Exchange-Traded Funds (ETFs) have seen a rapid rise in popularity since their introduction in the mid-1990s. Their unique structure combines the advantages of mutual funds with the adaptability and liquidity features of individual stocks, which may explain their growing appeal.
Unlike mutual funds, which can only be bought or sold at the end of a trading day, ETFs trade throughout the day on exchanges. This flexibility makes them attractive for both long-term investors and active traders.
This highly adaptable financial instrument has recently expanded into the world of digital currencies, giving rise to cryptocurrency ETFs. These funds track the value of one or multiple crypto assets, offering a streamlined way to invest in the unpredictable yet potentially rewarding cryptocurrency market.
Key Takeaways
- Crypto ETFs track cryptocurrency prices, enabling investment without direct ownership.
- They function by creating and redeeming shares based on the value of underlying crypto assets.
- Benefits include ease of use, diversification, and trading flexibility.
- Offering crypto ETFs helps brokers meet client demand, diversify services, and access crypto markets.
What Is a Cryptocurrency ETF?
A cryptocurrency ETF is an investment vehicle that tracks the price of one or more digital currencies. These financial instruments enable investors to gain exposure to the crypto space without directly purchasing, selling, or securely storing crypto assets.
This feature makes crypto ETFs particularly appealing to traditional investors who are interested in the high-return potential of cryptocurrencies but are concerned about their volatility or feel daunted by the technical challenges of managing crypto holdings.
Crypto ETFs mimic the mechanics of traditional ETFs, which usually track specific indices, sectors, commodities, or assets. In the case of crypto ETFs, they may track a single cryptocurrency like Bitcoin or Ethereum, or a basket of multiple cryptocurrencies.
The goal of these ETFs is to mirror the performance of the tracked cryptocurrencies, allowing investors to gain exposure to price movements without holding the assets directly.
How Do Cryptocurrency ETFs Work?
The creation and redemption process is central to how cryptocurrency ETFs operate, as it aligns the ETF’s value with its underlying assets. Simply put, authorized participants (APs)—typically large financial institutions—purchase the underlying cryptocurrencies and generate ETF shares for the crypto ETF.
APs buy large quantities of the applicable cryptocurrencies and deposit them with the ETF provider. In exchange, the ETF provider issues ETF shares to the AP, which can then be traded on the stock market. The value of the ETF shares rises and falls with the price of the cryptocurrencies they track.
To prevent the ETF share price from drifting too far from the value of the assets it follows, APs step in to arbitrage—either buying additional cryptocurrencies to create more ETF shares (during high demand) or selling the underlying cryptocurrencies (during low demand).
In simple terms, crypto ETFs allow investors to put money into the cryptocurrency market without dealing with unfamiliar tools like digital wallets or cryptographic keys.
Advantages and Risks of Trading Crypto ETFs
Every investment opportunity comes with its own set of strengths and weaknesses. The emerging market of crypto ETFs combines the unpredictability of cryptocurrencies with structural elements of traditional ETFs, bringing both benefits and risks.
Benefits of Trading Crypto ETFs
Ease of Use – Crypto ETFs merge cryptocurrency with the traditional investment landscape, making them easily accessible for everyday investors. For example, you don’t need to learn the mechanics of blockchain, store private keys, or use digital wallets. Crypto ETFs trade on traditional stock exchanges, allowing anyone with a standard brokerage account to participate in the crypto market.
Cost Efficiency – Despite regulatory ambiguities, investors already familiar with ETFs may find crypto ETFs an affordable way to gain exposure to volatile asset classes. Certain funds allow investors to access crypto markets without committing large amounts of capital.
Diversification – One of the advantages of crypto ETFs is the opportunity for diversification. While some ETFs track individual cryptocurrencies like Bitcoin or Ethereum, others follow a basket of digital tokens. This is similar to the difference between sector-specific ETFs and broad-market ETFs—the former may rise or fall with a specific industry, while the latter spreads risk across multiple sectors.
Liquidity – Crypto ETFs trade on traditional stock exchanges, meaning they can be bought or sold at any time during trading hours. This liquidity enables investors to react quickly to market changes. For instance, if the price of Bitcoin begins to drop sharply, holders of a Bitcoin ETF can sell their shares immediately to limit potential losses.
