Back in February 2021, Purpose Investments made history by getting the clearance required to launch the first-ever Bitcoin ETF. It was only a matter of time before the two most potent investment instruments – Cryptocurrencies and Exchange Traded Funds (ETF) – combined to give you a Crypto ETF. But the road to this has been very bumpy, to say the least.
However, before we get into that, let’s understand how crypto ETFs work.
What is an ETF?
ETFs are a type of investment fund that allows you to track the performance of an asset or group of assets – from publicly traded companies and commodities to entire industries. Investors can use these to diversify their holdings without exposing themselves directly to the asset. Mostly, ETFs are a collection of assets (like stocks) that have been grouped together for a specific theme (growth, stocks in the tech sector, etc.).
VOO, for example, is a single ETF that tracks the performance of the S&P500, an index representing the 500 largest publicly traded companies in the US.
For investors who want a simplified investment solution, and are only focus on gains and losses, ETFs can provide a credible alternative. ETFs are fully regulated and can be bought through various online brokerage platforms and apps.
How does a Bitcoin ETF work?
A Bitcoin ETF is an exchange-traded fund that tracks the price of Bitcoin and allows investors to buy or sell BTC on a stock exchange throughout the day. The ETFs can be cash-settled or asset-settled. Basically, when you cash out, you will receive either fiat currency (a.k.a. conventional money like CAD) or actual Bitcoins. With Bitcoin ETFs, traditional investors can indirectly buy Bitcoins through the normal trading platforms they are familiar with.
Crypto ETFs vs buying crypto
So, why not just invest in crypto? Why go through the ETF route at all? Well, there are some legitimate reasons for that:
- Since you are not holding actual Bitcoins, you won’t need to worry about public addresses, private keys, crypto wallet storage, etc.
- ETFs are an investment vehicle, which is why investors should be able to short their positions if they believe that BTC will drop in the future.
- Even though cryptos are pretty well-known, ETFs are better understood across the investment world. A traditional investor will be much more at ease with ETFs than go through the crypto learning curve.
- Unlike with actual Bitcoin or other cryptocurrencies, you can hold a crypto ETF in a registered tax-sheltered account like a TFSA or RRSP
Can Bitcoin ETFs increase institutional investment?
Bitcoin ETFs could provide the ideal entry point for institutional investors who want to get into the crypto market but haven’t been able to do it for a variety of reasons:
- Most hedge funds can’t hold coins since they can’t be adequately insured. Any drastic price fluctuations could lead to loss of credibility and profit objectives.
- There is still a frustrating lack of proper regulations when it comes to cryptocurrencies. This has pretty much been the biggest reason why institutions haven’t been able to enter the market in droves. ETFs, on the other hand, is already a well-established and properly regulated instrument.
- Finally, we have the liquidity problem. Even if an exchange has enough volume, these institutional investors are looking to make hundreds of millions of dollars worth buying and selling orders. As such, an ETF could bring in the liquidity required to handle these demands.
Tax efficiency benefits of ETFs
Investors in Canada have an incredible opportunity of planning for their retirement with the government-regulated Registered Retirement Savings Plan (RRSP) and the Tax Free Savings Account (TFSA). Both of these accounts will allow you to grow your money long-term by investing in various financial instruments, including ETFs.
- TFSA: With this account, any gains you make through investments and savings are tax-free.
- RRSP: A tax-advantaged account that provides tax breaks to those who invest money in it.
Through crypto ETFs, you will be able to invest in these accounts and unlock tax efficiency benefits.
The long winding road to crypto ETFs
The likes of Gemini and VanEck have long tried (for the last 3 years) to bring Bitcoin ETFs into the USA, but their applications have been repeatedly thwarted by the SEC.
Finally, in February 2021, Purpose Investments got the all-clear to bring in the world’s first Bitcoin ETF from the Ontario Securities Commission (OSC). In just one month, they managed to cross $1 billion in assets under management.
Following this, Brazil and Chile have also greenlit their respective Bitcoin ETFs. On the other hand, Canada has managed to deploy a second Bitcoin ETF and four Ethereum ETFs, thoroughly cementing its lead in the global crypto ETF market.
Crypto ETFs: The bottom line
If you have risk tolerance, it’s much more logical to invest directly in cryptocurrencies rather than going through ETFs since the gains are much higher. However, if you are risk-averse or are an institution bogged down by regulatory demands, it makes much more sense to go through the ETF route.