Cryptocurrency Exchange Traded Fund (ETF) makes it possible for investors to invest in crypto without having to deal with a crypto exchange.
A cryptocurrency exchange-traded fund (ETF) is a fund consisting of several cryptocurrencies that monitor the price or value of one or more digital tokens.
The ProShares Bitcoin Strategy ETF (BITO), the first cryptocurrency ETF, began trading in October 2021. This ETF monitors the cost of bitcoin futures.
Before we talk more about cryptocurrency exchange traded funds, let's talk a little about what exchange traded fund is
What is Exchange Traded Fund (ETF)
An exchange traded fund, or ETF is a financial instrument that follows the value of a certain asset or group of assets. Its key advantage is that it enables investors to diversify their holdings even when they don't own any of the assets.
A gold ETF, for instance, would monitor the value of the gold assets it represents.
As their name implies, they can be purchased and sold using a regular brokerage account much like stock, and they trade on exchanges.
What is a Cryptocurrency Exchange Traded Fund?
Cryptocurrency Exchange Traded Fund is an ETF that monitors changes in the value of one or more virtual currencies.
Fundamentally, it functions like a conventional ETF and is exchanged on stock exchanges or traditional market exchanges rather than cryptocurrency platforms, just like a regular share.
Crypto ETFs give its price leverage while enabling investors to invest in cryptocurrencies without having to deal with the headache of using a cryptocurrency exchange.
How does a Cryptocurrency Exchange Traded Fund work?
An exchange that issues and lists a cryptocurrency ETF must have custody of the underlying digital coin for it to work. Investors then purchase shares to represent their ownership interests in the exchange-traded fund. As a result, the investors are indirectly exposed to the base cryptocurrency's volatility.
The fundamental benefit of cryptocurrency ETFs is that they function exactly like ETFs backed by conventional assets.
While traditional ETFs directly own the underlying asset, cryptocurrency ETFs either own cryptocurrency futures, options, or other crypto-based products. The goal is to mimic the price variations of the underlying coin. Because they don't hold any of the underlying cryptocurrency directly, there may be times when the ETF fluctuations don't exactly track those of the underlying cryptocurrency.
The exchange-traded fund's share price would move along with the cost of the cryptocurrency. The ETF rises in value along with cryptocurrency, and vice versa.
However, the ETF would trade on a stock exchange like the NYSE or TSX rather than a cryptocurrency exchange.
Types of Cryptocurrency ETF
There are two types of them:
- Physically backed ETF
- Futures ETF
Physically-backed: To establish this kind of cryptocurrency ETF, an asset management firm must purchase some actual coins from the market, much like it would purchase shares to establish a conventional ETF. It can then create a fund and list it for trading on the stock exchange, representing the value of the crypto assets it owns.
Your investment will appreciate if the value of the digital tokens used to create the fund rises. Owners can thus become exposed to cryptocurrencies without the cost and danger of outright ownership.
Futures ETF: The term “futures ETF” refers to a fund that represents the value of cryptocurrencies that you can buy or sell per the terms of the contract.
Shares in this kind of ETF are based on cryptocurrency futures contracts rather than actual coins. An agreement to purchase or sell an item at a defined price at a given point in the future is all that a futures contract is.
On the other hand, if you bought or sold futures, you would not be the owner of the underlying crypto asset. You only have a contract that commits you to buy or sell cryptocurrency at any moment in the future. Future ETFs will therefore be able to cope with price fluctuations and market volatility with ease.
Since there are no tangible assets to safeguard, these are less hazardous than physical-backed ETFs. According to reports, the SEC is prepared to accept this kind of crypto ETF.
How to invest in a Cryptocurrency Exchange Traded Fund
If you don't want to actively manage your cryptocurrency investments but still want to diversify your portfolio, a cryptocurrency ETF can be a better option than purchasing digital assets directly. The steps listed below can be used to invest in blockchain-based ETFs:
- Create an account with a broker by going through their onboarding procedure, such as Fidelity Investments, Robinhood, etc.
- Choose the portion of your overall investment budget that you wish to dedicate to ETFs.
- Open a brokerage account, then start looking for ETFs to invest in. For instance, enter BITO (ticker symbol) into the search bar if you plan to invest in ProShares Bitcoin Strategy ETF.
- If you wish to purchase any cryptocurrency ETFs, place a market order. Select Buy. Enter the most shares you can buy within your current spending limit.
- Create an automated investment plan with your broker if you want to grow your investment account over time.
Benefits of Cryptocurrency Exchange Traded Fund
Here are some of the benefits of cryptocurrency exchange-traded funds
- The main advantage of investing in exchange traded fund is the accessibility to a risky asset class. Cryptocurrency exchange traded fund (ETFs) provide exposure to a rapidly expanding asset class at a fraction of the cost of buying cryptocurrency directly.
- Investing in bitcoin ETFs is a great choice for new investors because the learning curve is delegated to analysts.
- Another benefit of cryptocurrency ETFs is that they offer exposure to cryptocurrencies without requiring additional ownership costs. By owning cryptocurrency ETFs, investors are spared from expenses like custody fees, network costs, and transaction costs.
- An ETF provider is in charge of the fund's security, providing investors with a sense of security, especially concerning phishing attempts, cryptojacking, or crypto heists.
- Cryptocurrency ETFs allow investors to diversify their portfolios without having to pay for individual coins.
Limitations of Cryptocurrency Exchange Traded Fund
Here are some of the drawbacks of Cryptocurrency Exchange Traded Fund (ETF)
- Cryptocurrency ETFs might not reflect the underlying cryptocurrency precisely tick for tick. In fact, due to backwardation and liquidity, there will be times when they may diverge from the underlying cryptocurrency.
- One essential component of cryptocurrencies, decentralization, is sacrificed when they are used in ETFs. Allowing a custodian to retain your digital assets is necessary for investing in crypto ETFs.
- ETF Management Is Expensive. Holding a sizable number of shares in a crypto ETF may eventually result in expensive management costs.
- Crypto ETFs cannot be traded with other cryptocurrencies. As it is merely an investment fund that monitors the price of crypto and not a cryptocurrency.
Conclusion
Cryptocurrency Exchange Traded Fund allows equities traders to speculate on the cryptocurrency markets and execute trades from their primary brokerage accounts.
Crypto ETFs are advantageous to stock traders who do not want to register fresh accounts to trade cryptocurrencies, even though they are not ideal trading vehicles. In the upcoming years, there will probably be a lot of developments in the field of crypto ETFs.
Regardless of the investment instrument you choose, you don't own any cryptocurrency when you invest in crypto exchange-traded funds. Therefore, before investing your hard-earned money in the volatile market, always evaluate your risk-return tradeoff.