Exploring the Pros and Cons of Investing in Crypto ETFs

Navigating the World of Cryptocurrency ETFs

As cryptocurrencies capture more and more attention from retail and institutional investors, cryptocurrency exchange-traded funds (ETFs) have emerged as an accessible way to gain exposure to these volatile assets.

“Crypto ETFs mark a monumental shift in the regulatory landscape,” said Christina Lynn, a behavioral finance researcher and certified financial planner at Mariner Wealth Advisors. “Their approval lends legitimacy to the asset class and provides [investors] with a more straightforward, regulated investment vehicle.” However, she suggested anyone interested “abandon get-rich-quick schemes and aim for an above-average return on investment.”

Whether you’re considering adding a crypto ETF to your portfolio or want to understand how these instruments compare to direct cryptocurrency investments, this guide gives you what you need to know.

Key Takeaways

• Crypto ETFs allow investors to gain exposure to digital assets through traditional brokerage accounts without the need to manage wallets or custody issues.
• Spot ETFs hold actual cryptocurrencies, while futures ETFs track price movements via derivatives.
• The major U.S.-listed crypto ETFs by issuers like iShares, Fidelity, and Grayscale have had significant growth despite major price changes among crypto assets.
• If you are interested in crypto ETFs, you’ll need to assess the effect of expense ratios, tracking errors, and evolving regulations on risks and returns.

Understanding Crypto ETFs

An ETF is a pooled investment vehicle that trades on stock exchanges like a regular stock, but holds a basket of securities such as stocks, bonds, or other assets, allowing investors to buy and sell shares throughout the trading day at market-determined prices. Crypto ETFs do the same thing, but track the performance of one or more of the major cryptocurrencies.

The most attractive aspect of crypto ETFs is their convenience. Instead of dealing with the technical challenges of setting up digital wallets, managing private keys, or storing cryptocurrencies securely, investors can simply buy ETF shares from their broker just like they would with any other stock or traditional ETF. This accessibility makes crypto exposure possible for both retail and institutional investors without requiring deep technical knowledge of the crypto ecosystem.

Lynn suggests that when choosing a crypto ETF, “opt for the product with the lowest fees, as this helps maximize returns by minimizing costs—a principle that applies equally to both traditional and crypto ETFs. Additionally, consider ETFs that offer high liquidity and providers with a strong and reliable track record in managing crypto assets.”

Types of Crypto ETFs & How they Work

There are four major types of crypto ETFs available, each designed to meet different investor needs and risk appetites:

• Spot ETFs: When investors buy shares of a spot crypto ETF, the fund manager uses those funds to buy an equivalent amount of the cryptocurrency (such as bitcoin or ether) and holds it in secure storage—often a cold wallet or through a trusted custodian. Each share of the ETF represents fractional ownership of the underlying crypto assets.
• Futures ETFs: Instead of holding crypto, futures-based crypto ETFs invest in cryptocurrency derivatives contracts. A futures contract is an agreement to buy or sell an asset at a preset price on a specific future date. By holding these contracts, the ETF track the expected future price movements of the cryptocurrency.

Important

Because futures contracts have expiration dates, futures-based ETFs must periodically “roll over” —selling contracts nearing expiration and purchasing new ones. This can sometimes lead to tracking errors, meaning the ETF’s performance might not perfectly mirror the spot market price of the cryptocurrency.

• Inverse and leveraged ETFs are designed to deliver multiples of the daily performance of a given cryptocurrency index or inverse exposure. Inverse ETFs profit from declines in the underlying asset’s price (and vice versa), while leveraged ETFs amplify gains (and losses). Both types carry considerably higher risks and are generally more suitable for short-term trading rather than long-term investing.
• Blockchain company ETFs: While not directly investing in cryptocurrencies, blockchain ETFs focus on companies involved in the blockchain space and related technology. This broader exposure lets investors benefit from the growth of the blockchain sector without the direct volatility of crypto prices.

Pros & Cons of Crypto ETFs

Pros of Crypto ETFs

• Diversification: Crypto ETFs offer a way to gain exposure to a basket of crypto assets or related companies, unlike investing in a single cryptocurrency. Investors can benefit from broader market trends without the concentration risk that comes with direct ownership.
• Simplicity and accessibility: Like traditional ETFs, crypto ETFs can be traded through standard brokerage accounts.
• More security: By investing in a regulated fund, investors cut the risk of direct crypto ownership, such as hacking or losing access to digital wallets.
• Professional management: Crypto ETFs are managed by professionals with the expertise and resources to navigate the volatile cryptocurrency market.

