While a cryptocurrency ETF may seem like a safer way to get in on the Bitcoin action , experts say it’s important to understand how these funds operate, as well as what goes into valuing the digital currencies they own.
And while the structure of an ETF can be helpful in some instances, when it comes to Bitcoin, that very structure may be too restrictive for the volatile and fast-paced nature of the Bitcoin it holds.
“Bitcoin and Bitcoin ETFs (have) very different value propositions,” says Ryan Clements, a securities lawyer and assistant professor at the University of Calgary.
“When you buy an ETF, you should at least be aware of the ecosystem (these operate within) and what’s the risk … that, if the ecosystem does not operate as intended, your ETF may trade dislocated from the underlying net asset value of the Bitcoin.”
Why the interest in crypto ETF?
For some investors, the ETF structure may provide a level of trust and familiarity they don’t get within the crypto ecosystem itself.
“When you buy an ETF, there’s a prospectus that comes with it, continued disclosure, it’s in the securities regime,” says Clements.
“You’re buying something you’re used to getting, through a regulated intermediary, and in a process that you’re used to transacting in.”
Certain ETFs will also have tax benefits if held within an RRSP or Tax-Free Savings Account (TFSA).
But the fact that these ETFs are regulated doesn’t make them risk free – and their validity isn’t something regulators unanimously agree on.
Futures-based vs. spot crypto ETFs
Canadian regulators allow both spot crypto ETFs (which hold actual cryptocurrency like Bitcoin and Ethereum) as well as futures-based ETFs, which are based not on the actual Bitcoin, but rather on futures contracts estimating what the future price of Bitcoin will be.
In the U.S., the Securities and Exchange Commission (SEC) has rejected all applications for spot-based Bitcoin ETFs.
“The explicit reason given by the SEC is that it’s the obligation of the applicant to prove that the Bitcoin market is not manipulated,” says Bob Seeman, co-founder of cybersecurity company RIWI and author of the book Bitcoin: Unlicensed Gambling.
“That’s very hard for them to do because the Bitcoin market is manipulated. There’s a thousand people who own 27% of Bitcoin, and there’s no disclosure requirement when they buy and sell (it). There are no licences required for people to trade.”
There are also costs associated with buying the futures contracts from month-to-month, which can cut into returns.
“They have to roll over the contract, so they have to keep some cash; they can’t invest the entire portfolio in the futures products, whereas the spot ETFs, or if you hold Bitcoin directly, you can invest the entire amount,” says Clements.
“Futures products also have a potential for lower returns because the futures price can trade higher than the spot price. Sometimes, there’s a dislocation between the secondary market trading price and the asset value of the underlying asset.”
Crypto, crypto ETF or nothing at all?
Would-be investors also need to be aware that ETFs trade during regular market hours, while crypto trades 24/7. If you’re in crypto to make a quick and flashy buck, the very nature of the ETF product might keep that from happening.
“You’re making a trade-off where you pay a management fee, reduce your trading window, but you get disclosure and you do it in a process and system you’re used to, versus a more direct access, which gives more flexibility,” Clements says.
“But there’s a lot of people right now who don’t trust interfacing directly into crypto” – something he says could change as crypto asset trading platforms become regulated in Canada; a process which has already begun.
“I see regulators looking at access points and trying to ensure they have regulated parameters,” he says.
In Canada, the approach seems to be that “if investors are going to be in this market, let’s do it in a regulated way.”
“There are gaps, for sure,” says Clements.
“But those gaps aren’t really accessed by mainstream investors.”
For Seeman, regulatory efforts aren’t enough to warrant the risk investors take when putting their money into crypto – whether they hold it directly or through a registered vehicle.
“Anyone who wants to buy it needs to understand what it is. You can only invest in an asset, and an asset is something that generates cash flows or has utility. Bitcoin is not an asset – people are just trading it,” he says.
“It’s like buying a number of lottery tickets or going to Vegas – don’t buy more than you are prepared to lose entirely.”