Crypto ETFs for Dummies: What Are They and How Do They Work?

The SEC dashed hopes for a Bitcoin ETF in 2022, rejecting several applications amid crypto's tumultuous year. But what are crypto ETFs, and could approvals still happen in 2023? This article covers how crypto ETFs work, their benefits, risks,...

In a disappointing turn of events for cryptocurrency investors, the SEC repeatedly rejected several applications for Bitcoin exchange-traded funds (ETFs), dashing high expectations after many anticipated the approval of the first U.S.-listed crypto ETF, with initial filings occurring as far back as 2013.

However, the landscape is evolving towards increased institutionalization, and now the crypto world is eagerly awaiting the potential impact of them. Let's dissect this narrative, which predates most popular cryptocurrencies, and explore how these could serve as a compelling investment avenue in the crypto space.

Exchange Traded Funds Explained

An ETF, or exchange-traded fund, can encompass any cryptocurrency, such as Bitcoin or Ethereum. Essentially, it is a collection of cryptocurrency assets bundled together into a fund that can be traded on stock exchanges.

To put it simply, ETFs for cryptocurrencies work similarly to stock indexes like the S&P 500, which track and group the prices of the top 500 US stocks. A crypto ETF does the same thing but for cryptocurrencies.

It will allow investors to participate in the price movements of cryptocurrencies without needing to purchase them directly. The ETF issuer acquires the underlying crypto assets and then offers shares of the fund to investors. These shares mirror the crypto prices, enabling easy access for mainstream investors to engage with crypto market volatility within a regulated investment product.

How Does a Crypto ETF Work?

A company can create a crypto ETF if it is licensed and approved by the securities regulator in its respective country, such as the SEC in the United States. Once approved, the company can sell shares to investors, pooling together their funds to buy and trade the underlying cryptocurrencies on their behalf.

Many financial giants, such as; BlackRock, Fidelity, VanEck, ARK Invest/21 Shares, WisdomTree, Valkyrie, Bitwise, and Invesco, have all filed for a spot Bitcoin ETF - More Below 👇

List of Pending Bitcoin ETFs - Bloomberg

Investors could purchase shares in the crypto ETF, with each share representing ownership of a portion of the underlying basket of cryptocurrencies held by the Exchange Traded Fund. Just as a stock ETF moves with changes in the stocks it owns, a crypto fund share price would fluctuate based on the performance of the digital assets in its portfolio, such as Bitcoin during regular market hours.

Advantages of Crypto ETFs

The main benefit of opting for a crypto ETF is eliminating the intricate processes involved in storing and securing actual cryptocurrencies as the fund manages these complexities, ensuring investors can focus solely on the potential returns. It simplifies the investment process, making it more accessible to a wider range of investors.

Moreover, they are subject to stricter regulatory oversight than buying cryptocurrencies directly, as providers must register with financial regulators and adhere to stringent operational standards, which provides investors with added protections. We’ll take a look at all the advantages of cryptocurrency Exchange Traded Funds.

Easier Than Managing Cryptocurrency Yourself

You don't have to worry about keeping them safe or figuring out how to use crypto wallets and exchanges. The ETF provider takes care of buying, selling, and keeping your crypto assets secure. It's a simpler way to invest, especially if you want to be more hands-off.

But remember, if you invest in the fund, you don't directly own cryptocurrencies like Bitcoin or Ethereum. Instead, you own shares, and the issuer looks after the cryptocurrencies on your behalf. This is important if you want to have direct control over your crypto assets.

More Regulatory Oversight

As a regulated investment, crypto ETFs must play by SEC rules that don't apply to direct crypto purchases. Funds have requirements covering reserves, financial reporting, transparency, and risk management. This extra supervision provides assurances that your investment is being handled above board, free from manipulation.

More Like Traditional Investments

In many ways, crypto ETFs operate just like the familiar Exchange Traded Funds you already know. You can buy and sell shares through your regular broker whenever the stock market is open. The fund tracks crypto market returns automatically so you don't need specialized technical skills. Just simple, diversified exposure to this relatively new asset class.

Are Crypto ETFs Risk-Free?

No. Of course not. As with any volatile investment, crypto ETF values rise and fall with the underlying market prices. Proper due diligence is key to mitigating risks like insolvency of the issuer. If the company doesn't handle things well or runs into money problems, it could hurt investors.

The Path to Widespread Crypto ETF Adoption

In the U.S., the SEC has rejected all applications so far due to concerns over market manipulation and lack of sufficient regulation in the underlying cryptocurrency venues used for ETF pricing. However, other major nations have shown a willingness to approve pioneering products that could evolve standards over time. Canada paved the way in 2021 with its first Bitcoin ETF, and others have since launched in Europe.

If these early crypto ETFs prove successful long-term in safely tracking prices and reducing volatility, it may increase SEC comfort with the structure. Further approvals by Canada, Europe, and possibly Asia in 2023 could pressure the U.S. to act.

Current Availability of Crypto ETFs

While no crypto ETFs have been approved in the US yet, other countries are leading the way in providing their investors with regulated access to digital asset exposure through familiar structures.

Canada - Several Bitcoin and Ethereum ETFs are now available and trading on major Canadian exchanges. This was one of the first countries to approve them, paving the way for greater mainstream adoption.
Brazil - One of the first Bitcoin ETFs launched here in 2021, expanding access points for Latin American investors and showing regulation can enable safe investment.
Europe - Some cryptocurrency exchange-traded notes (ETNs) exist, though regulations still vary widely across countries. Several nations are exploring ETF approval to standardize rules.
Dubai - Access to invest in a cryptocurrency ETF was opened to retail investors here in 2021 in its ambitions to be a digital asset hub and attract capital.
South Africa - An ETF bundle containing several top cryptocurrencies by market cap launched in South Africa in 2020, one of the earliest in Africa.

So while availability began internationally, the expanding global adoption is putting pressure on US regulators to provide domestic investors with a similar on-ramp to digital assets through this established investment vehicle. A US approval could have substantial ripple effects across the cryptocurrency space and be a big step toward mainstream adoption.

Satoshi’s Vision

Critics argue that Exchange Traded Funds would transform Bitcoin into an "institutional product" with large players dominating the market. However, nothing prevents individuals from participating in the crypto market - it remains permissionless.

While Wall Street's involvement may challenge the ethos of cryptocurrencies, it cannot prevail without individuals choosing to hold onto their coins. We think that these funds ultimately broaden access to Bitcoin, even if the ideological landscape evolves.

As Bitcoin is often seen as the gateway to crypto ETFs, it may not remain the sole option indefinitely. Established cryptocurrencies like Ethereum could also become candidates in the future, and even lesser-known coins like Dogecoin might follow suit, just like Satoshi intended.

Conclusion

Crypto Exchange Traded Funds - ETFs offer a convenient and regulated avenue for mainstream investors to engage with cryptocurrencies. However, they come with their own set of considerations and trade-offs.

While the recent SEC delays disappointed Bitcoin ETF applicants and eager investors, the likelihood of a positive decision continues to grow. The court's criticism of the SEC's previous rejection suggests a changing landscape.

Combine this with the increasing mainstream acceptance of cryptocurrencies, and the dream of a Bitcoin ETF is still very much alive. It's just a matter of time.

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*Important Disclaimer: While every effort is made on this website to provide accurate information, any opinions expressed or information disseminated do not necessarily reflect the views of Bitfinity itself. The information provided here is for general informational purposes only and should not be considered as financial advice.