If you have an in-depth knowledge of the crypto industry, there is a huge chance that you’ve heard about crypto ETF, especially with the recent spot Bitcoin ETF approval. Regarded as a major move of the crypto industry in their quest for mainstream adoption, the crypto EFT helps to bridge the gap between traditional investments and investments in the blockchain landscape. So what’s a crypto ETF and how does it work? Let’s enter the world of crypto ETF, exploring everything you need to know as a potential investor in crypto ETF.
What is a Cryptocurrency ETF?
See crypto ETF as a basket that holds different cryptocurrencies, is operated by professionals, and can be traded like a regular stock on your brokerage platform. So instead of you, the investor, buying and storing a cryptocurrency yourself, you can simply buy shares from this “basket”. This way, you gain exposure to the price movements of cryptocurrencies in the “basket” without stressing yourself with the technical work involved in trading and storing cryptos.
All in all, cryptocurrency ETFs are the comprehensive use case of innovative blockchain technology. For example, the first crypto ETF that attempted to track the price of BTC was Bitcoin ETF. Bitcoin is currently the most valued cryptocurrency existing.
How does a Cryptocurrency ETF work?
Unlike traditional ETFs that directly possess the underlying asset, crypto ETFs either hold the cryptocurrency futures, alternatives, or any other crypto-based securities. The goal of this is to imitate real-life cryptocurrency’s price fluctuations. Regardless, there are periods when the movements of the ETF don’t exactly correspond to the movements of the underlying cryptocurrency because the crypto EFTs don’t own any crypto themselves.
Generally, cryptocurrency ETFs are either supported by physical crypto assets or any other synthetic variants like derivatives. In the case of it being backed by physical crypto assets, investors indirectly own the cryptocurrencies without going through the hassle of owning them outright. On the other hand, when it comes to crypto ETFs backed by derivatives, the ETF share price mimics the price trends of the derivatives.
Now that you know what is a Crypto ETF, you may ask, why are crypto ETFs important? The most apparent reason they are important is portfolio diversification since they offer investors exposure to different crypto assets, especially, beyond traditional securities markets.
What are the types of Cryptocurrency ETFs?
There are primarily two major types of Crypto ETFs in existence. They include:
1. Futures ETFs
Futures ETFs don’t directly keep crypto, but instead, they invest in contracts that are tied to their prices. They offer investors easier access to cryptos, but may only partially imitate the underlying crypto’s price movements.
2. Spot ETFs
Spots ETFs are the real deal, as they directly hold the real cryptocurrencies in very secure vaults. Essentially, these EFTs can track the price movements more closely, however regulatory hurdles make them less popular.
Check this out: Bitcoin ETFs Explained: What are they & how do they work?
What are the benefits of Cryptocurrency ETFs?
Although there is still regulatory uncertainty around the idea of cryptocurrency ETFs, here are some ways they can be of benefit to investors:
1. Exposure without ownership
The most notable benefit of crypto ETFs is the fact that they provide exposure to crypto without extra ownership expenses or even exposure to risk. For instance, there are specific custody charges for cryptocurrencies, and some of these secure digital wallets may even charge a yearly fee.
Although these charges may seem small, they can add up quickly, which will eventually cost investors a lot of money. Also, cryptocurrency ownership has other hidden expenses, such as network and transaction fees, which are all covered by the ETF providers, even if you pay for it indirectly through your fees.
2. Lowers the learning curve
When it comes to investing in crypto ETFs, the learning curve is outsourced to skilled analysts, which makes it ideal for novice investors. So investors don’t have much work to do, as the bulk of the work will be done by professionals.
3. Lowers cost for investors
As stated earlier, owning crypto ETFs protects crypto investors from expenses like custody charges and even network and transaction fees. So, crypto ETFs allow you to diversify your portfolio without the costs and stress of buying and trading the tokens yourself.
4. More security for investors
An ETF provider is directly responsible for the security of the fund, thereby offering a solid sense of security to investors. So you’d feel safe against phishing attacks, cryptojacking, or even crypto heists.
5. Easy diversification
There is presently no fully developed infrastructure that has been set in place for purchasing and selling cryptocurrencies. For example, although some tokens are provided on specific crypto exchange platforms, others are not. Regardless, investors can still diversify their portfolios via cryptocurrency ETFs without needing to pay for individual tokens.
