Cryptocurrency and the blockchain it lives on have been hot topics on Wall Street for some time now, and for a good reason. If you had purchased $10,000 worth of Bitcoin — the most popular cryptocurrency — five years ago, your investment would have ballooned to become worth more than $830,000 today.
There’s nothing that turns investors’ heads quite like seeing this type of growth.
That’s why ProShares recently launched the first Bitcoin ETF, the ProShares Bitcoin Strategy ETF (ticker: BITO). These crypto ETFs seem to be trending too, as other firms like Vaneck, Valkyrie, and Invesco are all planning the launches of their own versions. But what exactly is a Bitcoin ETF and is it something you should consider for your portfolio?
What Is a Bitcoin ETF?
Like any other exchange-traded fund, Bitcoin ETFs trade on major stock exchanges like the Nasdaq or New York Stock Exchange (NYSE). All you need in order to purchase shares is a brokerage account and a few bucks to invest.
What’s different about these funds and other ETFs is the asset class the funds invest in. Most ETFs provide access to a diversified portfolio of stocks, futures, and other assets. Bitcoin funds are centered around Bitcoin itself.
Theoretically, there are two ways this can work:
- “Physical” Bitcoin Fund. A fund could hold actual bitcoin (BTC) in a cryptocurrency wallet and sell shares in their holdings to the investing public.
- Derivatives. A fund could also invest in Bitcoin derivatives, like futures, sharing their spoils with investors who own shares in the fund.
Although both models are theoretically possible, that’s not exactly the case from a regulatory standpoint. The United States Securities and Exchange Commission (SEC) wouldn’t approve publicly traded ETFs based on bitcoin holdings alone, at least not considering the current regulatory state of the cryptocurrency market.
Cryptocurrencies are still the Wild West of the finance industry, and unfortunately scams and fraud are prevalent. Regulators fear a fund that held units of bitcoin as its underlying asset would be far too risky given the current environment.
Instead, the Bitcoin ETFs that regulators have approved in the United States are Bitcoin futures ETFs, investing in Bitcoin futures contracts on the Chicago Mercantile Exchange (CME). This is an important differentiation because futures exchanges are heavily regulated in the U.S.
Data shows that the price of BTC in the spot market tracks pretty closely to the movement in the Bitcoin futures market, according to Matthew Hougan, Chief Investment Officer at Bitwise Asset Management. This means that activity in Bitcoin futures reflects the changes in the spot price of BTC fairly accurately.
So, when you purchase a Bitcoin ETF, you’re essentially purchasing shares in a wide range of Bitcoin futures contracts, which generally ebb and flow in the same direction as the price of Bitcoin itself, but with far less regulatory concern.
Pros on Investing in a Bitcoin ETF
Bitcoin enthusiasts and investors alike are excited about these ETFs, but what exactly is all the excitement about? There are several advantages to getting involved in these funds.
1. Exposure to Cryptocurrency Outside of Exchanges
Without these funds, if you want exposure to cryptocurrency, you’ll have to go through a cryptocurrency exchange. Unfortunately, these exchanges are unregulated and are littered with security risks.
With Bitcoin ETFs, you’ll gain exposure to changes in Bitcoin’s price without having to work through an unregulated exchange.
2. No Storage or Security Hassles
Storage and security are hot topics across the blockchain industry. Nearly every week, a new story pops up about a new scam that’s draining cryptocurrency wallets of all they have. With these funds, you never actually hold the underlying digital assets, so the risk of theft is alleviated.
3. Clearer Tax Implications Than With Owning Cryptocurrency
There are more questions than answers when it comes to the tax implications of cryptocurrency and gains generated through the trading of these digital assets. However, securities tax laws are cut and dried, and those are the laws that will govern taxes associated with these funds.
4. Ability to Short Sell
It’s impossible to short sell in the cryptocurrency market. However, in the stock market, short selling is a great way to capitalize off assets you expect to fall in value. With Bitcoin ETFs hitting the market, it’s finally possible to place bets against the growth in the value of digital tokens.
5. No Wallet Password Mishaps
You’ll need a password to access your cryptocurrency wallet. Thanks to the decentralized nature of the industry, there’s no authority or institution that owns your account that can help you manage your password if you forget it. That means that if you lose your password, there’s no way to recover it.
