As the world struggles to make up its mind about Bitcoin, cryptocurrency ETFs are emerging as a way to buy in without going all in.
Globally, crypto-based ETFs are still in short supply. Governments and exchanges are approaching them with trepidation. Six have been approved in Canada so far (three Bitcoin and three Ethereum ETFs), and one in Brazil. In the States, Coinbase’s successful IPO has reignited positive sentiment around crypto, but the SEC has yet to give the green light on crypto-led ETFs.
In Australia, the time could be upon us. The Australian Stock Exchange (ASX) is on track to bring cryptocurrency investment to the mainstream, possibly by the end of 2021. With digital assets becoming too established to ignore, a number of crypto-based ETFs are being reviewed. Fund managers VanEck and Betashares have both lodged crypto-based submissions, but no fund names have been revealed just yet.
What are crypto ETFs?
ETFs work similarly to managed funds. They track the value of a group of underlying assets and can be also used as part of a thematic investing strategy where you place investment into a pool of typecast funds. This might be tech, biotech, or cloud computing. You can read more about thematic investing here.
Crypto ETFs track the value of cryptocurrency, but trade on traditional market exchanges (as opposed to crypto exchanges). If a cryptocurrency increases in value, so does the value of the ETF.
How do crypto ETFs work?
As with all ETF investing, you’re not buying the underlying asset. You’re buying shares of the fund.
The company issuing the asset and listing it on an exchange retains custody of the underlying digital coin. You’ll purchase shares representing your rights into the ETF. This gives you indirect exposure to the volatility of the base cryptocurrency.
You buy and sell into a crypto ETF the same way you’d buy a share on the stock market.
This means you don’t need to go through the hassle of setting up a digital wallet or trading on unregulated exchanges.
There are several big pluses to buying into crypto ETFs as opposed to purchasing crypto coins directly.
- Cryptocurrency ETFs are a way to hop on the crypto train without driving it yourself. The fact you’re owning a security rather than the asset itself lends reassurance.
- Cryptocurrency bought on the digital market is, by its very nature, decentralised and unregulated. Crypto ETFs are professionally managed and heavily regulated by the exchange they’re listed on.
- Perhaps one of the biggest advantages is that there’s no chance of losing a digital wallet, password, or hard drive full of Bitcoin. All funds stay on the exchange you’ve purchased them through.
- Crypto ETFs are particularly useful for diversification. They can invest in multiple cryptocurrencies at once which provides some cushion against volatility. They can also include other asset classes.
Crypto ETFs may hold a single cryptocurrency, multiple cryptocurrencies, or cryptocurrencies plus companies directly involved in the value/supply chain. Examples of the latter include Nvidia and AMD (who make GPUs used in crypto mining), Coinbase (which recently listed on the stock market), and Visa and Mastercard (who are integrating crypto payments in their networks).
They can also be based entirely on companies that use blockchain technology. Blockchain ETFs function in a similar way and can also provide efficient diversification.
- They’re tax efficient. In many countries, cryptocurrency is still unregulated, so it doesn't qualify for tax benefits. But profits from crypto-based ETFs may qualify for tax exemptions in Australia.
- ETFs remove psychological barriers to crypto. 1 Bitcoin is worth around AUD $70,000 at the time of writing. Some people don’t like the idea of buying a meagre Satoshi (0.00000001 of a Bitcoin) or some other tiny denomination. Investors with an ownership mentality might prefer the sound of 1000 shares of a $10/share BTC ETF, for example.
- ETFs have become a familiar asset class to retail investors. Crypto can seem much less intimidating when piggybacking on reputationally safer, longer-established fund types.
Other than the fact they’re not yet available in some countries, there are a couple of things to keep in mind when assessing crypto ETFs for your portfolio...
- When buying into an ETF, you’ll deal with fees from the fund manager that you wouldn’t incur from buying a share or a Bitcoin directly. Namely, these will include transaction costs as well as management fees. These cover the costs of trading and holding shares of the ETF respectively. Bitcoin ETFs can come with not-insignificant fees, sometimes upwards of 2% a year. This will inevitably eat into returns in a way that owning Bitcoin directly would avoid.
- Bitcoin ETFs tend to miss out on all of the perks Bitcoin was created to provide. First and foremost, the perk of independence from central banks. For many, the hedge BTC provides against central banks, fiat currencies, and equities is its biggest draw, closely followed by the protection and privacy awarded by the blockchain. Cryptocurrency ETFs are regulated by the government, so if these are your priorities, you might prefer to buy crypto directly.
- Perhaps an obvious one, but directly-owned Bitcoin (or other cryptocurrency) can be used like a regular currency to buy things or make payments ‘IRL’. How much of a benefit this might be is up for debate, but when you buy into a crypto ETF, you won’t be able to use the funds transactionally.
- As we discussed earlier, some crypto ETFs will be diversified with other stocks and asset classes. This means that if the price of BTC shoots up 50%, the value of your ETF holding won’t. So while an ETF provides leverage to BTC’s price, it may or may not be an accurate tracker of its value.
Questions still remain about Bitcoin’s future. It’s often traded on sentiment as opposed to measurable value. It may never be adopted globally in the way it was once intended. Although the natural diversification provided by an ETF helps to mitigate the risk, Bitcoin is still a volatile asset, and due diligence should be conducted.
The coming months will reveal a winner. By bringing the first crypto ETF to the ASX, VanEck hopes to democratise the asset, making it accessible to retail investors. BetaShares is confident of ‘significant demand’ from Aussie investors.
While confidence in Bitcoin as a mode of currency rises and falls, crypto ETFs may provide a safer and more appealing route into the asset class.