Risks of Trading Crypto ETFs
Volatility – Cryptocurrencies are notorious for their price volatility. Sharp price swings are common and directly impact crypto ETFs. For example, in 2020, Bitcoin’s value dropped dramatically, falling from nearly $10,000 to around $5,000 in just one month. A similar decline would affect the value of any Bitcoin ETF.
Regulatory Risk – The legal and regulatory landscape for cryptocurrencies is still evolving and varies by country. Changes in regulations can significantly impact the value of crypto ETFs. For instance, if a major economy imposes stricter regulations on cryptocurrencies, it could trigger a market-wide sell-off, reducing the value of crypto ETFs.
Market Manipulation Risk – The cryptocurrency market is susceptible to manipulation, such as "pump and dump" schemes, where fraudsters artificially inflate a currency’s price before selling their holdings, causing a sharp price drop. Such manipulation can adversely affect the value of ETFs tracking those currencies.
ETF Expense Ratios – Like traditional ETFs, crypto ETFs have expense ratios, which are essentially management fees charged by the ETF provider. For example, if an ETF has an expense ratio of 0.75%, you would pay $7.50 annually for every $1,000 invested. While this may seem small, these fees can add up over time and eat into potential returns.
How to Trade Crypto ETFs
Depending on your skill level, risk tolerance, and personal preferences, there are several ways to trade crypto ETFs.
ETF CFDs
Trading ETFs using Contracts for Difference (CFDs) is a common strategy. With CFDs, an agreement is made between the broker and the trader to settle any price fluctuations. Without buying the underlying asset, you can still profit from price movements by trading ETFs via CFDs.
CFDs allow you to trade ETFs in both directions. If you expect the ETF’s price to rise, you can take a long position. Conversely, if you believe the price will fall, you can short the ETF.
ETF Options
ETF options trading is another avenue to explore. These derivative contracts, tied to futures prices, allow you to hold a position without committing to buying or selling the underlying asset at contract expiration. The strike price you agree to when buying an options contract is based on the futures price.
If the futures price approaches the strike price before expiration, you profit; if it moves away, you lose the premium paid.
ETF Futures
Futures contracts also allow investors to speculate on an asset’s price at a future date. Unlike CFDs and options, buyers of futures contracts must either take delivery of the underlying product or roll over the contract’s expiration date.
👉 Explore advanced trading methods
Where Can You Buy Crypto ETFs?
Cryptocurrency ETFs, much like traditional ETFs, can be listed or traded on established exchanges or through brokers. Therefore, the first step to investing in crypto ETFs is to set up an account with a broker that provides access to exchanges listing these ETFs.
Popular brokerage platforms like Charles Schwab, Fidelity, or TD Ameritrade are commonly used by investors. Several online and app-based brokers have also entered the space to cater to a new generation of investors.
Once you’ve set up your brokerage account and deposited funds, investing in crypto ETFs is straightforward. Use the platform’s search function to find the desired crypto ETF. This can be done by typing the ETF’s ticker symbol—a unique combination of letters assigned to each fund.
For example, if a Bitcoin ETF has the ticker symbol "BTCF," you can search for it using this code on your trading platform.
After locating the ETF, you can place an order to buy shares. The process is similar to purchasing regular stocks—you specify the number of shares you want and the price you’re willing to pay per share. Once your order matches with a seller, the trade is executed, and the ETF shares are added to your portfolio.
Why Investment Firms Offer ETFs
From a brokerage perspective, adding ETFs—including crypto ETFs—to their list of tradable assets offers several advantages.
First and foremost, ETFs meet growing investor demand. As financial markets evolve, investors seek modern, flexible, and diversified investment tools. ETFs fit this need perfectly, offering an efficient way to gain exposure to a wide range of asset classes, from stocks and bonds to commodities and now cryptocurrencies. By offering ETFs, brokers can meet this demand, attract new clients, and retain existing ones.
The potential for increased trading volume is another attractive reason. Due to their intraday tradability and flexibility, ETFs often see high trading volumes. Greater trading activity can generate more revenue for brokers, especially those that earn from trading commissions.
