Crypto ETFs: When Bitcoin Meets Wall Street

Deemed too fantastical before, the crowd is now crypto-curious. With ETF looking-glass in hand, investors eagerly plunge into the dream of decentralised wonderlands. Peek into the future finance now with our pocket guide on ETFs.

The year 2022 was not for the faint of heart; scarred investors still shudder at last year's epic crash and high-profile blowups that incinerated billions of dollars. Yet if you can stomach the vertigo, 2023's eye-popping rallies in digital assets may leave you drooling over the meteoric gains of crypto exchange-traded funds (ETFs).

Take the Valkyrie Bitcoin Miners ETF, which has skyrocketed an astonishing 119% so far this year. Still, most investors remain frozen in place, with crypto ETFs attracting a paltry $12 million in flows compared to the $118 billion that's flooded into crypto overall. Clearly, the typical rush to chase performance remains stuck at the starting gate.

With the wreckage of implosions still smoldering and the stench of risk clinging tightly to crypto, who can blame the skittish? Yet for those with strong stomachs able to keep their nerve amid volatility, crypto ETFs open a window into the breakneck world of digital assets through a familiar investment structure.

This primer will unpack how crypto ETFs work, the rewards they offer, and the perils that may leave you reaching for aspirin.

What Is a Cryptocurrency Exchange-Traded Fund (Plus a Bit of History Explainer)?

Like classic ETFs, crypto ETFs track an index or basket of assets. But rather than stocks or bonds, they trace weaving prices of bitcoin, ether, and other cryptocurrencies. As crypto prices swing up and down each day, a crypto ETF's share price responds in kind. They are exchanged on a daily basis, much like regular stocks.

As crypto aficionados believe that crypto ETFs pave the way for mainstream crypto adoption, they’ve been trying to legitimize them for years. The Winklevoss twins, those visionary Facebook litigants-turned-crypto kings, applied to launch the first bitcoin ETF way back in 2014. No dice. The SEC slammed the door, saying crypto was too shady. In a 2018 "Dear John" letter, the SEC tried to elucidate the reasons for its unbending resolution to reject all proposals — no transparency in how crypto exchanges set prices, rampant potential for market tricks, not enough trading to matter, blah blah.

That didn’t stop the try-hards, however. In 2021 alone, the agency fielded 12 applications, with proposals still raining down on the SEC like coins from a cash machine. The year 2021 was precisely when the wheels turned and the first crypto ETFs finally traded — for bitcoin futures, not bitcoin itself, but close enough for some. It was also back then that the SEC changed the man at the helm. Gone was Jay Clayton, the old-school chairman who frowned on crypto. Entered Gary Gensler, who taught MIT's first blockchain class.

Fast forward to today: Crypto is now a $2 trillion market, far bigger than in 2018 and even 2021. Coinbase, the biggest U.S. exchange, is itself public. But the SEC is still pondering whether to allow ETFs to hold real-live bitcoin.

So, what now? The holy grail remains just out of reach. But the crypto cavalry continues to amass outside the SEC's gates, armed with arguments on why now is the time. As the battle for a real bitcoin ETF is brewing, who knows if we are not that far off the goal yet?

👉 To sum up, the crypto ETFs invest in bitcoin futures or stocks of crypto companies. They offer a taste of bitcoin's thrill ride without the dire risk of financial wipeout if the wheels fall off. Still, if a fund owns too much of the futures, its price could go off the rails. And let's face it, crypto remains volatile as a bucking bronco. Despite the bitter pills, ETFs offer fantastic “training wheels” for those weary of holding real tokens themselves and, for others, just another opportunity to make money.

Bitcoin ETFs vs Blockchain ETFs

In the frenzy over all things crypto, it's easy to confuse bitcoin and blockchain. But bitcoin ETFs and blockchain ETFs are different. Here’s why:

• Blockchain ETFs bet on the companies building the infrastructure for digital assets and decentralized finance. Because blockchain technology has uses beyond bitcoin, from supply chain management to healthcare, blockchain ETFs invest in a range of companies deploying the blockchain software. For example, IBM paired with Maersk to put shipping data on a blockchain.
• Bitcoin ETFs, on the other hand, aim to track the price of bitcoin itself. Bitcoin ETFs trade bitcoin futures, not real bitcoin, because the SEC so far has not allowed a single real bitcoin ETF, fearing "fraudulent and manipulative acts" in crypto. For the SEC, bitcoin futures pack an extra punch of safety as they fall under the jurisdiction of the Chicago Mercantile Exchange (CME) and oblige investors to deposit cash on margin for trading, serving as collateral.

Crypto ETFs vs Mutual Funds

On the surface, crypto ETFs and mutual funds share a lot. Both let you invest through regular brokerage accounts. Both aim to track crypto prices. Both charge fees and are heavily regulated.

Look closer, though, and there are differences. Crypto ETFs trade like stocks, so you can jump in and out anytime the market's open. Mutual funds trade once a day, so your money's locked until the next trade. ETFs tend to have no investment minimum, while some mutual funds require $500 or more to start.

