What To Know Before Investing In Crypto ETFs

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Despite all the backlash over cryptocurrency exchange-traded funds (ETFs), ETFs are taking the investment world by storm. The real beauty of ETFs is that they allow investors to buy into the world of digital assets without having to own the asset themselves. However, uncertainties and knowledge gaps still persist among many investors who are looking to understand exactly how crypto ETFs function. 

This lack of clarity has led to the stalling of crypto ETF adoption among more risk-averse global asset managers, who are unsure of how to balance risk and reward in novel digital spaces. This is unfortunate because Crypto ETFs actually offer a great entry point into cryptocurrency as they pose less risk than direct investment.

Cryptocurrency ETFs are used to track the price of one or more digital tokens, either by investing in physical shares of the crypto or by adopting futures contracts, which are an agreement to sell the ETF for a predetermined price in the future. Investments are based on speculation of future value, rather than the asset’s current selling price. 

ETFs function similarly to conventional stock exchange-traded funds, providing a degree of comfort and familiarity to investors looking to creatively diversify their portfolios. After Bitcoin Futures (BTC-F) started publicly trading on Wall Street in October 2021, there was a wave of new investors from centralized finance who were looking to capitalize on ETFs as a cheaper, simpler way to gain exposure to digital markets. 

However, fluctuating regulations imposed by the SEC are proving difficult to monitor. This in turn creates challenges to identifying the best opportunities for ROI. But with sufficient information and tools, both existing and would-be investors can take advantage of the ever-changing regulatory landscape, protect their assets, and substantially increase profits. 

Risk analysis is key

The current uncertainty about a regulatory framework for cryptocurrency ETFs does indeed lead to some risk––largely through fluctuations in crypto value––but investors can mitigate these liabilities. Risk analysis for crypto ETFs requires the same approach from investors as they would undertake in traditional finance schemes. 

First, investors must consider the relationship between risk and return, weighing the higher risks associated with crypto ETFs against potential gains. Though crypto ETF holders don’t own actual crypto, they are still subject to many of the risks and volatility. Even though you may be invested in a publicly traded crypto ETF, you’re not entirely protected from the risks stemming from the fluctuating value of the unregulated currency itself. 

Therefore, before investing, it’s important to identify and understand the primary risks: trading interruption, redemption risks, and price volatility. Remember that liquidity remains an option for crypto ETF investors at times of high volatility, albeit at what are likely to be highly discounted rates.

It’s also crucial to understand and weigh risks between physical-backed versus futures-backed ETFs. Physical-backed, or owning actual shares of the crypto, poses more risk. Futures-backed leaves you less exposed, as there are no actual physical assets to be protected, because they are based on futures contracts—an agreement to buy or sell an asset at a predetermined price at a specified time.

Pros and cons of Crypto ETFs

Crypto ETFs are inherently more stable than the assets themselves, which is why investors can use ETFs as a comparatively safe way to invest in blockchain technology. This is because Investors in crypto ETFs are not purchasing anything—rather, they are investing in the prospect of the blockchain’s success. If you’re short on time and resources, crypto ETfs are a great way to diversify your portfolio, allowing you to invest in multiple cryptocurrencies at once. 

However, it is still possible for a crypto ETF to underperform the crypto itself. That’s because any future option can underperform the underlying asset it is tracking; futures lock in the price of a crypto months in advance, but the spot price varies widely on different crypto exchanges. Furthermore, when futures contracts expire and roll over to newer versions, they accrue management and transaction fees. 

Crypto ETFs, whether backed physically or through futures, are also ​​made for long-term investment. They don’t reap profit right away, which leads to delayed returns. ETFs are less than ideal for those looking to make a quick buck. 

The SEC’s approval of the first cryptocurrency ETF demonstrates policymakers’ desire to corral crypto into more regulated venues, so investors can expect more safeguards and less volatility to come. As Wall Street traders continue to adopt crypto ETFs, their efforts will also lead to increased federal oversight. 

Safeguard your portfolio

A better regulatory framework should arrive soon as the SEC continues to review crypto ETFs and assesses ways to mitigate price manipulation. Meanwhile, how do you manage your assets in a way that strengthens the safety of your portfolio?

The key takeaway here is diversification: ETFs allow investors to easily diversify their portfolios by investing in various cryptocurrencies under a single umbrella. But investors must also maintain patience. Crypto ETFs are part of a long game that will routinely go through boom and bust cycles. Don’t bail as soon as values go awry. Treat crypto ETFs as you would a conventional suite of assets, committing to a multi-year plan. Since crypto ETFs provide another degree of security, as investors don’t have to worry about personally securing their crypto wallet, they present investors with fewer worries. 

Some financial advisors maintain that intermediaries and middlemen involved in ETF investments, such as hedge funds, benefit more than individual investors. This doesn’t have to be the case. All you have to do is take responsibility for your own investments to obtain a degree of lucrative financial autonomy—and that’s what crypto is all about.

Some popular Crypto ETFs include: BITO, GBTC, ETHE, BITW, BTF, BITS, VBB, XBTF.

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Alexis Renault 1 year ago Member's comment

This is a good idea. I've been interested in getting into the crypto space, but have been intimidated by both my lack of knowledge, as well the associated volatility.  Crypt ETFs sound like a good alternative to test the waters.