The vast cryptocurrency with over 9,000 cryptocurrencies, owning and holding these tokens seems a major concern. Crypto ETFs can help with this concern. The cryptocurrency exchange-traded funds provide you with exposure to cryptocurrency without needing to directly hold any digital currency, allowing traders to buy and sell their shares. Like the other funds, crypto ETPs are easily accessible through major stock exchanges and traditional brokerage accounts. The rapidly growing ETFs are a type of exchange-traded product (ETP).
What are Cryptocurrency Exchange-Traded Funds?
Cryptocurrency exchange-traded funds (ETFs) monitor the cost-benefit analysis of different cryptocurrencies by focusing their portfolio on specific instruments. The ETFs, which are investment funds that trade on stock exchanges, allow their investors to buy assets or shares such as stocks, bonds, etc. without the need to purchase these assets directly themselves. The ETFs launched a new investment option called spot crypto ETFs, which allows investors to provide them with direct holdings of bitcoin by buying shares rather than derivatives like future contracts.
This represents a departure from the past practice of crypto ETFs that were focused on bitcoin futures rather than the actual bitcoin. For about a decade, the US Securities and Exchange Commission (SEC) had resisted approving such spot bitcoin ETFs due to concerns about market manipulation and investor protection. However, a 2023 ruling from the DC Circuit Court of Appeals put pressure on the SEC, leading to the authorization of the first spot crypto ETFs in early 2024.
These investments provide direct exposure to the retail traders to the prices without direct asset ownership. This enables the traders to observe the cryptocurrency prices without exchange transactions or directly having to own a digital asset. This may cost you a bigger amount than the other ETFs, and there are no oversights that will be available in the crypto industry, and the funds are regulated by themselves, unlike the other ETFs. These features of crypto ETFs make it harder to prevent fraud activities and to uphold fair market standards and practices while trading.
The working of crypto ETF
Normal ETFs typically mirror the market indexes by holding a collection of base assets and securities. In contrast, crypto ETFs employ multiple tracking strategies for digital currencies. Other crypto ETFs invest in future contracts to buy or sell crypto at set dates and prices. Due to their portfolio composition, these ETFs’ share prices track changes in derivative prices rather than the underlying assets themselves. As a result, the share price of a cryptocurrency ETF fluctuates in tandem with crypto future contract prices.
However, synthetic cryptocurrency ETFs carry an additional layer of risk due to limited regulatory oversight and valuation uncertainties inert in the crypto exchanges from which they derive their pricing. Despite initial reluctance, US regulators have gradually warmed up to cryptocurrency ETFs. After rejecting over 20 spot ETF proposals between 2018 and 2023, the SEC approved the first crypto futures ETFs in October 2021. Moreover, in January 2024, the SEC greenlit the first spot crypto ETFs for the US market. Meanwhile, European and Canadian investors have had access to crypto EFs for years, which shows you the differences in regulatory approaches across regions.
How the crypto future ETFs work?
The ProShares bitcoin strategy ETF, the first crypto ETF in the US, offers a manifold example of how crypto futures ETFs operate. By allocating its portfolio evenly between Chicago Mercantile Exchange (CME) bitcoin futures contracts expiring at the end of the current month and those expiring the following month, the fund effectively tracks bitcoin price movements while managing roll costs and expiration risks. As futures contracts in the portfolio approach expiration, the fund executes and rolls over, selling expiring contracts and purchasing new ones for the upcoming month. This process incurs costs, including roll costs and potential price disparities between expiring and new contracts. Consequently, the ETF’s performance may deviate from its underlying cryptocurrency, resulting in a tracking error.
ProShares expands its cryptocurrency with the ether strategy ETF (EETH), an ether futures ETF mirroring its bitcoin counterpart. EETH tracks ether’s price movements using future contracts, providing investors with exposure to the second-largest cryptocurrency. ProShare also offers ETFs that are combined with bitcoin and ether, using equal weighting or market capitalization-based indexing inverse ETFs, such as ProShare’s short bitcoin strategy ETF, which utilizes futures contracts to provide inverse exposure to bitcoin’s performance, enabling investors to benefit from downward price movements in the cryptocurrency market.
