A deep dive on using exchange traded funds (ETFs)

Sheer number of crypto assets available today may make any trader feel overwhelmed. They might want to make their portfolio broad-based to minimize risk and yet, the enormous amount of research involved might deter them from executing the strategy. Blockchain-based exchange traded funds (ETFs) can provide them a way around.

What are ETFs

ETFs provide the investors exposure to an array of cryptocurrencies without having to actually own them. Bought and sold on the exchange like any regular cryptocurrency, these thematic funds provide one with broad market exposure as these funds generally invest in a range of stocks, bonds, and/or other assets.

A bitcoin ETF, for instance, is an exchange-traded fund that would track the price of bitcoin and facilitate the purchase or sale of the security on an exchange any time of the day. The security could be settled in cash or physically, meaning when an investor exists, they will receive either fiat or bitcoin. Johnny Lyu, CEO at KuCoin, explained how Bitcoin ETFs have changed the scenario on cryptospace, “The advent of Bitcoin ETFs is set to transform the investment scene by infusing the crypto sector with increased liquidity and providing a structure for regulatory oversight and risk management, paving the way for broader mass adoption of cryptocurrencies. If navigated well, it could potentially lead Bitcoin ETFs to herald a new chapter in cryptocurrency investment.”

Canada’s financial regulator, the Ontario Securities Commission (OSC), approved the world’s first two bitcoin ETFs in Aug 2023. These are Purpose Bitcoin ETF (BTCC) and the Evolve Bitcoin ETF (EBIT), both physically settled ETFs.

ETFs, route to broad market exposure

ETFs are low-risk investments in a broad-based market as they enable one to hold an array of stocks or other securities, thus facilitating diversification at a slashed cost. For individual investors, most of whom lack advanced skills, ETFs come across as a type of assets that allow one to build a diversified portfolio with relative ease. There are ETFs focused on categories like Bitcoin mining, strategy, crypto industry innovation, and more.

Investing[ into one ETF could give one exposure to several stocks from a particular category or a broad market index. For instance, Global X Blockchain ETF (BKCH) invests in enterprises benefiting from the adoption of blockchain technology. If anyone is interested in putting in their money in crypto mining companies, entities developing new blockchain applications, and crypto exchanges, they could invest in BKCH.

A key part of crypto asset management, ETFs simplify the complexities investors would have faced if they were to research, earmark, invest and manage funds in those companies separately. Buying individual stocks in companies is not just a cumbersome exercise in terms of the research required, but more expensive as well.

As a potent investing tool, ETFs enable one to build a diverse portfolio of digital assets, enhancing the probability of an investor finding successful investments. A broad-based portfolio helps because cryptocurrencies have been a volatile market. While one may gain if they put in their money in the right coin at the right time, they might also face huge losses if the market takes a dive.

ETFs are usually professionally managed by investment experts though there might be some passively-managed funds as well. Often, they compete with market index funds that are managed in line with a stated objective regarding returns. Prospective of an ETF provides information on the ETF’s investment objective, proposed strategies, costs, risks, and historical performance.

Blockchain-based ETFs vs cryptocurrency ETFs

Blockchain ETFs own the stocks of companies engaged in developing blockchain technology or simply using the tech to execute their operations. Such funds usually invest in a broader basket of assets than cryptocurrency ETFs that just track the price movements of individual cryptocurrencies.

Application of the blockchain technology goes well beyond cryptocurrencies in domains as diverse as healthcare, retail, finance and banking, real estate, supply chain and logistics, voting and governance, insurance, and more.

Take the case of a food product, where the blockchain may store the product details with a package, facilitating digital authentication of its quality throughout the product lifecycle. Yet another example could be a multinational corporation (MNC) that might be using technology to create an automated system for invoice management.