Offering ETFs allows brokerage firms to diversify the investment options on their platforms. Diversification isn’t just a strategy for investors; it’s also crucial for brokers. By providing a wide range of ETFs—based on industries, indices, commodities, and cryptocurrencies—brokers can ensure they cater to various investment preferences and strategies, broadening their client base.
Including cryptocurrency ETFs in their offerings also allows brokers to ride the wave of crypto interest. Despite volatility, interest in the cryptocurrency market has surged dramatically. Crypto ETFs enable brokers to tap into this trend, allowing their clients to participate in the crypto market in a more familiar and accessible way. This differentiates brokerage firms from competitors and can further drive client engagement.
Finally, the growth trajectory of the ETF market makes it a lucrative area for brokers to explore. The global ETF market has been expanding rapidly and is expected to continue its upward trend. Brokers that offer ETFs can benefit from this growth and position themselves as forward-thinking companies.
How to Add ETFs to Your Investment Firm
Ensuring liquidity for ETFs is a critical part of the process. Let’s discuss the detailed steps an investment firm needs to take to add ETFs to its platform.
The first step is to conduct market research. Understanding current market demand for ETFs, identifying the types of ETFs investors are interested in, and assessing the competition are key focuses of this research. This data helps the firm decide which ETFs to add and provides insights into potential marketing strategies.
Next, the company needs to ensure regulatory compliance. Different jurisdictions have varying regulations for ETFs, and the firm must adhere to them. This may involve obtaining necessary licenses or permits, filing documents with regulatory bodies, or adjusting the company’s operations to meet regulatory standards.
The third step is to update the company’s technological infrastructure. Since ETFs trade throughout the day like stocks, the broker’s trading platform must support intraday trading of these instruments. This might require software updates or a comprehensive overhaul of the trading platform.
A crucial part of the process is finding an ETF liquidity provider. Liquidity providers are essential for maintaining an orderly ETF market. They create and redeem ETF shares to ensure the ETF’s price stays close to the value of its underlying assets.
They also provide the necessary capital to facilitate trades. Finding a reliable liquidity provider is vital, as it ensures ETFs trade smoothly and transparently on the platform.
Finally, the last step is to list and launch the ETFs. This includes adding the ETFs to the trading platform, updating the broker’s product listings, and training staff to handle customer inquiries about the new products. Launching a marketing campaign to inform existing and potential clients about the new ETF offerings is also important.
Final Thoughts
In the first quarter of 2023, crypto ETFs outperformed all other ETFs, with growth rates ranging from 61.95% to 98.66%. With such a strong performance record, it’s clear why ETFs are a preferred investment tool for many market participants.
Therefore, having a comprehensive understanding of this investment vehicle and its intricacies is essential for both investors and financial service providers.
Frequently Asked Questions
Are ETFs and mutual funds the same?
No, ETFs and mutual funds are not the same. While both offer diversification and professional management, ETFs trade like stocks throughout the day on exchanges. Mutual funds are priced at the end of the trading day and can only be bought or sold at the net asset value (NAV) price.
Where can I buy crypto ETFs?
You can purchase crypto ETFs through brokerage platforms that provide access to specific ETFs. Ensure your chosen broker supports trading in crypto ETFs and follow their process to buy the desired fund.
Are ETFs safe?
ETFs carry risks but are generally considered relatively safe investment options. They are regulated, diversified, and transparent, which can help mitigate some risks associated with direct asset ownership.
How can I invest in Bitcoin through an ETF?
To invest in Bitcoin via an ETF, you need to find a BTC ETF listed on a recognized exchange. Open an account with a broker that allows trading in BTC ETFs, deposit funds, and place a buy order for the ETF shares. The ETF will track Bitcoin’s price movements, allowing you to gain indirect exposure to the cryptocurrency’s performance without buying Bitcoin directly.
What is the difference between a crypto ETF and holding cryptocurrency directly?
Crypto ETFs provide exposure to cryptocurrency price movements without the need to store or manage digital assets. Direct ownership involves holding cryptocurrencies in a digital wallet, which requires technical knowledge and carries security responsibilities.
Can I trade crypto ETFs outside regular market hours?
Most crypto ETFs trade only during standard exchange hours. However, some brokers may offer extended-hours trading, though liquidity may be lower during these times.