All About Cryptocurrency ETFs

Yesterday, a crypto asset management company called Hashdex debuted on Brazil’s Sao Paulo stock exchange as South America’s first crypto index ETF (Exchange Traded Fund).

The fund will track the Nasdaq Crypto Index (NCI) which was co-developed by both Nasdaq and Hashdex. During the pre-offer booking period, the ETF reached upto R$615m ($112m) in value, marking a breakthrough in the evolution of crypto asset classes in Latin America and all over the world.

If you’ve missed the last few alerts on your monthly crypto digest, here’s the latest. Crypto ETFs are the new buzz on the streets given their “easy-to-invest” status in the world of crypto exposure.

For years, regulators around the world (especially in the US) have resisted approving them as accepted crypto assets and allow their trading. A few firms have tried to bypass these restrictions (we’ll get to how in a while) and build the groundwork around their operation awaiting their authorisation someday.

Well, it looks like that day just got a little closer. Let’s give you a tour of this new and imminent crypto asset class that may become serviceable in your nearest financial markets very soon.

What are ETFs?

Picture a tracking device. Now picture affixing that device on to any asset (metals, commodities, stock indexes etc.) and imagine the device reading fluctuating as per the market value of these assets.

An ETF is essentially a type of security that tracks other assets (the underlying asset). It can be designed to track anything from the price of an individual commodity to a large collection of securities or even the entire index. And it can be traded on the exchange just like a stock i.e. can be bought and sold freely.

What are Crypto ETFs?

These are ETFs which are designed to track cryptocurrency or digital tokens. They are marketable securities that can be listed on the stock exchanges (instead of crypto exchanges) and would trade like common stocks.

It would be fair to describe crypto ETFs as blockchain’s side doors. They are a hybrid of traditional and cutting-edge investment structures and their purpose is to enable buying and selling of crypto assets smoothly.

Considering an average retail investor may find it difficult to navigate the avant-gardemechanisms involved in direct Bitcoin investments, ETFs provide a way to invest in them minus the complexities (mining, securing, storing et.al.). Investors neither have to sign up for a digital wallet nor a crypto exchange nor do they have to routinely monitor cryptocurrency prices. An ETF simplifies the investment in crypto while also providing leverage to the price of cryptocurrencies like Bitcoin without necessitating knowledge about how Bitcoin works.

So Why Aren’t We Legalising Them?

The answer is perhaps, the same regulatory distrust in all crypto assets witnessed all over the world due to concerns over manipulation and criminal activities.

The first crypto ETF, called the Purpose Bitcoin ETF, was launched this February on the Toronto Stock Exchange. In under a month, it crossed the billion-dollar mark in assets under management.

In yet another novelty in the crypto world, a firm called Horizons ETF announced plans to release a fund which will allow investors to take short positions on Bitcoin futures, sort of like an inverse Bitcoin ETF betting on the cryptocurrency plunge.

And now with another launch in Brazil, the enthusiasm and appeal to authorise crypto ETFs is gaining huge momentum in the USA, especially since the crypto-fever in American markets has been raging since the past year and climaxed recently after Coinbase’s IPO, the country’s largest cryptocurrency exchange.

Did You Know? Nigeria is the largest cryptocurrency market in the world, with 32% citizens saying they used or owned them, the highest in any country!

Prominent ETF Applicants

In the last eight years, the Securities and Exchange Commission (SEC) of the US has dismissed every Bitcoin ETF application. This has proved to be a thorn on the side of investors and brokerage firms who want to taste the exposure to the lucrative crypto asset classes so badly, they can almost taste it.

The firms in reference are mostly publicly-traded Bitcoin trusts, like Greyscale, Bitwise or Osprey. These are entities which offer closed-end fund holdings in Bitcoin to their investors in “cold storage” or offline mode.

They are, in essence, wannabe crypto ETFs who have adopted almost-similar business models to crypto ETFs in anticipation of becoming legitimised one day. Operative word being “almost” as they don’t want to sidestep regulation because crypto ETFs aren’t legal in the USA yet.

They do this by carefully distancing themselves from direct exposure to crypto assets. For instance, Grayscale only has a fixed number of shares unlike ETFs which can always create new shares.

Another difference lies in their accessibility since they are only available to US-based accredited investors. That leaves out the budding and fervent crypto enthusiasts who can’t qualify the net worth and income threshold to get in the game. So there isn’t retail participation yet.

The ETA for Crypto ETFs

The argument for authorising crypto ETFs that stakeholders like Greyscale, Osprey and others presented to the SEC over the years is basically this: You don’t have to fear what you don’t understand.

Bitcoin’s volatility has been a historical sore in the authorities’ eyes who are not used to such rapid fluctuations in the good old fiat currency systems. To counter this, the stakeholders say that once access to crypto increases, volatility will decline. Plus, ETFs will bring price competition to the markets along with transparency, tax reporting and trading efficiency.

Real ETFs also tend to have fewer and less volatile tracking errors which are currently faced by the crypto trusts because of their hybrid nature. Trusts have also traded at large premiums or equally large discounts to the price of underlying assets, which they say, will diminish once they start trading real crypto ETFs.

Another thing. ETFs can hold more than one asset class and offer a chance at diversifying one’s equity portfolio. This is what has enticed even big market players like Morgan Stanley to apply with the SEC for adding Bitcoin to 12 of its mutual funds. So, a chance to mitigate risks too, eh?

Cryptos Interruptus

But what about limitations? Bitcoin can be traded for other cryptocurrencies like Ethereum, XRP, Dogecoin etc. A Bitcoin ETF, however, not so much.

Secondly, crypto puritans still firmly believe that the entire premise of Bitcoin was to liberate the traditional financial structures. Integrating cryptocurrencies with stocks simply bundles them under the same regulatory purview which they were originally aimed at denouncing.

Let’s say that crypto ETFs are authorised and accepted tomorrow. Which fund or trust is likely to get clearance first? Because in spite of functioning dedicatedly in a market for so long, it may just be one firm’s day in the hey, the one who gets approval firstand singularly capitalises on the debut market swell, aka the market maker. That wouldn’t be fair to other firms, would it?

Regardless, investors are pretty optimistic that crypto ETFs will soon turn into a market reality. Between the wounded American flex over Canada sanctioning them first and the expectation that the incoming SEC Chairman Gary Gensler would be favourable given his deep expertise in cryptocurrencies, markets are extremely hopeful.

After all, even gold wasn’t readily market-accessible before ETFs came along. Owning Bitcoins may be like owning gold but owning a Bitcoin ETF is like owning a gold miner.

(Originally published April 28th 2021 in transfin.in)