Blockchain ETFs keep investing in stocks of regulated corporations, which are usually large technology firms with no direct involvement in cryptocurrencies. A glance at three top blockchain funds in 2022, ranked by one-year trailing total return, will help understand better. These funds, namely First Trust Indxx Innovative Transaction & Process ETF, Siren Nasdaq NexGen Economy ETF, and Amplify Transformational Data Sharing ETF majorly invested in Infineon Technologies AG, JPMorgan Chase & Co., and International Business Machines Corp.

Examples of cryptocurrency ETFs could be ProShares Bitcoin Strategy ETF (BITO) and Bitwise Crypto Industry Innovators ETF (BITQ). BITO provides exposure to BTC via futures contracts, which are derivatives mentioning terms to buy or sell Bitcoin at a future date. BITQ offers a broader focus on the cryptocurrency ecosystem taking an investor beyond BTC.

Kritika Ravichandran, Founder of a decentralized vetting protocol Partnr, stated how cryptocurrency ETFs work, “For someone who understands mutual funds and stocks, the best instrument to understanding cryptocurrencies as an asset is through Cryptocurrency ETFs. These can be held in a regular brokerage account and traded intraday like stocks.”

Where do ETFs invest

Depending on the objectives and scope, the ETFs might invest in hundreds of different projects. These can be segregated into a few broad categories:

Hardware companies: Blockchain systems require hardware such as microchip to function. Some blockchain-based ETFs could be investing in companies such as NVIDIA Corp that develop hardware like microchips.

Financial services: Companies such as Galaxy Digital Holdings manage crypto assets that have blockchain underneath their value.

Companies that own crypto assets: Few ETFs might put in funds in enterprises like MicroStrategy and Tesla having plenty of digital assets.

Crypto exchanges and miners: Coinbase and Kraken are examples of cryptocurrency exchanges. On the other hand, the likes of Riot Platforms and Hive Blockchain Technologies are mining companies.

While cryptocurrencies have been known for their volatility, leading to big gains and huge losses, ETFs provide an alternative to make the investment more broad-based. Limiting cryptocurrency investment to a few digital coins could be risky, given the quick ups and downs in the prices and evolving regulatory environment. ETFs that might be investing in scores or even hundreds of stocks are designed to provide plenty of diversification.

Concepts to remember when investing in ETFs

It is important to understand a few concepts before investing in ETFs:

Active vs passive ETFs: In active ETFs, portfolio managers take care of the funds invested. Passive EFTs, on the other hand, just track a stock index. Passive ETFs are designed to match an index’s performance, while active ETF managers work to get past an index’s graph.

Dividends and dividend reinvestment plan (DRIP): ETFs usually pay dividends. One could take home the dividends or opt to have them automatically reinvested via DRIP.

Expense ratios: ETFs charge fees, termed as the expense ratio, listed as an annual percentage. If an ETF has a 1% expense ratio, it means one needs to pay $1 in fees for every $100 they invest.

Technical advantage of buying crypto or blockchain-based ETFs

Buying BTC and other cryptocurrencies requires one to keep wallets supporting those coins. For many, cryptocurrency wallets are still uncharted territory. If they have several wallets to hold their coins, the burden of security becomes considerable. They have to keep their private keys secure. The investors might also need to buy hardware wallets to store crypto assets with extra safety.

When purchasing an ETF, investors don’t have to fret about private keys, storage, or security. Resembling shares of stock, they own shares in the ETF. They get exposure to a basket of digital coins without going through the process of purchasing crypto assets multiple times. Simplifying crypto investment for regular folks can drive up the public adoption of cryptocurrencies.

How to invest in ETFs

Traders can buy cryptocurrency-related ETFs through brokers such as Robinhood, Fidelity, Trading212, or TD Ameritrade.

Here are the steps one needs to follow when investing in ETFs:

Open a brokerage account: One needs to figure out a suitable broker and open an account with them.

Decide the amount to invest: Depending on the investment goals and other factors, determine the right amount to invest in an ETF.

Place a market order: Find the ticker symbol of the desired ETF and place a market order for it.

Set up an automatic investment plan: Anyone interested in buying more shares of an ETF at regular intervals can set up an automatic investment plan.

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