Exchange-traded funds (ETFs) have gained popularity as an investment method since the mid-1990s due to their daily liquidity and lower transaction costs. Typically, ETFs track a specific index and are usually traded on exchanges.

In the stock market, ETFs allow investors to trade their shares continuously throughout the trading day, unlike mutual funds, which only allow investors to buy or redeem shares at the end of the trading day.

In the cryptocurrency market, a fund that tracks the price of one or more digital tokens and consists of several cryptocurrencies is called a cryptocurrency ETF. In this article, we will discuss how a cryptocurrency ETF works and the benefits and risks associated with cryptocurrency ETFs.

What is a cryptocurrency ETF?
A fund is considered an exchange-traded fund if it meets one of the following two criteria:

Crypto ETFs invest in companies that are transforming business applications by building and implementing blockchain technology.
Blockchain-based ETFs invest in cryptocurrency investment products offered by asset managers such as Bitwise, Grayscale or futures and options whose prices are linked to the performance of Ethereum and other cryptocurrencies.
In general, cryptocurrency ETFs are an extended use of blockchain technology. For example, Bitcoin ETFs are the first cryptocurrency ETFs to attempt to track the price of BTC, the most valuable cryptocurrency among digital assets.

On October 18, 2021, the ProShares Bitcoin Strategy ETF (BITO) began trading Bitcoin ETF, followed by Valkyrie (BTF) and VanEck (XBTF). Although ETFs are not directly linked to the spot price of bitcoin (the current market price at which the underlying security can be bought or sold), the managers of these products track the price of bitcoin through the futures markets. In addition, Grayscale’s Bitcoin Investment Trust is not available to the general public since it is not an ETF.

In addition to the indirect impact on BTC, bitcoin ETFs can pose risks to investors if the fund owns a significant portion of the futures market. Therefore, investors should exercise caution when investing in volatile securities such as cryptocurrencies.

How does a cryptocurrency ETF work?
Crypto ETFs hold cryptocurrency futures, options or other crypto-based securities, unlike traditional ETFs, which directly own the underlying asset. The aim is to simulate fluctuations in the price of the underlying cryptocurrency. However, there may be times when the movements of ETFs do not exactly match the underlying cryptocurrency because they do not hold them themselves.

Cryptocurrency ETFs are backed by either physical cryptoassets or synthetic options such as derivatives. In the first case, crypto-investors indirectly own cryptocurrencies without incurring any costs of owning them directly, and in the second, instead of reflecting the actual prices of cryptocurrencies, the price of ETF shares mimics the price movements of derivatives.

So why are exchange traded funds important? The most obvious reason is portfolio diversification, as investors in a Bitcoin or Ether ETF may have access to more than one crypto asset, especially outside of traditional stock markets.

What are the benefits of cryptocurrency ETFs?
While there is regulatory uncertainty regarding crypto ETFs, crypto investors who own exchange-traded funds can benefit from the following:

The biggest advantage of investing in exchange-traded funds like Proshares Bitcoin Strategy ETF is the availability of the volatile asset class component of investing.
The learning curve is passed on to analysts when investing in cryptocurrency ETFs, making it an ideal investment vehicle for first-time investors.
Owning a crypto ETF saves investors from costs such as storage fees, network and transaction fees.
The ETF provider is responsible for the integrity of the fund, which gives investors a sense of security, especially regarding phishing attacks, cryptocurrency theft or cryptocurrency theft.
There is currently no fully developed infrastructure for buying and selling cryptocurrencies. For example, some tokens are offered on some cryptocurrency exchanges, while others are not. However, investors can diversify their portfolios using cryptocurrency ETFs without paying for individual tokens.
Related: What is Cryptojacking? Beginner’s Guide to Cryptocurrency Mining Malware

Are cryptocurrency ETFs safe?
First, let’s answer these questions: Are cryptocurrency ETFs regulated and are ETFs suitable for beginners? Before finding out if funds traded on a crypto exchange are safe.

Source: CoinTelegraph