Exploring the Pros And Cons of Investing in a Cryptocurrency ETF
Since the emergence of the first ETF in 1993, when the American Stock Exchange launched Standard & Poor’s 500 Depository Receipts (SPDRs), the ETF market has grown into a $3 trillion industry that is experiencing investment inflows from institutional and retail investors alike.
What is an ETF?
ETFs (exchange-traded funds) provide investors with a convenient low-cost way to purchase an index that tracks underlying assets such as stocks, bonds or commodities without having to go and individually buy each underlying asset. Instead, investors can simply buy shares in the specific index-tracking ETF that they would like to hold in their investment portfolio.
Furthermore, ETFs allow investors to own assets that are otherwise difficult to buy and store, such as gold or silver, for example, which is another reason why this asset class has grown in such popularity over the last 24 years.
Currently, there are thousands of ETFs ranging from straightforward stock index-tracking funds to very esoteric ETFs such as the AlphaClone Alternative Alpha ETF, which mimics hedge fund trading strategies for U.S. equities or the ProShares Ultra Nasdaq Biotechnology, which gives investors 2x leveraged exposure to the Nasdaq Biotechnology Index.
Interestingly, there is a new asset class that may soon also be available for purchase through an ETF. That asset class is digital currencies.
Bitcoin and Ethereum ETFs
Due to the increasing demand for digital currencies such as bitcoin and ethereum as investments, several investment companies have filed digital currency ETFs with the U.S. Securities and Exchange Commission (SEC) in the hope to package this new digital asset class into a well-known and regulated investment vehicle.
A bitcoin ETF, for example, would allow large institutional investors to easily gain exposure to this promising new asset class in a fully regulated format. Additionally, it would also provide retail investors with the opportunity of investing in bitcoin without having to personally buy and securely store the digital currency themselves.
Having the option to buy and sell an ETF whose value tracks the price of bitcoin or ethereum as easily as you would buy or sell a stock would be welcomed by investors who would like to diversify their portfolios to include these hot new digital assets.
Pros and Cons of Digital Currency ETFs
When it comes to digital currency ETFs, there are pros as well as cons that need to be taken account from an investor’s point of view.
Pros Are Centered Around Ease of Use
The main selling point of a bitcoin or an ethereum ETF would be that these investment vehicles could be easily bought and sold on regulated stock exchanges, which would mean:
- Any investor could easily gain exposure to digital currencies as an asset class.
- No need to learn or worry about the technicalities of purchasing digital currencies
- Investors would be able to deal with regulated financial institutions when buying and selling these ETFs, instead of dealing on unregulated online digital currency exchanges.
- ETF are more liquid would be easier for buying/selling than digital currency exchanges.
- Investors would not be faced with the tricky aspect of secure storage of their digital currency holdings. Digital currencies are kept in digital wallets and can be prone to cyber theft. Digital currency ETF investors would not have to worry about this are their coins would be stored by the fund’s custodian.
As appealing as a digital currency ETF may sound, there are also several downsides to owning a bitcoin or ethereum ETF versus holding the actual digital currency itself.
Cons and Why Owning the Asset is a Better Investment
First, digital currencies are known to be a good hedge against financial markets turmoil. The price of bitcoin, for example, has spiked in the wake of the Greek debt crisis, during Cyprus’ bank bail-ins and after the announcement of the ‘Brexit’ referendum results.
- Holding bitcoin indirectly through an ETF could negate the hedge ability of the investment
The price of the ETF could easily be negatively affected when investors sell off risky assets. While the price of shares in an ETF is meant to track the underlying asset(s), their value is also driven by supply and demand for the ETF’s shares. Hence, a bitcoin ETF would likely not act as a hedge as well as the digital currency itself would.
Second, ETF investors need to trust the custodian of the ETF.
- While a custodian bank’s own funds and those of clients should be legally separated, it could occur that investors lose the capital they have invested in an ETF held at a custodian that is forced to declare bankruptcy.
This risk is considered to be rather low, the global financial crisis in 2008 has shown the world that it is possible even for large banks to fail.
Third, most proposed digital currency ETFs do not insure their bitcoin holding against theft or loss.
- If your investment is lost to hackers, ETF managers will not reimburse the funds.
While you would expect bitcoin ETF managers to know how to securely store large digital currency holdings, it is also possible for professionals to fall victim to theft when it comes to their bitcoins.
Despite the benefits that a digital currency ETF can bring to the market, as an investor you will most likely be better off investing directly in the digital currency of your choice. Whether you are looking at investing in bitcoin, ethereum or ripple, you will probably be better off allocating a part of your retirement fund in digital currencies directly, instead of investing in an investment vehicle that only provides you with indirect exposure and carries several other risks along with it.