The cryptocurrency market has gained immense popularity, but owning and managing cryptocurrencies, also known as digital assets, can be complicated and overwhelming. Crypto ETFs offer a simpler alternative, enabling investors to engage with the cryptocurrency market without the challenges of managing individual cryptocurrencies, of which there are many.
This guide will provide you with the information you need to confidently navigate the exciting—and potentially volatile—world of cryptocurrency exchange-traded funds.
Cryptocurrency ETFs: An Overview
Cryptocurrency exchange-traded funds (ETFs) track the price performance of cryptocurrencies by investing in a portfolio linked to these digital assets. Similar to other ETFs, crypto ETFs are traded on traditional stock exchanges, allowing investors to hold them in standard brokerage accounts.
As of early 2024, a growing number of ETFs—known as exchange-traded products (ETPs)—have started offering investors the opportunity to invest in Bitcoin through their holdings. After nearly a decade of regulatory challenges, the Securities and Exchange Commission (SEC) approved the first spot crypto ETFs in early 2024, following a ruling from the D.C. Circuit Court of Appeals in 2023.
These investments enable retail traders to gain direct exposure to cryptocurrency prices without owning the assets themselves. This approach allows individuals to speculate on cryptocurrency prices without needing to operate on a crypto exchange or manage the complexities and costs associated with owning digital assets directly.
However, crypto ETFs typically come with higher fees compared to other ETFs. While these funds are regulated, there is a lack of oversight in the crypto markets where the funds are invested.
Types of Crypto ETFs and How They Work
There are two main types of crypto ETFs: spot ETFs and futures ETFs.
Crypto Futures ETFs
A crypto futures ETF tracks the price of futures contracts. A futures contract is an agreement to buy or sell cryptocurrency at a predetermined price at a later date. The value of the futures contract depends on whether the holders expect the cryptocurrency's price to rise or fall. Therefore, the price of a futures contract can fluctuate based on the sentiments of its holders, often being higher or lower than the actual price of the cryptocurrency.
Crypto Spot ETFs
In contrast, spot ETFs track the real-time value of a cryptocurrency, known as its “spot” price. Spot ETFs hold a specific amount of cryptocurrency in their funds and issue shares based on that quantity, as well as market demand. This structure allows spot ETFs to provide investors with more direct exposure to cryptocurrencies compared to other types of ETFs.
Advantages of Crypto ETFs
Cryptocurrency ETFs are an emerging asset class, and while regulatory uncertainty exists, they offer several advantages for accessing crypto markets.
Exposure Without Ownership
The biggest advantage of cryptocurrency ETFs is that they provide exposure to the crypto market without the extra costs or risks associated with owning and managing digital assets. For instance, owning cryptocurrencies can involve custody fees for secure digital wallets, which may charge annual fees. These costs can add up, but with ETFs, the providers handle transaction and network fees, even if you indirectly pay for them through the fund’s expense ratio.
Lowering the Learning Curve
The complex terminology associated with cryptocurrencies can be a barrier for many investors. Terms like "halving" and "blockchain" can make it difficult for average investors to understand the landscape. Investing in a cryptocurrency ETF simplifies the process, making it easier for newcomers to learn and engage with crypto.
More Security for Investors
Security is a significant concern in the crypto world, with numerous hacks targeting exchanges, wallets, and poorly designed blockchains. Individual investors may find it challenging to navigate security measures effectively. A cryptocurrency ETF manages these security aspects on your behalf, providing peace of mind.
Lower Costs for Investors
With over 9,000 cryptocurrencies available for trading worldwide, the market can be complex and challenging to navigate. Some tokens are only available on certain exchanges, and additional costs can arise when buying crypto. Cryptocurrency ETFs allow investors to diversify their holdings without the hassle and fees associated with purchasing and exchanging tokens directly.
Disadvantages of Crypto ETFs
Despite their benefits, cryptocurrency ETFs also have some drawbacks, especially given the evolving regulatory landscape.
The Risk of Tracking Error
Crypto ETFs may not always mirror the price movements of the underlying digital tokens, particularly those relying on futures contracts, which need to roll over positions as contracts expire. This can lead to discrepancies between the ETF price and the actual cryptocurrency price.
Higher ETF Fees
While crypto ETFs help investors avoid some costs associated with owning digital currencies, they come with their own fees. Many crypto ETFs are actively managed, resulting in higher expense ratios compared to traditional ETFs. For example, the ProShares Bitcoin Strategy ETF has an expense ratio of 0.95%, whereas the SPDR S&P 500 ETF's expense ratio is only 0.09%.
Volatility
Although crypto ETFs simplify trading digital currencies, they are still subject to the significant price fluctuations typical of the crypto market. This volatility can pose a greater risk for investors, especially those accustomed to the stability of traditional ETFs.
Lack of Direct Ownership
Investors in crypto ETFs do not own the underlying digital assets. While ETFs offer convenience, they also mean that investors lack direct control or access to the cryptocurrencies, and the decentralization and anonymity often associated with crypto do not extend to ETF shareholders.
Bottom Line
The recent approval of spot ETFs signals a promising future for the acceptance of crypto ETFs, potentially leading to significant growth. This move is likely to attract a broader range of investors, particularly those interested in the crypto market but preferring regulated financial instruments. Additionally, increased competition among ETF providers has resulted in lower fees, making these investment options more accessible and attractive.
Overall, the landscape of crypto ETFs is expected to evolve and integrate further into traditional financial portfolios. However, as with any volatile asset, it's essential to conduct your own research, diversify your portfolio, and stay informed about the latest industry news and developments.