What is the difference between Bitcoin Spot and futures ETFs?
The differences between Bitcoin spot and futures ETFs lie in their tracking methods and the underlying assets they hold. Spot ETFs aim to track Bitcoin’s price by holding the actual cryptocurrency, offering direct exposure to its movements. Spot Bitcoin was approved in January 2024, making it the first of its kind for investors. They provide simplicity and regulatory oversight but come with risks like potential theft and price volatility.
Futures ETFs, on the other hand, track Bitcoin’s price through futures contracts, not holding the actual cryptocurrency. They are useful in volatile markets and offer a more efficient way to gain exposure to Bitcoin. Risks include contract expiry and rollover, leading to increased costs and potential tracking errors.
The Disadvantages of Crypto ETFs
One of the major disadvantages of Crypto ETFs is their novelty. It is still unknown how far regulation will affect it in the future. Here are some other notable disadvantages of Crypto ETFs:
1. The risk of tracking error
Crypto ETFs do not constantly imitate the price movements of the underlying digital asset. Unfortunately, this is particularly true for ETFs that rely on futures contracts to keep track of cryptocurrencies, which will have to roll over their immediate positions as contracts expire.
2. Lack of direct ownership
As an investor in crypto ETFs, you are not the direct owner of the digital assets, which is another disadvantage. Although crypto ETFs bring convenience, you will not have custody or access to your cryptocurrency itself. Also, the decentralization and anonymity related to crypto don’t pertain to ETF shareholders.
3. Higher ETF fees
While crypto ETFs assist investors evade some costs and the burden of directly possessing digital currencies, they still have their own fees. Since they are usually actively managed by professionals, crypto ETFs may even have higher expense percentages than other kinds of ETFs.
4. Volatility
Although cryptocurrency ETFs streamline some of the tasks involved in trading digital assets, they are still very much subject to the erratic price movements of the crypto markets. This implies that there is more risk for you, which you may not be used to if you are already accustomed to the lower volatility of traditional ETFs.
Exciting read: How to choose the right crypto exchange for trading
Are Cryptocurrency ETFs safe?
Yes, crypto ETFs are safe and you can invest confidently in them because they are issued by authorized and regulated companies. Also, they traded on reputable, regulated exchanges. For these reasons, they are considered safe for investments.
Apart from the regulation of these ETFs, you must be aware of the underlying risks of cryptocurrency ETFs. For example, novices or advanced traders have to know that there is just a limited choice of funds to begin exploring cryptocurrency ETFs.
Also, the funds available can only track some digital currencies and are highly subject to cybercrime dangers like hacking. In addition, because of the volatility of the crypto market, extensive price fluctuations are bound to also happen in cryptocurrency ETF investments, particularly in the case of physical-backed funds.
Hence, the safety of any cryptocurrency investment you make is completely in the hands of investors handling them and relies upon their knowledge of the advantages and disadvantages of different financial instruments.
How can I invest in a Cryptocurrency ETF?
To invest in blockchain-based ETFs, just follow the simple steps below:
- Open an account with brokers by visiting the website of a reputable broker and completing their registration process.
- Decide the percentage of your entire investment budget you would like to invest in crypto ETFs.
- Thereafter, fund your brokerage account and search for ETFs you would like to invest in. You can use the search bar on the website to complete this step.
- Set a market order for the cryptocurrency ETFs you want to purchase. Tap on “Buy” and input the maximum number of shares you would like to purchase within your budget.
- If you hope to continuously expand your investment portfolio, just set an auto investment plan with your selected broker.
Note that there are some expense ratios or management fees generally associated with ETF investments. So you must be willing to pay these fees before you process. Also, you should think about your exit plan before even investing in crypto EFTs.
So what are crypto ETFs? Essentially, crypto ETFs provide you with a way to get exposed to the volatile world of cryptocurrencies without needing to buy and store the digital currencies yourself. Essentially, they provide you with a convenient and much safer way to explore the world of cryptocurrency. However, you must remember that due diligence is key when it comes to crypto investment via ETFs. Research the precise ETF you hope to invest in, understand all the risks involved, and always invest responsibly. Lastly, you should be cautious at all times while investing in assets as volatile as cryptocurrencies.
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