Exchange Traded Funds (ETFs) since the mid-1990s, they have gained popularity as a means of investment due to their intraday liquidity and low transaction costs. In general, ETFs track a specific index and are generally traded on exchanges.
In the stock market, ETFs allow investors to trade their shares continuously throughout the trading day, unlike mutual funds, which only allow investors to buy or redeem shares at the end of the trading day.
In the cryptocurrency market, it is a fund that tracks the price of one or more digital tokens and consists of various cryptocurrencies is called a cryptocurrency ETF. This article will discuss how a cryptocurrency ETF works and what are the benefits and risks of cryptocurrency ETFs.
What is a cryptocurrency ETF?
A fund is considered an exchange-traded fund if it meets one of the following two criteria:
- Cryptocurrency ETFs invest in businesses that transform business applications by creating and deploying blockchain technology.
- Blockchain-based ETFs invest in cryptocurrency investment products provided by asset managers such as Bitwise or Grayscale or futures and optionswhose prices are linked to the performance of Ether (ETH), bitcoins (BTC) and other cryptocurrencies.
In general, cryptocurrency ETFs are a widespread use case blockchain technology. For example, Bitcoin ETFs are the first crypto ETFs which seeks to track the price of BTC, the most valuable cryptocurrency among digital assets.
On October 18, 2021, the ProShares Bitcoin Strategy ETF (BITO) began trading as a Bitcoin ETF, followed by Valkyrie (BTF) and VanEck (XBTF). Although there are no ETFs tied directly to the spot price of Bitcoin (the current market price at which the underlying securities can be bought or sold), the managers of these products track the price of BTC through futures markets. Also, Grayscale’s Bitcoin Investment Trust is not accessible to the general public as it is not an ETF.
Along with offering indirect exposure to BTC, Bitcoin ETFs could pose a risk to investors if the fund holds a significant portion of the futures market. Therefore, investors should be cautious when investing in volatile securities such as cryptocurrencies.
How does cryptocurrency ETF work?
Crypto ETFs either own cryptocurrency futures, options, or other cryptocurrency-based securities, unlike traditional ETFs that directly own the underlying asset. The idea is to mimic the price fluctuations of the underlying cryptocurrency. However, there may be times when the movements of the ETF do not exactly correspond to the movements of the underlying cryptocurrency because they do not hold any of it themselves.
Cryptocurrency ETFs are either backed by physical crypto assets or synthetic variants such as derivatives. In the first case, crypto-investors indirectly own cryptocurrencies without bearing any of the costs associated with their direct ownership, and in the second case, the price of ETF shares, instead of reflecting the prices of real cryptocurrencies, mimics the price movements of derivatives.
So why are crypto ETFs important? The most obvious reason is portfolio diversification, as bitcoin or ether ETF investors can gain exposure to more than one crypto asset, especially outside of conventional stock markets.
What are the benefits of cryptocurrency ETFs?
Although there is regulatory uncertainty surrounding cryptocurrency ETFs, crypto investors who own exchange-traded funds can benefit from the following benefits:
- The primary benefit of investing in exchange-traded funds like the Proshares Bitcoin Strategy ETF is the price element of investing in a volatile asset class.
- The learning curve is outsourced to analysts when investing in cryptocurrency ETFs, making it an ideal investment vehicle for novice investors.
- Owning a crypto ETF saves investors costs such as custodial fees and network and transaction fees.
- The ETF provider is responsible for the safety of the fund and offers investors a sense of security, especially when it comes to phishing attackscryptojacking or crypto robbery.
- Currently, there is no fully developed infrastructure for buying and selling cryptocurrencies. For example, although certain tokens are offered on specific cryptocurrency exchanges, others are not. However, investors can diversify their portfolios with cryptocurrency ETFs without having to pay for individual tokens.
Are Cryptocurrency ETFs Safe?
Let’s first answer these questions – are cryptocurrency ETFs regulated and are ETFs good for beginners? — before finding out if funds traded on a crypto exchange are safe.
All parties involved in investing in cryptocurrency ETFs are subject to verification and their trades are monitored to prevent market abuse or financing of illegal activities. This means that crypto exchange-traded funds can be invested with more confidence as they are issued by regulated companies and traded on well-known regulated exchanges.
However, the US Securities and Exchange Commission has received numerous requests to legitimize crypto spot exchange-traded funds, but no bitcoin spot ETF has existed yet. However, the Bitcoin futures ETF has been accredited by several companies.
In addition to regulation, you should be aware of the risks of investing in cryptocurrency exchange-traded funds. For example, beginners or advanced traders need to understand that there is a limited selection of funds to start researching cryptocurrency ETFs. Also, the available funds track only a few digital currencies and are subject to cybercrime risks such as hacking.
In addition, due to the volatility of the cryptocurrency market, there is no doubt that investing in crypto exchange-traded funds can also experience wide price swings, especially in the case of funds with physical collateral. The safety of any cryptocurrency investment therefore rests in the hands of investors and depends on their knowledge of the pros and cons of various financial instruments.
How to invest in cryptocurrency ETF?
A cryptocurrency ETF can be an ideal choice over buying digital assets outright if you don’t want to actively manage your cryptocurrency investments but still want to diversify your portfolio. To invest in blockchain-based ETFs, follow these steps:
- Open an account with brokers like Fidelity Investments, Robinhood, etc. by completing their registration process.
- Decide what percentage of your total investment budget you want to invest in ETFs.
- Fund your brokerage account and search for ETFs to invest in. For example, if you are looking to invest in the ProShares Bitcoin Strategy ETF, enter BITO (ticker symbol) in the search box.
- Place market order for the cryptocurrency ETF you want to buy. Click Buy. Enter the maximum number of shares you can buy with your current budget.
- If you want to continuously expand your investment portfolio, set up an automatic investment plan with your broker.
Despite the simplicity of the above process, be aware of the expense ratio or management fee associated with ETF investments. For example, investors who hold mutual funds and exchange-traded funds are subject to an annual fee known as an expense ratio. If you want to know how ETFs make money? Then the cost ratio is the answer. Fund expense ratios and transaction fees are how ETF providers primarily offset their costs.
In addition, their exit plan should also be thought about. For example, even hodlers or long-term investors are likely to want or need to sell some of their holdings at some point, meaning they will pay additional trading costs when selling.
Cryptocurrency ETFs Vs. mutual funds
Brokers and management companies provide mutual funds that can be actively or passively managed. Active management means that experienced professionals actively trade to increase returns, while in passive management, fund managers replicate a specific benchmark or index to match its performance. A cryptocurrency mutual fund specializes in investing in one or more digital currencies.
As previously mentioned, a cryptocurrency ETF tracks the price of one or more digital tokens, which is quite similar to investing in a mutual fund. In addition, existing investment accounts can be used to purchase both crypto mutual funds and ETFs, creating an expense ratio for investors. However, there are various differences between the two investment vehicles as shown in the table below:
Regardless of your choice of investment vehicle, keep in mind that when you invest in crypto mutual funds or exchange-traded funds, you do not technically own any cryptocurrency. Therefore, always weigh your risk-return trade-off before investing your hard-earned money in a volatile market.
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