Exchange-traded funds (ETFs) have grown in popularity as a means of investing since the mid-1990s due to their intraday liquidity and low transaction costs. In general, ETFs track a specific index and are generally traded on exchanges.
In a securities market, ETFs allow investors to trade their shares continuously throughout the trading day, unlike mutual funds, which only permit investors to purchase or redeem shares at the close of the trading day.
In the cryptocurrency market, a fund that tracks the price of one or the multiple digital tokens and consists of various cryptocurrencies is called a cryptocurrency ETF. This article will discuss how a cryptocurrency ETF works and the benefits and risks involved in cryptocurrency ETFs.
What is a cryptocurrency ETF?
A fund is treated as an exchange-traded one if it meets either of the two following criteria:
- Cryptocurrency ETFs invest in businesses transforming business applications by creating and deploying blockchain technology.
- Blockchain-based ETFs invest in cryptocurrency investment products provided by asset managers like Bitwise or Grayscale or futures and options, whose prices are linked to the performance of Ether (ETH), Bitcoin (BTC) and other cryptocurrencies.
In general, cryptocurrency ETFs are the extended use case of blockchain technology. For instance, Bitcoin ETFs are the first crypto ETF that try to track the price of BTC, the most valued cryptocurrency among digital assets.
On October 18, 2021, ProShares Bitcoin Strategy ETF (BITO) started trading Bitcoin ETFs, followed by Valkyrie (BTF) and VanEck (XBTF). Although there are no ETFs tied directly to the spot price of Bitcoin (the current market price at which underlying security can be bought or sold), managers of these products watch the price of BTC via the futures markets. Also, Grayscale’s Bitcoin Investment Trust can’t be accessed by mainstream audiences, as it is not an ETF.
Along with offering indirect exposure to BTC, Bitcoin ETFs could pose risks to investors if the fund holds a sizable portion of the futures market. Therefore, investors should be cautious while investing in volatile securities like cryptocurrencies.
How does a cryptocurrency ETF work?
Crypto ETFs either own the cryptocurrency futures, options or other crypto-based securities, in contrast to traditional ETFs that directly own the underlying asset. The intention is to emulate the fundamental cryptocurrency’s price fluctuations. However, there may be periods when the ETF movements don’t precisely match those of the underlying cryptocurrency because they don’t hold any of it themselves.
Cryptocurrency ETFs are either backed by physical crypto assets or synthetic variants such as derivatives. In the former, crypto investors indirectly own cryptocurrencies without bearing any expenses of owning them outright, and in the latter, instead of reflecting the prices of actual cryptocurrencies, the ETF share price imitates the price movements of derivatives.
So, why are crypto ETFs important? The most evident reason is portfolio diversification, as Bitcoin or Ether ETF investors can get exposure to more than one crypto asset, in particular, beyond conventional securities markets.
What are the benefits of cryptocurrency ETFs?
Although there is regulatory uncertainty around cryptocurrency ETFs, crypto investors who own exchange-traded funds may benefit from the following:
- The primary benefit of investing in exchange-traded funds like Proshares Bitcoin Strategy ETF is the affordability element of investing in a volatile asset class.
- The learning curve is outsourced to analysts while investing in cryptocurrency ETFs, making it an ideal investment …….
Source: https://cointelegraph.com/news/what-is-a-cryptocurrency-etf-and-how-does-it-work