What is a cryptocurrency ETF and how does it work? – Coin telegraph | Jewelry Dukan

Exchange-traded funds (ETFs) have enjoyed increasing popularity as an investment vehicle since the mid-1990s due to their intraday liquidity and low transaction costs. In general, ETFs track a specific index and are usually traded on exchanges.

In a securities market, ETFs allow investors to trade their shares continuously throughout the trading day, as opposed to mutual funds, which only allow investors to buy or redeem shares at the end of the trading day.

In the cryptocurrency market, a fund that tracks the price of one or more digital tokens and consists of different cryptocurrencies is known as a cryptocurrency ETF. This article explains how a cryptocurrency ETF works and the benefits and risks associated with cryptocurrency ETFs.

What is a cryptocurrency ETF?

A fund is treated as an exchange traded fund if it meets either of the following two criteria:

  • Cryptocurrency ETFs invest in companies that are transforming business applications through the development and deployment of blockchain technology.
  • Blockchain-based ETFs invest in cryptocurrency investment products from asset managers such as Bitwise or Grayscale, or futures and options whose prices are linked to the performance of ether (ETH), bitcoin (BTC) and other cryptocurrencies.

In general, cryptocurrency ETFs are the advanced use case of blockchain technology. For example, Bitcoin ETFs are the first crypto ETFs to attempt to track the price of BTC, the most valuable cryptocurrency among digital assets.

On October 18, 2021, ProShares Bitcoin Strategy ETF (BITO) started trading Bitcoin ETFs, followed by Valkyrie (BTF) and VanEck (XBTF). Although there are no ETFs that are directly tied to Bitcoin’s spot price (the current market price at which the underlying security can be bought or sold), the managers of these products monitor the price of BTC through the futures markets. Also, Grayscale’s Bitcoin Investment Trust is not accessible to the mainstream audience as it is not an ETF.

In addition to providing indirect exposure to BTC, Bitcoin ETFs could pose risks for investors if the fund holds a significant portion of the futures market. Therefore, investors should exercise caution when investing in volatile securities such as cryptocurrencies.

How does a cryptocurrency ETF work?

Crypto ETFs either own the cryptocurrency futures, options, or other crypto-based securities, unlike traditional ETFs, which own the underlying asset directly. The intention is to mimic the price fluctuations of the fundamental cryptocurrency. However, there may be times when ETF movements don’t exactly match those of the underlying cryptocurrency as they don’t believe in it themselves.

Cryptocurrency ETFs are either backed by physical crypto assets or synthetic variants such as derivatives. In the former, crypto investors indirectly own cryptocurrencies without incurring the costs of owning them directly, and in the latter, the ETF share price mimics the price movements of derivatives rather than reflecting actual cryptocurrency prices.

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 beyond the traditional securities markets.

What are the advantages of cryptocurrency ETFs?

Although there is regulatory uncertainty surrounding cryptocurrency ETFs, crypto investors who own exchange traded funds can benefit from:

  • The primary benefit of investing in exchange-traded funds like Proshare’s Bitcoin Strategy ETF is the affordability of investing in a volatile asset class.
  • The learning curve is offloaded to analysts while investing in cryptocurrency ETFs, making it an ideal investment vehicle for novice investors.
  • Owning crypto ETFs saves investors from costs such as custodial, network and transaction fees.
  • An ETF provider is responsible for the security of the fund and offers investors a sense of security, especially in relation to phishing attacks, cryptojacking or crypto heists.
  • Currently there is no fully developed infrastructure for buying and selling cryptocurrencies. For example, although certain tokens are offered on certain cryptocurrency exchanges, others are not. However, investors can diversify their portfolios with cryptocurrency ETFs without having to pay for individual tokens.

Related: What is cryptojacking? A beginner’s guide to crypto mining malware

Are cryptocurrency ETFs safe?

First, let’s answer these questions – are cryptocurrency ETFs regulated and are ETFs good for beginners? – before determining whether crypto exchange-traded funds are safe.

All parties involved in cryptocurrency ETF investments are vetted and their trades are monitored to prevent market abuse or funding of illegal activities. However, it is safer to invest in crypto exchange-traded funds since they are issued by regulated companies and traded on well-known, regulated exchanges.

Still, the US Securities and Exchange Commission has received numerous requests to legitimize crypto exchange-traded spot funds, but there hasn’t been a bitcoin spot ETF yet. However, the bitcoin futures ETF has been accredited by a few companies.

Aside from regulation, one should be aware of the risks of investing in exchange-traded cryptocurrencies in funds. For example, novice or advanced traders need to understand that there is a limited range of funds to start exploring cryptocurrency ETFs. Also, available funds track few digital currencies and are exposed to cybercrime risks like hacking.

Additionally, given the volatility of the cryptocurrency market, there is no doubt that investments in cryptocurrency exchange-traded funds can also experience large price swings, particularly physically backed funds. Therefore, the safety of any cryptocurrency investment is in the hands of investors and depends on their knowledge of the pros and cons of various financial instruments.

How to invest in a cryptocurrency ETF?

A cryptocurrency ETF can be an ideal choice instead of buying digital assets outright if you don’t actively manage your cryptocurrency investments but still want to diversify your portfolio. To invest in blockchain-based ETFs, do the following:

  • Open an account with brokers like Fidelity Investments, Robinhood, etc. by completing their onboarding process.
  • Decide what percentage of your total investment budget you want to invest in ETFs.
  • Fund your brokerage account and look for ETFs to invest in. For example, if you want to invest in the ProShares Bitcoin Strategy ETF, type BITO (ticker symbol) in the search bar.
  • Place a market order for the cryptocurrency ETFs you want to buy. Click Buy. Enter the maximum number of shares you can purchase with your current budget.
  • If you want to continually expand your investment portfolio, set up an automatic investment plan with your broker.

See also: A Beginner’s Guide to Cryptocurrency Trading Strategies

Despite the simplicity of the above process, you should be aware of the expense ratio or management fee associated with ETF investing. For example, investors holding mutual funds and exchange-traded funds are subject to an annual fee called the expense ratio. If you want to know how ETFs make money? Then the expense ratio is the answer. The funds’ expense ratio and transaction fees mainly cover the costs of the ETF providers.

In addition, one should also think about their exit plan. For example, even hodlers or long-term investors will likely want or need to sell some of their holdings at some point, which involves paying further trading costs on sale.

Cryptocurrency ETFs vs Mutual Funds

Brokers and asset management companies offer mutual funds that can be either actively or passively managed. Active management means that experienced professionals actively make trades to increase returns, while in the case of 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 mentioned earlier, a cryptocurrency ETF fund tracks the price of one or more digital tokens, making it quite similar to investing in mutual funds. Additionally, existing investment accounts can be used to buy both crypto mutual funds and ETFs, and investors incur an expense ratio. However, there are several differences between the two investment vehicles, which are detailed in the table below:

Regardless of your choice of investment vehicle, please note that if you invest in crypto mutual funds or exchange-traded funds, you do not technically own cryptocurrency. Therefore, always measure your risk/reward ratio before investing your hard-earned money in the volatile market.

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