What is an ETF?
ETFs or Exchange Traded Funds are instruments that have both potential benefits and potential risks. In other words, ETFs are interesting assets to diversify one’s trading portfolio and will facilitate investors’ access to virtual currency markets, a situation that could increase their economic potential to unsuspected limits.
The real global expansion of this instrument was only noticed after it landed on Wall Street. The U.S. authorities have allowed the trading of bitcoin futures ETFs since October 2021.
Indeed, since October 20, Bitcoin is accessible on the New York Stock Exchange, through an ETF (index fund or tracker), ProShares Bitcoin Strategy ETF (BITO).
This tool could bring Bitcoin to a market capitalization never seen before. But it could also affect Bitcoin’s price negatively, as it would allow many new speculators to take on the role of determining its price.
Also known as a tracker, an ETF will simply replicate the performance of an underlying asset, be it a stock market index or, precisely, Bitcoin.
The main characteristic of the ETF is that it is traded on secondary stock markets, being investment vehicles very typical of the traditional financial world.
It facilitates acquisitions in a sector. You have ETFs that track the performance of a sector, for example healthcare. Instead of buying stocks one by one to build up a balanced portfolio in that sector, the investor has only one stock to buy with the ETF. This is much more convenient and less expensive.
The different types of ETFs
There are several types of ETFs, among which :
- ETFs on market indices, which replicate the performance of equity indices (such as the CAC 40), sector indices (such as energy, banks) or bond indices.
- Strategy index ETFs, which replicate the performance of indices incorporating more sophisticated investment strategies. Due to its complexity, this type of ETF is aimed at investors with a good knowledge of financial markets.
- ETFs with leverage (or reverse leverage), which multiply the trends of the index being tracked, both up and down. You can thus multiply your gains as well as suffer heavy losses.
How to invest in ETFs?
There are two ways to invest in an index fund. The first is to go through a broker or your bank. Be careful though, not all banks offer the possibility of investing in index funds. You should also pay attention to the transaction fees charged by your bank.
You can buy then ETF units from an authorized financial intermediary either, under certain conditions, at the time of their creation (primary market) or directly on the stock exchange (secondary market).
These units can therefore be bought or sold on the stock market at any time like shares. The types of orders are the same as those for shares.
To do this, you must have an ordinary securities account and/or a PEA for eligible ETFs. ETFs can also be eligible for life insurance in the form of units of account.
We are know aware of what an ETF is and how to invest in but what about the Bitcoin ETF?
What is a Bitcoin ETF?
According to the definition below, Bitcoin ETF will then hold futures on the value of Bitcoin over a given time period. In other words, it is linked to Bitcoin futures contracts, allowing investors access to Bitcoin without trading it.
Bitcoin is a digital currency that was created by Satoshi Nakamoto in 2009. Unlike sovereign or fiat currencies, BTC is not governed by any financial or political authority. Bitcoin is mined in the Bitcoin blockchain.
Bitcoin is mined in a blockchain in a transparent and encrypted cryptographic system. It is therefore a digital currency that is secure and totally independent of all financial market authorities. It was even designed to guarantee its independence and for this reason it is the subject of significant reserve value and speculation.
The main problem for many investors who want to invest in cryptocurrencies or get a foothold in the likely underlying technological revolution is access to these assets.
Even if exchanges (marketplaces) have multiplied and allow through an intuitive interface to buy cryptos, it can remain complicated for many individuals, and imposes a double management of their assets with notably a different tax regulation than that of more traditional stock market products.
In addition, it adds a layer of risk. Whether it is through an exchange, or by holding digital assets on a physical medium you are exposed to different threats: default of the exchange, hacking, loss of the physical medium or of your access codes. Adding an intermediary means adding a layer of risk.
Beyond this issue, the projects behind the many existing cryptocurrencies are not all as solid as each other, far from it. And it can be complex to choose which projects to invest in.
Investing in ETFs indexed on baskets of cryptocurrencies can therefore represent a more regulated alternative. Nevertheless, these products remain technical, and intended for informed investors. It is therefore necessary to understand how they work and, above all, the level of risk you are exposing yourself to.
Bitcoin ETF : Pros and Cons
- Transparency. One of the great characteristics of ETFs is that as a listed asset, it is possible to know its value at any time.
- Flexibility. An ETF can be purchased at any time and the purchase will be effective according to its price at that moment. This means that there will be no waiting until the end of the session and there will be no exit windows as happens with some funds.
- Liquidity. An ETF can be bought and sold at any time, just like a stock. They are 100% liquid.
- Diversification. A traded fund is an already diversified instrument in itself. When you invest in a basket of stocks, there will always be some degree of diversification. And with an ETF, you can “buy” an entire index without having to invest in each of its stocks.
- Commissions. ETFs have lower management fees than a traditional fund.
- Bitcoin and other cryptocurrencies ETFs have not been approved by the SEC or CNMV, so at the moment they have a fairly limited offering.
- Because of the volatility that cryptocurrencies still experience, sudden fluctuations in value could play a disadvantageous role for ETF investors.
- The supply in existing cryptocurrency ETFs currently does not diversify risk levels like traditional ETFs do. In fact, at the moment, ETFs only provide access to a limited number of cryptocurrencies.
- Depending on each country’s regulations, ETFs may generate foreign taxes if purchased in another country. In addition, commission rates may apply for buying and selling these funds.