Spot cryptocurrency ETFs
Spot crypto ETFs provide investors with direct exposure to cryptocurrencies, offering a simplified investment experience. These funds buy and securitize cryptocurrencies, enabling shareholders to own and benefit from the price movements indirectly. With the ability to issue and redeem shares, spot crypto ETFs to retail and institutional investors looking for crypto exposure. Beginning in 2014, asset managers pursued SEC approval for spot bitcoin ETFs. Following a surge in interest, the SEC received over 3500 crypto-related fund applications between October 2022 and October 2023. In a significant milestone, the SEC approved the first 11 spot bitcoin ETFs in January 2024. Later in May 2024, the SEC also approved the spot ether ETFs along with the concerns they have about Ethereum’s features on staking, which allows the shareholders to generate revenue by locking up their tokens to verify transaction authenticity on the network. There was confusion on how staking rewards should be taxed on reports.
Pros of crypto ETFs
- The key benefit of ETFs is the exposure that the trader will be able to access without the need for ownership. There isn’t the risk of owning and holding these ETFs; there will only be custody charges or an annual fee.
- Despite growing interest, cryptocurrency jargon remains a significant barrier to adoption. The technical terminology, rooted in its technological underpinnings, can overwhelm average investors. Unfamiliarity with networking technology and concepts like halving, blockchain, and mining creates a steep learning curve. However, investing in a cryptocurrency ETF offers a more accessible entry point.
- Cryptocurrency security concerns have long plagued the industry, with high-profile hacks on exchanges, storage devices, wallets, and vulnerable blockchains. For individual investors, ensuring the security of their digital assets can be a daunting task, requiring specialized knowledge and expertise. However, cryptocurrency ETFs offer a secure solution. By investing in an ETF, individuals can use professional asset management, security protocols, and regulatory oversight, mitigating the risk of hacks and breaches.
- The cryptocurrency market consists of more than 9,000 options, but choosing from this vast selection can be daunting. With the fragmented exchanges, country-specific restrictions, and additional fees, buying and selling cryptocurrencies can be complex and costly. However, in cryptocurrency ETFs, individuals can tap into a different crypto of their choice without shouldering the burdens of token exchanges, excessive fees, and geographic restrictions. This convenience and cost-effectiveness make investing easier.
Cons of ETFs
- Cryptocurrency ETFs don’t always mirror the price movements of their underlying digital tokens. This divergence is particularly pronounced in the ETFs that rely on futures contracts to track cryptocurrencies. As these contracts expire, ETF managers must roll over their positions, which can lead to tracking errors, contango, and backwardation. These can result in higher costs and reduced investment returns.
- Even though the ETFs eliminate the cost of having ownership of a digital currency and a wallet, they consist of their fees, which can be higher as they are actively managing the crypto ETFs than other ETFs.
- Cryptocurrency ETFs are still cryptocurrencies and can undergo various price fluctuations.
- Even though it is convenient for you to not have direct ownership of these cryptocurrencies, you wouldn’t have any control or access to the cryptocurrency. Owning a cryptocurrency and cryptocurrency ETF can be a very different experience. While ETFs provide regulated exposure to digital assets, they don’t offer the same decentralization and anonymity benefits that a cryptocurrency provides you with. ETF shareholders are subjected to centralized management, regulatory oversight, and disclosure requirements, whereas direct cryptocurrency owners get to experience decentralized control, pseudonymity, and direct asset ownership.
Conclusion
Cryptocurrency ETFs provide retail investors with a convenient and accessible way to participate in the digital cryptocurrency market. By providing exposure to a variety portfolio of cryptocurrencies, these funds bridge the gap between traditional investing and the new world of digital assets. However, investors must exercise caution, as cryptocurrency ETFs come with a unique risk and are much more expensive than ETFs, containing management fees, tracking errors, liquidity risks, and regulatory uncertainties. There are many risks involved.