What is a cryptocurrency ETF and how does it work?
A cryptocurrency exchange-traded fund (ETF) invests in various cryptocurrencies and monitors the price of one or more digital tokens.
Because of their intraday liquidity and cheap transaction costs, exchange-traded funds (ETFs) have risen in popularity as a form of investing since the mid-1990s. ETFs, in general, follow a specified index and are traded on exchanges.
ETFs enable investors to trade their shares continuously throughout the trading day in a securities market, unlike mutual funds, which only allow investors to acquire or redeem shares at the end of the trading day.
A cryptocurrency ETF is a fund that follows the price of one or more digital tokens and is made up of numerous cryptocurrencies in the cryptocurrency market. This article will explain how a cryptocurrency ETF operates as well as the advantages and hazards associated with cryptocurrency ETFs.
What exactly is a cryptocurrency ETF?
If a fund fits one of the two following conditions, it is classified as an exchange-traded fund:
Cryptocurrency ETFs invest in companies that use blockchain technology to alter commercial applications.
Blockchain-based ETFs invest in cryptocurrency investment products offered by asset managers such as Bitwise or Grayscale, as well as futures and options whose values are related to the performance of cryptocurrencies like as Ether (ETH), Bitcoin (BTC), and others.
In general, cryptocurrency ETFs are a more advanced use of blockchain technology. Bitcoin ETFs, for example, are the first crypto ETFs that attempt to follow the price of BTC, the most valuable cryptocurrency among digital assets.
ProShares Bitcoin Strategy ETF (BITO) began trading Bitcoin ETFs on October 18, 2021, followed by Valkyrie (BTF) and VanEck (XBTF). Although no ETFs are directly linked to the spot price of Bitcoin (the current market price at which the underlying investment may be purchased or sold), managers of these products monitor the price of BTC through futures markets. Furthermore, since it is not an ETF, Grayscale’s Bitcoin Investment Trust is inaccessible to the general public.
In addition to providing indirect exposure to BTC, Bitcoin ETFs may provide dangers to investors if the fund controls a significant percentage of the futures market. As a result, investors should exercise caution while investing in volatile assets such as cryptocurrency.
How does a cryptocurrency ETF function?
In contrast to conventional ETFs, which directly hold the underlying asset, crypto ETFs either own cryptocurrency futures, options, or other crypto-based products. The goal is to mimic the price swings of the core coin. However, since ETFs do not own any of the underlying cryptocurrency, there may be times when their movements do not perfectly follow those of the underlying cryptocurrency.
Cryptocurrency ETFs are backed by either actual crypto assets or synthetic derivatives. In the former, crypto investors indirectly possess cryptocurrencies without incurring the costs of outright ownership, but in the latter, the ETF share price imitates the price movements of derivatives rather than representing the values of real cryptocurrencies.
So, what is the significance of crypto ETFs? The most obvious rationale is portfolio diversification, since Bitcoin or Ether ETF investors may get exposure to several crypto assets, particularly outside of traditional securities markets.
What are the advantages of bitcoin exchange-traded funds (ETFs)?
Despite regulatory ambiguity surrounding cryptocurrency exchange-traded funds, crypto investors who hold exchange-traded funds may profit from the following:
The key advantage of investing in exchange-traded funds, such as Proshares Bitcoin Strategy ETF, is the low cost of investing in a volatile asset class.
When investing in bitcoin ETFs, the learning curve is outsourced to analysts, making it a perfect investment vehicle for inexperienced investors.
Investing in crypto ETFs saves investors money on expenses like as custody, network, and transaction fees.
An ETF provider is responsible for the fund’s security, providing investors with reassurance in the face of phishing attempts, cryptojacking, or crypto heists.
At the moment, there is no fully built infrastructure for purchasing and trading cryptocurrencies. For example, although certain tokens are available on particular cryptocurrency exchanges, others are not. Investors, on the other hand, may diversify their portfolios by purchasing cryptocurrency ETFs rather than individual tokens.
Are bitcoin exchange-traded funds (ETFs) secure?
Before determining if crypto exchange-traded funds are secure, let us first address the following questions: Are cryptocurrency ETFs regulated? Are ETFs suitable for beginners?
All parties engaging in bitcoin ETF investments must be verified, and their transactions are monitored to avoid market misuse or supporting criminal activities. However, since crypto exchange-traded funds are issued by licensed organizations and sold on well-known, controlled exchanges, investors may invest with more confidence.
Nonetheless, the Securities and Exchange Commission of the United States has received multiple petitions to legitimate crypto spot exchange-traded funds, although no Bitcoin spot ETF exists as of yet. However, a few companies have approved the Bitcoin futures ETF.
Aside from regulation, investors in bitcoin exchange-traded funds should be mindful of the hazards. Beginners and seasoned traders, for example, should be aware that there is a restricted selection of funds to begin studying bitcoin ETFs. Furthermore, the accessible funds monitor just a few digital currencies and are vulnerable to cybercrime concerns like as hacking.
Furthermore, given the volatility of the cryptocurrency market, there is little question that large price changes may be expected while investing in cryptocurrency exchange-traded funds, particularly physical-backed funds. As a result, the safety of any cryptocurrency investment is in the hands of investors and is dependent on their understanding of the benefits and drawbacks of different financial instruments.
How do I buy a cryptocurrency ETF?
If you don’t want to actively manage your cryptocurrency investments but still want to diversify your portfolio, a cryptocurrency ETF may be a better option than purchasing digital assets directly. Follow the steps below to invest in blockchain-based ETFs:
Complete the onboarding procedure for brokers such as Fidelity Investments, Robinhood, and others.
Determine how much of your entire investing budget you want to put into ETFs.
Fund your brokerage account and search for ETFs to invest in. For example, if you want to buy ProShares Bitcoin Strategy ETF, enter BITO (ticker symbol) into the search field.
Place a market order to purchase cryptocurrency ETFs. Click the Buy button. Enter the number of shares you can buy with your current budget.
Set up an automated investment plan with your broker if you want to constantly expand your investing portfolio.
Regardless of how simple the preceding procedure seems, be mindful of the cost ratio or management charge connected with ETF investing. Investors in mutual funds and exchange-traded funds, for example, pay an annual charge known as an expense ratio. If you’re wondering how ETFs create money, read on. The expenditure ratio is the solution. ETF providers mainly recuperate their expenses via expense ratios and transaction fees.
Additionally, one should consider their exit strategy. Even hodlers, or long-term investors, will most likely want or need to sell part of their assets at some time, which will necessitate incurring another trading fee when they do so.
Mutual funds vs. cryptocurrency ETFs
Mutual funds, which may be managed actively or passively, are available via brokers and asset management firms. Active management refers to experienced professionals actively making trades to improve returns, while passive management refers to fund managers replicating a certain benchmark or index to match its performance. A cryptocurrency mutual fund invests in one or more digital currencies.
A cryptocurrency ETF fund, as previously said, monitors the price of one or more digital tokens, making it very similar to a mutual fund investment. Furthermore, current investment accounts may be utilized to purchase both crypto mutual funds and ETFs, with investors incurring an expense ratio. However, as shown in the table below, there are many distinctions between the two investment vehicles:
Regardless of your investment vehicle choice, please note that when you invest in crypto mutual funds or exchange-traded funds, you don’t technically own any cryptocurrency. Therefore, always measure your risk-return tradeoff before investing your hard-earned money into the volatile market.