryptocurrencies.
Both ETFs are traded on stock exchanges, offering investors a more convenient way to gain exposure to the underlying assets without holding the assets directly.
Despite these similarities, there are some differences between the two. The underlying assets for crypto ETFs are digital currencies, which can be more volatile and complex than traditional stocks. This leads to unique risk factors. Additionally, the regulatory landscape for crypto ETFs is less established. Regulators in many countries are still working toward drafting rules for this emerging new asset class.
Moreover, settlement and custody for digital assets have unique technical requirements compared to traditional stocks. Crypto ETF operators need secure storage solutions like cold storage to protect against potential cyberattacks.
There are two primary types of cryptocurrency ETFs.
The first type are physically-backed cryptocurrency ETFs, also known as spot ETFs. An investment firm that manages the ETF purchases and holds the cryptocurrencies themselves. When investors buy shares in these ETFs, they indirectly own the underlying cryptocurrencies, gaining exposure without the need to buy and manage individual coins.
The first spot Bitcoin ETF was listed on August 15, 2023 in Europe, and numerous other spot Bitcoin ETFs are pending approval elsewhere.
Physically-backed crypto ETFs come with several pros and cons:
Pros:
Easier to get exposure to cryptocurrencies
Compliant with financial regulations
The ETF operator is responsible for the security, storage and tracking of the underlying crypto
Cons:
Management fees could reduce overall returns
Potential tracking errors by management fund
Limited cryptocurrency options for physically-backed ETFs
The second type is known as synthetic crypto ETFs. They track cryptocurrency derivatives like crypto futures and exchange traded products (ETPs). For instance, a Bitcoin Futures ETF is a type of synthetic crypto ETF.
In synthetic ETFs, the share price moves in tandem with the derivative instrument's price rather than the actual cryptocurrency's value. Nevertheless, the price would eventually move towards the spot price as the settlement date approaches.
These ETFs carry additional risks due to their reliance on derivatives and potentially lower transparency in their operations.
Crypto ETFs offer several advantages to investors interested in the cryptocurrency market.
Firstly, they provide a convenient way to obtain exposure to a range of digital assets, removing the technical requirements associated with directly buying and managing individual cryptocurrencies.
Secondly, ETFs are integrated within the conventional financial framework, allowing investors to diversify their portfolios through familiar platforms like retirement plans and individual brokerage accounts.
Lastly, crypto ETFs remove the steep learning curve required for investing in cryptocurrency by relying on the analysts who trade for you. There is no need to learn all the cryptocurrency jargon and technicalities of blockchain. It allows investors to capture the potential upside while avoiding the complexities associated.