ETFs 101: Could They Change the Entire Scope of Crypto Investments?

Beginner’s Guide / 23.05.2020

Predicting the price of cryptocurrencies is challenging, thanks to their volatile nature. Consider bitcoin’s volatility, which has seen the coin fluctuate between $3,000 – $20,000 over the last three years. The uncertainty and volatility are perhaps significant reasons why investors shy away from digital assets.

Given that there is a growing increase in digital assets investments, finding a solution is vital. Exchange-Traded Fund (EFTs) come in at this point and could be instrumental in crypto investing

So, could ETFs revolutionize crypto investing? In this article, we highlight what role they have played so far and how they could benefit investors. 

Exchange-Traded Funds

An Exchange-Traded Fund (ETF) refers to a collection of securities that can be bought and sold through an exchange, and help track an underlying index. This includes securities like stocks, bonds, and commodities. ETFs give traders a better way to trade assets without having to buy all the components individually. 

ETF involves two main actors. ETF owner and investor. An ETF owner/provider is the owner of the assets. They design the fund to track the performance and later sell shares in that fund to investors.

ETFs are particularly relevant to investors as they take mutual fund investing to another level. They offer lower costs, flexibility, transparency in trading, and tax efficiency for taxable accounts. 

Crypto Exchange-Traded Funds

Crypto ETFs are funds that track the performance of cryptocurrencies such as bitcoin futures through holding the primary crypto-assets. Commonly known as bitcoin ETFs, crypto EFTs provide exposure to crypto price movements to minimize risks associated with owning a digital currency. 

A crypto ETF tracks the price of digital currency by purchasing and storing the coin and then dividing shares in the coins’ ownership among stakeholders.

Unlike ETFs, which allow investors to track the price of an underlying index, crypto ETFs present a certain level of expenses and risks. For example, if we consider the prices of bitcoin and given proposals like VanEck SolidX ETF application, which holds 25 BTC per share, crypto ETFs can be quite expensive to retailers.

According to Joshua Gnaizda, founder of Crypto Fund Research, “Keys (used to access bitcoin holdings) not in cold storage can be hacked, private keys can be lost, and stolen money be moved nearly anonymously.” Crypto ETFs are, therefore, riskier than other EFTs.

At its core, the idea behind crypto ETF is to combine traditional ETF with the most popular crypto assets. This strategy provides a legitimate and easier way to invest the price of bitcoin or other cryptocurrencies that are accessible on markets familiar to the investors. 

How Do Crypto ETFs Work?

Investing in ETFs is safest since it doesn’t involve any digital wallets. Investing in crypto ETF does not necessarily mean buying it. Instead, it is based on the following strategies:

  • Physical-backed ETFs

Here, the fund (investment management firm) owns the coin that ETF tracks. The fund creates small-sized shares from the coins and sells them to investors. Meaning, an increase in the value of the fund’s currency equates to a rise in the units’ value owned by the trader. Consequently, if the value of bitcoin falls, then the value of the trader’s shares will decrease.

  • Futures-backed ETFs

Here, shares are not based on the actual bitcoins. Instead, they are based on the Bitcoin futures contracts. It takes the form of an agreement with a fixed date and price to buy and sell Bitcoins. Investors make a profit when prices fluctuate. Interestingly, this strategy is more preferred than the physically-backed EFTs, according to CoinDesk.

Benefits of Crypto ETFs

  • Easy to Invest 

Crypto ETFs provide an easier way to invest in cryptocurrency for anyone regardless of your technological know-how.

  • Shares ownership easier than Bitcoin outright

Bitcoin outright requires that you self-track your capital gains. With ETFs, however, you neither have to store your keys and wallet nor worry about self-tracking your capital gains.

  • Increased confidence among investors 

If legalized, Bitcoin ETFs may become the leading investors’ attraction into a somewhat ‘suspect’ industry as they come fully regulated. This is also true with improved tax implications that come with trading ETFs.

Risks of Crypto EFTs

  • Volatility

Cryptocurrencies are known for their volatile nature and substantial price fluctuations in a short period. This puts your crypto EFT at risk of losing value if the market moves against you.

  • Lack of risk diversification. 

Unlike other ETFs that include a range of securities to help achieve risk diversification, crypto ETFs provide access to a limited range of digital currencies.

State of Crypto ETFs in the US

The US security and exchanges commission (SEC) has rejected at least 9 Bitcoin ETF applications. These include apps from Direxion and Bitwise Asset Management, VanEck/SolidX.  

The battle between the SEC and Bitcoin ETF enthusiasts began in July 2013 when the Winklevoss twins, Tyler and Cameron, sought approval to launch the Winklevoss Bitcoin Trust. After five years of legal battle, their second application was rejected in July 2018.

The long road toward crypto ETFs being approved by the SEC took its latest turn on Aug. 2, 2019, when the commission once again delayed its decision on three ETF proposals by asset managers, Bitwise Asset Management, VanEck/SolidX, and Wilshire Phoenix.

Currently, there is no investable Crypto ETF on United States exchanges. There are, however, bitcoin ETF financial products available on OTC Bitcoin Trust and in European exchanges, including Bitcoin ETN and Bitcoin Investment Trust.

Final Word

As the cryptocurrency industry matures and the efficiency and security of EFT trading improves, there are all reasons to vouch for the listing of crypto ETFs on significant exchanges worldwide.

While the SEC has so far rejected several proposals for crypto ETFs, conceding approval would have a significant impact. In essence, these funds could bolster adoption by opening up Bitcoin investments to the public while promoting considerable legitimacy for digital currency. 

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Born in Bucharest, Marius is the founder of Crypto Adventure. Since his first contact with Bitcoin and cryptocurrencies, he never stopped believing that they are one of the most important innovations of our time, which will forever change the way business is done.