What is a Crypto ETF? A Simple Guide for Beginners

Crypto ETFs, or cryptocurrency exchange-traded funds, are investment funds traded on a traditional stock exchange. These funds provide a straightforward way for investors to gain exposure to digital assets, including Bitcoin (BTC) and Ethereum (ETH), without the need to directly own them.

There are two main types of crypto ETFs: spot ETFs and futures ETFs. Spot ETFs funds hold the digital asset, and investors own its shares, while Futures ETFs track the prices of digital currencies through futures contracts.

While cryptocurrency ETFs offer several benefits, such as portfolio diversification and liquidity, they also carry risks, including a lack of direct ownership of the digital currency. Therefore, before investing in such funds, it is crucial to understand their working methodology.

Let’s find out what a crypto ETF is, its types, and the ways to invest in such a fund securely.

What are ETFs?

ETFs, or exchange-traded funds, are regulated investment funds that comprise a diverse range of securities, including commodities, stocks, and other assets. These funds are listed on traditional stock exchanges, such as the New York Stock Exchange (NYSE), where investors can buy and sell them like stocks. However, unlike stocks, which represent direct ownership of an asset, ETFs represent a basket of assets, including bonds, stocks, and derivatives such as futures contracts.

Often compared to mutual funds, Exchange-traded funds (ETFs) differin many ways. Unlike mutual funds, which are typically priced at the end of the day, ETFs are traded throughout the day, providing investors with greater flexibility. Additionally, you don’t need a minimum initial investment, like mutual funds, to start investing in ETFs, which makes them more accessible to investors.

With hundreds of ETFs available in the market, one ETF that is gaining significant interest from investors is the crypto ETF.

What is a Crypto ETF?

A cryptocurrency ETF is a regulated fund that tracks the price movements of one or more digital currencies, such as Bitcoin (BTC) or Ethereum (ETH). Instead of buying the digital asset directly, you can purchase the shares of crypto ETFs via selected traditional brokerage accounts or exchanges. These ETFs operate similarly to traditional ETFs, but are backed by one or more underlying digital assets, currently BTC and ETH.

When an investor buys a share in a crypto ETF, the ETF issuer purchases an equivalent amount of the digital currency to hold in reserves. It ensures the ETF tracks the price of the underlying asset. For example, when the price of Bitcoin rises, a BTC ETF will experience corresponding gains, and when it falls, the ETF shares decline accordingly.

It is important to note that owning a share in an ETF does not mean that you can redeem it for the underlying digital asset. Currently, cryptocurrency ETF shares are purchased and sold using fiat currencies.

Why are Crypto ETFs Important?

A crypto ETF offers retail and institutional investors indirect exposure to the digital asset market. It relieves them of the burden of directly owning and managing a cryptocurrency. This way, traditional investors can easily participate in cryptocurrencies through regulated investment tools.

The U.S. Securities and Exchange Commission (SEC) approved the first spot Bitcoin ETFs in 2024. Since then, cryptocurrencies have been significantly adopted by retail investors around the world. This approval endorses the legitimacy of digital currencies, opening new avenues for investment. 

On the first day of its approval, the spot Bitcoin ETF trading volume exceeded $4.5 billion. Over 600 institutional investors, including Wells Fargo and JPMorgan, among others, invested in spot BTC ETFs within their first six months of trading.

Likewise, the SEC approved spot Ethereum ETFs the same year, resulting in over $1 billion in trading volume on their first day of trading.

Types of Crypto ETF

Currently, the two primary types of cryptocurrency ETFs traded in the open market are spot ETFs and futures ETFs. Both ETFs follow different approaches to providing exposure to cryptocurrencies.

Spot ETFs

These are financial products that give direct exposure to investors to the price of the underlying asset, such as BTC. When a trader purchases a share in a spot ETF, the fund buys the underlying cryptocurrency, which is stored securely on behalf of the investor. This is being done to ensure the purchased crypto ETF tracks the price of the actual digital asset.

Futures ETFs

These funds do not hold the crypto asset directly. Instead, they hold futures contracts, which are agreements to buy or sell a digital currency at a specific price on a future date. Crypto futures ETFs do not track the price of the underlying cryptocurrency. For example, the issuer of Bitcoin futures ETF offers shares to investors by holding BTC futures contracts, thus allowing them to bet on the future price of the asset without directly owning it.

How to Invest in a Crypto ETF?

To invest in a crypto ETF, the first thing you need to do is select and open an account on a brokerage platform, such as Robinhood or Fidelity. After funding your account and providing the necessary documents, you need to research the available crypto ETFs on these platforms.

When researching, consider factors such as liquidity, performance, and fees. Once you select a crypto ETF, enter the specific investment amount you desire to purchase the ETF shares.

Remember to continuously monitor your investments and stay updated on market developments to adjust your strategy accordingly.

Important Reads: How to Buy Bitcoin? Everything You Need to Know

Advantages of Crypto ETF for the Crypto Industry

Crypto ETFs have positively impacted the cryptocurrency industry in many ways.  These funds address issues like regulatory concerns and price volatility.

The following are some of the benefits of crypto ETFs.

• Cryptocurrency ETFs allow traditional investors to participate in digital assets without bearing the expenses of direct ownership or the risks associated with holding them.
• It might be difficult for some investors to grasp the scope and roles of digital currencies. A crypto ETF offers a straightforward way to participate in the cryptocurrency space, thus simplifying investments.
• Since regulated firms offer crypto ETFs, this regulatory compliance instills confidence in traditional investors with the assurance that their investments are continuously monitored.
• A crypto ETF offers investors the opportunity for portfolio diversification, thus mitigating risks. For example, a BTC ETF may hold other assets that can balance the ETF overall.

Drawbacks of Crypto ETF

Cryptocurrency ETFs come with several drawbacks. The following are some of the disadvantages of these investment funds.

• Crypto ETFs are actively managed funds and can have a higher expense rate than other ETFs. Therefore, before selecting a crypto ETF, going through its fee structure can be helpful.
• Cryptocurrencies are volatile digital assets, and crypto ETFs reflect this volatility. Short-term price fluctuations can lead to substantial gains or losses.
• The cryptocurrency market is live 24/7, while crypto ETF trading is possible during market hours. This could expose investors to uncertain price movements.
• Investing in a crypto ETF does not offer direct ownership of digital currencies. It could be challenging for those seeking complete control over their crypto investments.

Update on Upcoming Crypto ETFs

Following the launch of Bitcoin and Ethereum ETFs, efforts have been made to introduce other crypto ETFs.

For example, leading industry proponents are exploring the way for other crypto-based ETFs, such as XRP and Solana ETFs. This will enable traditional investors to diversify their digital asset portfolios and manage risk efficiently.

Key Takeaways

Cryptocurrency ETFs provide a simple way for institutions and retail investors to participate in digital currencies like Bitcoin, without directly owning them. While these investment funds offer several benefits, it is essential to remember that they also carry risks. Therefore, it is advisable to take a balanced approach and conduct market research to capitalize on the potential of a crypto ETF.

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