Crypto ETF: Definition, How It Works, and How to Invest


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ETF is an exchange-traded fund which is a basket of securities you buy or sell via a brokerage form on a stock exchange, thereby offering diversification and convenient trading.

ETF tracks the price of one or various digital tokens and consists of various cryptocurrencies.

ETFs (Exchange-traded funds) have become famous as a way of investment since the mid-1990s due to their intraday liquidity and fewer costs of the transaction. Generally, ETFs track a specific index and are traded on exchanges.

In a securities market, ETFs enable investors to trade their shares continuously throughout the trading day, contrary to mutual funds, which only permit investors to purchase or redeem shares t the close of the trading day.

In the crypto market, a fund tracking the price of one or different digital tokens consists of various cryptocurrency ETFs. This article will explain how a cryptocurrency ETF works and the benefits and risks you can face during cryptocurrency ETFs.

What is a cryptocurrency ETF?

A fund is dealt with as an ETF if it meets any one of the following criteria:

  1. Cryptocurrency ETFs are invested in businesses transforming business applications by making and deploying blockchain technology.
  2. Blockchain-based ETFs are being invested in cryptocurrency investment products provided by asset managers such as Grayscale or Bitwise or futures and options, whose rates and prices are related to the performance of Bitcoin (BTC), Ether (ETH), and other cryptocurrencies.

Generally, cryptocurrency ETFs are the extended use case of blockchain technology. For example, Bitcoin ETFs are the first crypto ETF (pioneers) trying to track the price of BTC. It is one of the most called cryptocurrencies in digital assets.

Pro-Shares Bitcoin Strategy ETF (BITO) started trading Bitcoin ETFs on October 18, 2021, followed by VanEck (XBTF) and Valkyrie (BTF).

However, no ETFs are tied directly to the spot price of BTC, and managers of these products watch the price of BTC by the futures markets. Moreover, Grayscale’s Bitcoin Investment Trust can’t be accessed by mainstream audiences as it is not an ETF.

Other than offering indirect exposure to BTC, Bitcoin ETFs could cause greater risks to investors if the fund has a sizable portion of the futures market. Hence, investors should be cautious while investing in volatile securities like cryptocurrencies.

How does a cryptocurrency ETF work?

Crypto ETFs own cryptocurrency futures, options, or other cryptocurrency-based securities. Contrary to the traditional ETFs that directly own the underlying asset. The aim is to compete with the real cryptocurrency’s price alterations.

But, there may be a time when the ETF movements don’t precisely match those of the underlying cryptocurrency as they don’t hold any of it themselves.

Crypto ETF: Definition, How It Works, and How to Invest

Crypto Exchange Traded Funds are either backed by physical crypto assets or synthetic variants like derivatives.

In the former, crypto investors indirectly have the ownership of cryptocurrency without bearing any expenses of owning them outright, and in the Katter, instead of reflecting the prices of real cryptocurrencies, the ETF share price copies the price changes of the derivatives.

Here comes an important question: Why are crypto ETFs so important?

The most prominent reason is portfolio diversification, as Ether or Bitcoin ETF investors can access more than one crypto asset beyond traditional securities markets.

Benefits of cryptocurrency ETFs

Despite regulatory uncertainty around cryptocurrency ETFs, crypto investors who own ETFs may get many benefits, such as:

  • The primary benefit of investing in ETFs like Pro-shares Bitcoin Strategy ETF is the most affordable option for investing in a volatile asset.
  • The learning curve is outsourced to analysts while investing in crypto ETFs, making it an ideal investment vehicle for novice investors.
  • Owning crypto ETFs saves investors from costs such as custody charges and network and transaction fees.
  • An Exchange Transfer Funds provider is responsible for the safety of the fund and offers a sense of security to investors, specifically regarding crypto-jacking /crypto heists and phishing attacks.
  • Right now, there is no fully developed infrastructure in place to buy and sell cryptocurrencies. For example, although specific tokens are offered on specific crypto exchanges, others are not. But investors can diversify their portfolios with crypto ETFs without paying for individual tokens.

Cryptocurrency ETFs safety

All the investors must go through the verification process and watch their trades to prevent market abuse or funding illegal activities. So, one can invest in crypto ETFs as they are issued by regulated companies and traded on well-known, regulated exchanges.

Furthermore, the U.S Securities and Exchange Commission has received various requests to legitimize crypto spot ETFs. However, no Bitcoin spot ETF has come into existence yet.

How to invest in a cryptocurrency ETF?

To invest in ETF, follow these steps:

  • All you need to do is first, make an account with brokers like Fidelity investments, Robinhood, and others.
  • Decide what percentage of your investment you want to invest in ETFs.
  • You need to fund your brokerage account and then look for ETFs you want to invest in. For example, if you invest in Pro-Shares Bitcoin Strategy ETF, type BITO into the search bar.
  • Place a market order for crypto ETFs you want to buy. Click Buy. Enter the maximum number of shares you want to purchase with your budget.
  • If you want to extend your investment portfolio, set up an automatic investment plan with your broker.

Cryptocurrency ETFs vs. Mutual Funds

Asset management and Broker companies provide mutual funds, which are managed actively or passively. Active management means seasoned professionals do trades actively for increasing returns.

Fund managers replicate a benchmark or index in passive management to match its performance. A cryptocurrency mutual fund tends to invest in one or more digital currencies.

Furthermore, existing investment accounts are used to buy ETFs and crypto mutual funds, and investors incur an expense ratio. However, there are many obvious differences between the two investment vehicles listed below:

Crypto exchange-traded funds vs. Crypto mutual funds

 Cryptocurrency ETFsCryptocurrency mutual funds
Trading timelineDuring normal trading hoursOnce per day
Investment capNo minimum investment capMinimum investment cap applicable
Portfolio management strategy Most cryptocurrency ETFs are passively managedMost cryptocurrency mutual funds are actively managed.

Wrapping Up

Regardless of your investment vehicle choice, when you invest in ETFs and crypto mutual funds, you don’t still own any cryptocurrency. Hence, always check your risk-return tradeoff before investing your money in the volatile market.

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Mufasa is the lead writer at CryptoMufasa who likes to share all the latest info on the crypto world with you! Mufasa Enjoys enjoys a good read and recommendations so don't forget to comment on the posts and let him know.


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