Most ETFs are passively managed funds on autopilot, simply mimicking an index (however, futures ETFs often require skilled skippers at the helm to navigate the crypto seas). For mutual funds, autopilot won’t cut it, as portfolio managers are actively steering the fund to try and outperform a benchmark.

As of now, there are more ETFs than mutual funds in crypto.

Crypto ETFs vs Stocks

Stocks are shares in a specific company. They provide returns linked directly to that firm's performance and profits. If the company strikes it rich, your stock could soar. If it goes bust, your shares could be worthless. You own part of that business.

ETFs are bundles of assets, like crypto coins or blockchain stocks, in one package. Their price depends on the net value of the coins or stocks inside. ETFs trade like stocks but don't convey ownership of what they hold.

Both can be bought commission-free and traded during regular market hours. But while ETFs spread risk across many assets, with stocks, you're betting on one horse.

👉 Instead of betting on one business, however, you can opt for a stock ETF, which bundles many companies in one sector or industry into a single investment. The goal of stock ETFs is growth through exposure to both current leaders and disruptors looking to hit the big time. Unlike mutual funds, stock ETFs don't require hefty upfront investments or charge marketing and distribution fees. Lower costs mean higher returns for you. However, stock ETFs themselves own no actual shares of the companies in their mix. They aim to track the stocks' overall performance.

Crypto ETFs vs Direct Investment

There’s a big difference between investing in crypto ETFs and buying bitcoin or any other crypto directly. Both have advantages and disadvantages, so choosing either depends on how much hassle you're willing to handle.

Buying bitcoin directly means securing a digital wallet, signing up for a cryptocurrency exchange, and linking a bank account to fund your purchases. If all that sounds complicated, a bitcoin ETF may be for you. These funds track the price of bitcoin without the complexity of owning the digital currency.

👉 Think of it this way: You want to invest in gold. Option 1: Buy physical gold bars, find a secure vault, and deal with transporting and insuring your shiny stash. Option 2: Buy shares in a gold ETF that handles all the logistical headaches for you. With a bitcoin ETF, fund managers buy and trade bitcoin futures, while you simply invest in the fund like a stock. Whether bitcoin goes up or down, your ETF shares follow suit, for better or worse.

Now for the downside: With an ETF, you'll never actually own any bitcoin. You're just trading exposure to its price movements. If you buy bitcoin outright, you can spend it as currency, trade individual coins, and have full control and security over your digital assets. But you also risk losing your shirt if bitcoin plummets, and you're responsible for keeping wallets and accounts safe from cybercriminals.

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How Does Crypto ETF Work

A crypto ETF is an exchange-traded fund that mirrors the value fluctuations of one or more digital currencies, just like a traditional ETF.

As we’ve discovered above, crypto ETFs come in two flavors — spot and futures.

Spot bitcoin ETFs (not yet approved by the SEC in the US) reflect the actual price of bitcoin, while futures ETFs are based on the index-determined price of CME's bitcoin futures products.

Crypto ETFs aim to eliminate the risks associated with holding cryptocurrency assets by allowing investors to gain indirect exposure to the base cryptocurrency's volatility. The issuing company takes on the responsibility of securing and managing the underlying digital coins, and investors buy shares that represent their rights in the ETF.

When crypto is on a tear and surging in value, your ETF shares will climb higher and higher. Conversely, if prices pull back, your ETF investment will follow suit on the downside. In either case, you get to tap into crypto’s thrilling potential without needing a crypto wallet or remembering your private keys.

Some of the active bitcoin futures ETFs include ProShares Bitcoin futures ETF (BITO), Valkyrie Bitcoin Strategy ETF (BTF), and VanEck Bitcoin Strategy ETF (XBTF).

Example of Crypto ETF

Jimmy has been in crypto for years and is making a killing. His dad, on the other hand, is intrigued by the buzz but feels out of his depth. The whole idea of buying and securing bitcoin, not to mention staying on top of the ever-changing market, seems too complicated for his boomer taste.

Rather than miss out, Jimmy's dad decides to dip a toe in with a cryptocurrency ETF. He purchases shares of an ETF in his regular brokerage account, giving him instant exposure to a basket of major cryptocurrencies like bitcoin and ether. The ETF is professionally managed so he doesn't have to lift a finger or learn what a "private key" is. Even though the crypto market is volatile, the ETF share price has been climbing steadily higher, earning him a nice return without the hassle.

This easy on-ramp into crypto investing boosts Jimmy's dad's confidence. He's making money from cryptocurrency, even if he's not exactly sure how the underlying assets work! The ETF allows him to capitalize on the performance of coins like bitcoin without needing to become an expert.

Crypto Exchange-Traded Funds Risks & Rewards

The pros of crypto ETFs are compelling, as they are poised to bridge the gap between crypto believers and traditional investors.