Cons of Crypto ETFs

• Potentially higher fees: ETFs have management fees and other expenses that can erode returns over time.
• Lack of direct ownership: When you invest in a crypto ETF, you do not own the underlying cryptocurrency.
• Limited trading hours: ETFs are traded during regular stock market hours, unlike the 24/7 nature of cryptocurrency exchanges. This can restrict your ability to react to market movements outside these hours.
• Regulatory and market risks: Shifts in regulations can lead to increased uncertainty and impact the performance or even the availability of these funds.
• Volatility: The significant swings in the cryptocurrency market are the biggest risks with these assets.

Pros

• Diversification potential

• Accessibility

• Security

• Professional Management

Cons

• Potentially higher costs

• Lack of direct ownership

• Not traded 24/7

• Potential for regulatory shifts

Regulatory Environment

The regulatory landscape for crypto ETFs has shifted dramatically in the mid-2020s. Under new U.S. Securities and Exchange Commission (SEC) leadership and a more crypto-friendly administration, the approval process for crypto ETFs has accelerated considerably.

Nevertheless, “there is still no comprehensive federal regulation of any type of digital assets or cryptocurrency,” said V. Gerard Comizio, associate director of business law programs at American University’s Washington College of Law and author of Virtual Currency Law: The Emerging Legal and Regulatory Framework.

The SEC approved the first spot Bitcoin ETFs in January 2024 and spot Ethereum ETFs in mid-2024, a major change from the previous years when only futures-based crypto ETFs were permitted in the U.S. markets. A key factor in shifts since their approval is the changing political attitudes toward digital assets, with President Donald Trump himself a purveyor of meme coins and members of his administration previously involved in various cryptocurrency offerings.

However, regulatory scrutiny remains selective. While bitcoin and ether ETFs have gained approval, other cryptocurrencies face varying levels of regulatory uncertainty. For example, analysts suggest that ETFs holding Litecoin may have an advantage in gaining approval since the SEC has never classified it as a security. In contrast, XRP faces a more challenging path because of ongoing legal questions about its status.

For investors, understanding these regulatory nuances is crucial. The approval status of different crypto ETFs can significantly impact their liquidity and trading volumes, that is, your ability to buy and sell your shares with relative ease.

Important

The first spot bitcoin ETFs were approved by the SEC in January 2024.

Crypto ETFs vs. Direct Crypto Investments

Direct Crypto Investments

Investing directly in cryptocurrencies involves purchasing tokens through online exchanges or from a private party. This offers complete ownership, enabling participation in activities like staking, lending, or voting in decentralized governance. However, direct investments also require secure storage, navigating complex exchange interfaces, and the potential for hacking or fraud.

Direct crypto ownership means maintaining a digital wallet to store assets and transact. You are also responsible for remembering and keeping your private keys secure, which lets you access your wallet. Without your private keys, your tokens are as good as lost.

Crypto ETFs

Crypto ETFs, on the other hand, provide exposure to cryptocurrency markets without requiring you to handle digital wallets or worry about cybersecurity at the individual level. Instead, ETF shares stay in your brokerage account alongside the rest of your portfolio holdings.

The tradeoff, however, is that investors pay fees and lose the benefits of direct token ownership.

Strategic Considerations

• Risk management: Investors with a lower risk tolerance may appreciate the structure and professional management of crypto ETFs to gain exposure to cryptocurrencies.
• Investment goals: Those looking for potential additional benefits like staking rewards might prefer owning cryptocurrencies directly, despite the added responsibilities and risks.
• Market timing: The 24/7 trading environment of cryptocurrency exchanges allows for rapid reactions to market shifts, while ETFs are constrained to market hours.

The Bottom Line

Crypto ETFs are for investors who want exposure to the burgeoning cryptocurrency market while avoiding some of the complexities and risks associated with direct ownership. For investors considering crypto ETFs, aligning your investment strategy with your risk profile and financial goals is key. Conducting thorough research and, if necessary, consulting a financial advisor can help determine whether these funds are the right fit for your portfolio.