What is Exchange Trust Fund
If you have been an ardent follower of the cryptocurrency news trend in recent months, you must have heard of an exchange-traded fund (ETF). It’s a fund that tracks the price of many digital tokens and multiple cryptocurrencies through a special index and is generally traded on an exchange.
Since the mid-1990s, ETFs have grown as a popular means of investing concerning their low transaction costs and intraday liquidity which allows investors to trade their shares continuously in a single day, as compared to mutual funds that only permit investors to purchase and redeem shares at the end of the closing day.
Massive speculations have risen on how the approval of crypto ETFs will drive a major change in the perception of the crypto industry as a legitimate digital asset. And this is however believed to raise cryptocurrency to the same pedestal as an investment choice with commodities such as gold and silver.
In this article, we will discuss how crypto ETFs work as well as their numerous benefits and risks.
Understanding Crypto Exchange-Traded Funds
An exchange-traded fund refers to an investment fund that is made up of a collection of securities including stocks, bonds, currencies, and commodities and is listed for trading on exchanges. An ETF tracks the value shifts of an existing asset and is identical to a mutual fund. Whereas ETFs allow investors to trade their shares on a 24-hour cycle as though one is interacting with a company’s shares on a stock exchange, mutual funds only permit such at the end of a trading day.
Following the above context, a crypto ETF is an exchange-traded fund that tracks the price movements of one or multiple digital currencies. Identical to a traditional ETF, it can be traded as a standard share on a stock exchange. This will enable big league investors to put their money on a regulated asset that represents Bitcoin or other crypto assets, hence eliminating the need to physically own or manage crypto which somewhat makes both experienced and inexperienced users susceptible to hacks and scams.
Worthy of note: the workability of a cryptocurrency ETF depends on the custodial authority of the company listing and issuing the digital coin on an exchange. That way, investors can gain indirect exposure to the volatility of the underlying cryptocurrency.
In contrast to traditional ETFs that directly own the underlying asset, crypto ETFs either own the cryptocurrency options, futures, or other crypto-based securities. That’s to say, cryptocurrency ETFs are either backed by physical crypto assets or derivatives.
What are the Benefits of Crypto ETFs
Crypto ETFs can be a powerful financial tool for investors. Beyond this, an ETF approval can bring massive benefits to the crypto industry ranging from change in the perception of image, to price action, and purposeful security measures.
A Merger Between Traditional Finance and Crypto
As of last year, the crypto market recorded a market capitalization of about $2 trillion. Despite this tremendous statistical feat, it’s nothing compared to the tens of trillions of dollars stored in traditional mutual funds, insurance companies, and other financial institutions. There’s no doubt that crypto ETFs can bridge the rift between the crypto economy and the rest of the world’s economies. And this can foster greater market participation, which in turn can have a positive effect on the industry.
Diversification and Convenience
Since an ETF can contain more than one asset, there’s room for investors to find a way to diversify their portfolios. And such an option helps investors to kick against risks involved with investing in a single asset. Also, cryptocurrency ETFs make buying, selling, and storing digital currencies a lot simpler and more convenient for even unsophisticated investors.
Efficiency During Tax Filing
The decentralized nature of cryptocurrencies prohibits major bodies such as mortgage industries from allowing the direct purchase of virtual assets, hence leveraging regulated platforms such as stock exchanges can allow for a more reliable and more efficient tax filing.
Much Greater Confidence
Since Crypto ETFs come from regulated firms and are traded on regulated venues, non-crypto investors can invest in them with more confidence, courtesy of the fact that everything is continuously monitored.
What are the Disadvantages of Crypto ETFs?
Despite numerous benefits, crypto ETFs also have their drawbacks. Some of them are:
If there’s one thing cryptocurrencies have done, it’s to curb reliance on centralized financial systems. Also, they prioritize privacy compared to government-backed currencies. Although these are good reasons for cryptocurrency adoption, the use of crypto ETFs hinders it because investing in crypto ETFs allows a custodian to hold your digital asset.
High Management Cost
The convenient nature of crypto ETFs accosts it a management fee which is oftentimes a percent of the overall shares., hence exchange-traded funds can attract high management dividends.
Notably, a crypto ETF can contain one or multiple assets. Though ETF calculates the price movements of its underlying assets, multiple assets in a portfolio can affect tracking accuracy.
The liquidity risk exists once the ETF sells short of its base supply. Such occurrences keep the shareholders at odds. Also, ETFs can cause a hectic shift in the value of cryptocurrencies as it gains more exposure.
CrossFi is a cross-chain protocol that provides liquidity for Filecoin staking and rewards.
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