Understanding Crypto ETFs

18 Nov 2023

A crypto ETF, or cryptocurrency exchange-traded fund, is a financial instrument that allows investors to gain exposure to cryptocurrencies like Bitcoin and Ethereum without having to directly own the underlying crypto assets. A crypto ETF tracks the price of one or more cryptocurrencies and is traded on a stock exchange just like regular stocks.

Crypto ETFs have emerged as a popular way for mainstream investors to invest in the crypto market while avoiding some of the challenges of buying and securely storing cryptocurrencies themselves. Here is a detailed look at what crypto ETFs are, how they work, their benefits and risks, and examples of existing crypto ETFs on the market.

What is an ETF?

An ETF is a type of fund that owns underlying assets like stocks, bonds, commodities or cryptocurrencies and divides ownership of those assets into shares. The shares trade on stock exchanges just like regular stocks, allowing investors to easily buy and sell them throughout the day.

ETFs are offered by asset management companies and aim to track the performance of a market index or basket of assets. For example, the SPDR S&P 500 ETF (SPY) tracks the S&P 500 index and holds shares of the 500 companies in that index. Investors can buy shares of SPY to get exposure to the broad US stock market.

ETFs have become popular investment vehicles because they provide instant diversification, liquidity, transparency and often have lower fees than actively managed mutual funds. They allow individual investors easy access to a variety of markets and assets.

How Crypto ETFs Work

A cryptocurrency ETF works just like a regular ETF, except the underlying assets are cryptocurrencies like Bitcoin and Ethereum instead of stocks and bonds.

The ETF issuer purchases the cryptocurrencies and stores them securely. They then issue shares of the ETF that represent ownership interests in the pool of crypto assets held by the fund.

For example, a Bitcoin ETF like the ProShares Bitcoin Strategy ETF (BITO) holds Bitcoin secured in cold storage wallets. ProShares issues shares of BITO, with each share representing exposure to a small fraction of the fund’s Bitcoin holdings.

The price of a crypto ETF share corresponds directly to the price of the underlying cryptocurrency assets, minus fees and expenses. If the price of Bitcoin rises 10%, the value of each share of BITO will also rise by approximately 10%. This gives investors Bitcoin exposure without having to buy and custody Bitcoin directly.

Crypto ETFs trade on stock exchanges and can be bought and sold continuously throughout market hours, like any stock. This makes them much more liquid than direct cryptocurrency investments.

Benefits of Crypto ETFs

There are several potential benefits to investing in crypto assets through an ETF rather than owning them directly:

  • Easier access: Buying shares of a crypto ETF is as easy as trading stocks through a brokerage account. Investors don’t have to deal with cryptocurrency exchanges or wallets.
  • Diversification: A single crypto ETF can provide exposure to dozens of cryptocurrencies. This is safer than putting all your money in just one or two coins.
  • Lower costs: Crypto ETFs have lower expense ratios than actively managed mutual funds that invest in cryptocurrencies. They don’t charge transaction fees either.
  • Secure storage: The ETF provider deals with securing the crypto assets in cold storage or crypto custodians. Investors don’t have to worry about safely storing private keys.
  • Liquidity: Crypto ETFs can be traded any time the stock market is open, unlike the 24/7 but often illiquid cryptocurrency markets.
  • Regulatory oversight: Crypto ETFs must follow strict rules and regulations from the SEC that govern their operations and disclosures. This provides an added layer of protection for investors.
  • Tax efficiency: In most cases, buying and selling crypto ETF shares only triggers capital gains taxes, not income taxes that can apply to direct crypto investments.
  • Accessibility: Crypto ETFs allow any regular brokerage account to invest in cryptocurrencies. Direct crypto investments require using specialized exchanges and wallets.

In summary, crypto ETFs provide a simpler, diversified and regulated way to gain exposure to cryptocurrency prices for investors who don’t want to deal with the complex storage, security and taxation issues that come with direct crypto ownership.

Risks of Crypto ETFs

While they offer some advantages, crypto ETFs also come with their own unique risks:

  • Tracking error: ETF performance may not exactly match the price of the underlying cryptocurrencies due to fees, expenses and technical challenges.
  • Premiums/discounts: The ETF share price can trade above or below the net asset value of the fund. This means you could pay more or less than fair value.
  • Lack of insurance: Cryptocurrencies held by an ETF are not FDIC insured like bank deposits. If the fund is hacked, investors could lose money.
  • New asset class: Cryptocurrencies are highly volatile and their long-term adoption remains uncertain. Crypto ETFs may perform very differently than ETFs holding traditional assets.
  • Custody risks: While their custodians are regulated, there is still the risk funds could lose their crypto assets to hacking or mismanagement.
  • Costs: Although lower than active mutual funds, crypto ETFs may still charge annual management fees from 0.5% to 1% that erode returns over time.
  • No voting rights: Crypto ETF investors do not have any direct governance rights or say over the cryptocurrencies held in the fund.
  • Less upside: Investing in a crypto ETF means you won’t benefit as much from a rapid short-term surge in the price of an individual cryptocurrency.

Ultimately, investors should weigh the diversification and custodial benefits against the risks, costs and possible tracking error associated with crypto ETFs compared to owning cryptocurrencies directly.