👉 Imagine billions of dollars flooding from giant pension funds and investment firms into crypto ETFs — the price impact on coins like bitcoin and ether would be huge!

Crypto ETFs also make diversifying easy. With a single purchase, you gain exposure to a basket of cryptocurrencies or a mix of crypto and stocks without worrying about securing your digital wallets or choosing which coin to buy.

Filing your taxes also becomes simpler. The ETF trades on regulated exchanges, so you'll receive standard tax forms. And for investors nervous about crypto's volatility and uncertainty, ETFs offer peace of mind as rigorous rules keep everything in check.

Of course, there are downsides. Crypto ETFs sacrifice the decentralization and anonymity that attract many to cryptocurrency. Your assets are in the hands of a custodian, not secured in your own wallet. ETFs also come with management fees, which can eat into your profits over time.

The accuracy of the ETF in tracking actual crypto prices may vary, especially if the fund holds a diverse mix of assets. And although the ETF itself trades readily, your shares can't be exchanged directly for cryptocurrency. You're at the mercy of the broker if you want to cash out.

Liquidity can also dry up in certain market conditions, causing the ETF share price to drop sharply even if the underlying crypto assets remain stable. If the fund manager makes risky short sells, ETF investors end up footing the bill.

👉 Yet despite the risks, crypto ETFs offer an easy entrance to crypto for adventurous investors by fusing traditional and digital finance.

Exchange-Traded Funds and Taxes

With ETFs, like with other investments, you'll owe taxes on any profits. The good news is that buying and holding shares of a bitcoin ETF itself isn't a taxable event. But when you sell, get ready for a tax bill.

In the U.S., how much you'll pay for selling a bitcoin ETF depends on how long you've held your shares. If less than one year, short-term capital gains rates range from 10-37% depending on your income. Hold the ETF for over a year, and you'll face a lower long-term capital gains tax of 0-20%. High-income investors may need to pay an additional 3.8% net investment income tax on gains.

Bottom Line: Jump on the Crypto “Epic Token Frenzy”

For many mainstream investors, cryptocurrency remains mysterious and inaccessible. Crypto ETFs offer a solution, unlocking the door to this booming market in a familiar way.

Through ETFs, investors can gain exposure to leading digital assets like bitcoin as well as baskets of cryptocurrencies in a single fund. Without needing to master wallets or exchanges, the less experienced can ride the ups and downs of crypto right alongside tech-savvy traders. ETFs make investing in crypto as easy as buying stocks or bonds.

If you’ve been so far wary of plunging in and navigating the crypto currents, crypto ETFs can help set sail, providing the expert guidance and management that you might require.

Why miss out on this opportunity of a lifetime? With ETFs, you can share in the boundless promise of crypto markets through a platform or broker you already know and trust.

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FAQs

Who Owns the ETF?

ETFs are investment companies registered with the SEC, which also approves ETF investment advisors to oversee the fund. Some ETFs are actively managed and make trades to meet their investing objectives, while others are passively managed and aim to match the performance of a certain market index. In either case, most ETFs have a whole crew involved from portfolio managers to analysts and advisors, who have their say in which investments to buy, hold, or sell.

Before trusting an ETF with your money, find out who's really behind the wheel. The fund should disclose details about the team running the show, so you know exactly who is managing your money. For a crypto ETF, the management team should have experience and expertise specific to the cryptocurrency market and blockchain assets.

Is It Profitable to Invest in Crypto ETF?

Crypto-focused exchange-traded funds (ETFs) have shown remarkable performance so far this year: 13 of the top 20 highest-returning ETFs have invested in cryptocurrencies in 2023. Despite impressive returns, there are still not many investors venturing into the crypto frontier, and those who do seem to favor ETFs because they are 1) familiar with them and 2) because ETFs allow them to gain exposure to crypto in retirement accounts like IRAs and 401(k)s. There are indeed reasons to be cautious — crypto ETFs have only been around for a short time, so it's difficult to know how they will perform or if they will even continue to exist in the long run. Moreover, there are factors like additional fees and different risks. For instance, the Proshares Bitcoin Strategy ETF charges a 0.95% annual fee in addition to high futures costs.

Are Exchange-Traded Funds Good or Bad?

As with most investment tools, ETFs are neither good nor bad. They are simply a tool that offers more options to investors.

Let's face it, crypto can be confusing: terms like "halving" and "blockchain" sound like a foreign language to many. But with an ETF, analysts do the work of understanding this complex technology and market, while the curious just invest based on those analysts’ expertise. Security is also a concern when dealing with cryptocurrency. ETF providers handle all the safekeeping, with the SEC watching over the dealings above their heads.

So, if you’re feeling overwhelmed with thousands of crypto assets but don’t want to get left on the sidelines, you can get exposure to crypto through ETFs.

However, while crypto ETFs offer convenience, they also come at a cost. ETFs charge management fees, usually a percentage of your investment, so significant holdings can mean sizeable fees over time.

Finally, with ETFs, you don’t actually own any crypto, just a share in the fund.