When investing in Bitcoin funds, you’ll gain access to the crypto market without having to worry about keeping track of an irretrievable password. You access your funds by logging into your brokerage account as you already do, and if you lose your password, your brokerage can help you reset it.
Cons on Investing in a Bitcoin ETF
While these funds may seem great at first glance, there’s no such thing as a perfect asset in financial markets. Some of the disadvantages to investing in these funds include:
1. Lack of Regulation
While futures are regulated, Bitcoin largely is not. This lack of regulation can result in fundamental issues with Bitcoin itself, which will ultimately bleed into futures returns if investors sour on the currency.
2. Highly Speculative
Bitcoin and the blockchain it lives on are relatively new technologies. While proponents of digital currencies hail it as the pivotal shift in the monetary system the world has been waiting for, there are still major bugs that need to be worked out and no guarantee of widespread consumer adoption.
As such, any investment in Bitcoin or a Bitcoin derivative is a highly speculative one.
Bitcoin is a highly volatile asset, meaning that it sees wide swings in value over short periods of time. This volatility equates to high levels of risk.
4. Liquidity Issues
If the masses don’t latch onto the concept of Bitcoin funds, you may have a hard time finding a buyer when you decide it’s time to exit your position. Because they’re so new, it’s unclear how much trading volume any particular fund will see.
5. Management Fees
All investment-grade funds come with management fees, but Bitcoin-related funds tend to charge higher fees than traditional ETFs.
6. No Dividends
Bitcoin is a digital currency, not a company. Therefore, investors can’t expect to receive dividends as part of their return on investment.
7. Lack of Diversification
Bitcoin funds are just that — they invest in Bitcoin futures only. Unlike most other ETFs that invest in a diverse group of securities or an entire market index, there’s no diversification across other financial assets in these Bitcoin ETFs, further increasing your risk.
Should You Invest in a Bitcoin ETF?
There’s no one-size-fits-all answer to the question of whether a Bitcoin ETF is a good investment for you. But you might be a good candidate to consider a Bitcoin ETFs if you have the following qualities:
- You’re Young. Young investors have plenty of time to recover should their portfolios take a dive. Due to the high risk associated with Bitcoin-related investments, older investors nearing retirement with little time to recover from a decline should avoid them.
- You Have a High Tolerance for Risk. There are several risks to consider before diving into Bitcoin investments in general. While there’s the potential for significant gains, there’s also the potential that this speculative asset will dive in value. You must be able to tolerate that risk if you’re planning to invest in these funds.
- You Want Access Without Holding Actual Coins. The primary type of investor for Bitcoin ETFs is one with interest in Bitcoin and exposure to the asset, but no drive to open a cryptocurrency wallet and hold the “physical” asset in their portfolio.
Alternatives to Bitcoin ETFs
If you’d like some exposure to Bitcoin and other digital tokens, but you’re not interested in buying an ETF that’s solely focused on these assets, there are other options.
One of the best options is to consider buying into a technology ETF that invests in tech stocks. Tech companies make the computers that mine cryptocurrencies, operate the data centers that keep the blockchain alive, and develop the processing units that make crypto mining possible.
Investing in tech-focused funds gives you a vested interest in the growth of the blockchain without dedicating your investments entirely to the blockchain or one particular asset that lives on one.
If you’re not interested in the ETF approach, you also have the option to invest in individual companies that serve the cryptocurrency marketplace.
For example, Advanced Micro Devices makes the processing units that are most commonly used in both mining machines and data centers. Coinbase is a company that operates a popular cryptocurrency exchange platform.
Investing in these kinds of companies gives you the ability to benefit from the growth of the blockchain while shielding you from the risks associated with investing solely in digital assets. However, it’s important to do your research before investing in individual stocks.
All told, the fact that Bitcoin ETFs are starting to hit the stage is a feather in the cap of blockchain enthusiasts.
Many believe cryptocurrencies are the monetary system of the future. Other assets that live on the blockchain — such as smart contracts and NFTs — have the potential to change the way the world sees the ownership of digital assets while solving major problems in various industries from entertainment to health care.
While there’s no telling what the future may hold, history has shown that investing in pivotal technologies early on tends to pay off in a big way. It’s not surprising to see so many people jumping on the blockchain bandwagon.
However, if you decide to jump aboard, make sure you do your research, understand the risks, and limit your holdings to what you feel comfortable losing.