Existing Crypto ETFs

While no US pure-play crypto ETFs have been approved yet, regulators like the SEC are warming up to the idea. In the meantime, several crypto ETFs have launched in Canada and Europe. Here are some of the major existing crypto ETFs:

  • Purpose Bitcoin ETF (BTCC) - Launched in 2021 as the world’s first physically-backed Bitcoin ETF. Holds real BTC and trades on the Toronto Stock Exchange.
  • Grayscale Bitcoin Trust (GBTC) - GBTC functions like an ETF by holding Bitcoin and trading on the stock market, but it is technically a trust. One of the first regulated Bitcoin investment vehicles.
  • Valkyrie Bitcoin Strategy ETF (BTF) - BTF is an actively-managed US ETF that invests in Bitcoin futures contracts and other financial derivatives. Provides indirect Bitcoin exposure.
  • VanEck Bitcoin Strategy ETF (XBTF) - Similar to BTF, this ETF from VanEck invests in Bitcoin derivatives and futures contracts listed in Germany.
  • 21Shares Crypto Basket Index ETP (HODL) - Tracks an index of top 10 cryptocurrencies weighted by market cap. Provides diversified crypto asset exposure.
  • CI Galaxy Ethereum ETF (ETHX) - Holds physical Ethereum as its only asset. Aimed at providing direct exposure to Ethereum prices in a regulated fund.

Many existing crypto ETFs don’t directly hold cryptocurrencies but instead invest in derivatives and futures contracts to track performance. These provide exposure to crypto prices but don’t support the underlying digital asset markets. The launch of physically-backed crypto ETFs is expected to provide a big boost to further mainstream adoption.

The Future of Crypto ETFs

Crypto ETFs have yet to gain regulatory approval in the large US market, but the outlook is increasingly positive. The new Spot Bitcoin ETF proposed by Grayscale has garnered support from several major financial institutions and appears to have assuaged at least some of the SEC’s concerns.

In 2024, the SEC will likely greenlight the first US spot crypto ETFs that hold cryptocurrencies directly rather than derivatives. This would allow millions of Americans to invest in digital assets through regular brokerage accounts for the first time.

Here are some predictions for the growth of crypto ETFs in the coming years:

  • Bitcoin and Ethereum ETFs will be first to market once regulatory approval happens. These are the most mature assets.
  • DeFi, NFTs and other niche crypto markets will get their own specialized ETFs soon after.
  • Explosion of crypto ETF launches will provide exposure to different asset baskets, indexes, and investment strategies.
  • Cheaper “passive” crypto ETFs tracking major coins will compete with pricier “active” ETFs trying to beat the market.
  • Big money managers like BlackRock and Vanguard will launch spot crypto ETFs and bring billions in assets.
  • Total AUM across all crypto ETFs will steadily grow from a few billion to tens of billions as the market matures.
  • Crypto ETFs will eventually expand beyond just trading in the US & Canada to other major markets across Europe and Asia.
  • Fund giants will lobby regulators for a “Spot Bitcoin ETF” approval, which requires direct Bitcoin ownership.
  • Specialized products like leveraged, inverse, and option-based crypto ETFs will arrive to provide advanced trading.
  • Strict regulations around custody, insurance, audits and security will ensure crypto ETFs operate safely as their assets grow.

While the crypto fund market is still in its infancy, it is poised for massive growth as digital assets continue moving mainstream. Crypto ETFs will likely play a key role as regulated and easy-to-access onramps for millions of retail and institutional investors to participate in this emerging asset class.

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ETF is a type of fund that owns underlying assets like stocks, bonds, commodities or cryptocurrencies and divides ownership of those asset.ETFs have become popular investment and they provide instant diversification, liquidity, transparency and often have lower fees than actively managed mutual funds.
A crypto ETF, or Exchange-Traded Fund, allows investors to gain exposure to cryptocurrencies without directly owning them. It provides a convenient and regulated way to invest in digital assets, giving people the opportunity to diversify their portfolios.
ETFs approval from SEC will open a new window to crypto in fiat markets. Then a huge wave of adoption will rise .
Very enjoyed reading this article
Personally, I see it as just an attempt to 'bourgeoisify' Bitcoin. In my opinion, one should buy and secure their own coins.
A huge problem with ETFs is they remove transactions from the blockchains. The ETF only need to make those net transactions on the actual blockchain. For example if there's 3000 BTC in the ETF bought and 2800 sold, then the ETF can do 2800 BTC of those transactions off chain on their own orderbook. The net outstanding, 200 BTC they can then do on chain. Not only does this remove fees from the blockchain (which are used to pay miners/validators) it's also hidden from the public ledger. As far as the blockchain knows there's only 200 BTC of volume that's been transacted. When you start talking about purely synthetic instruments they don't ever have to touch the blockchain which removes all on chain transactions from the assets they're pegged to. Unfortunately, long term, these financial instruments will mean less people actually use crypto.
As a beginner, this helped me understand the basics of how they work and their pros/cons compared to owning crypto directly. The future outlook was insightful too.
Very informative article on etf
Nicely written bru
Blog BIT
Still not sure I fully trust cryptocurrency assets, but investing in a crypto ETF seems like a safer way to gain some exposure vs buying coins directly.