A Simple Guide to Understanding Ethereum ETFs
Explore the world of Ethereum ETFs with our comprehensive guide. Learn how they differ from Bitcoin ETFs, their functioning, and regulatory landscape.
Exchange-traded funds (ETFs) have been around for decades in the traditional financial markets. Both institutional and retail investors can use ETFs to gain exposure to a wide range of asset classes, such as stocks, bonds, oil, precious metals, and more.
Recently, Ethereum ETFs have also been added to the suite of product offerings. Like Bitcoin ETFs, they give investors access to the cryptocurrency market without having to hold the underlying digital asset directly. Of course, if you wish to own ETH directly, you can use a cryptocurrency multi-wallet like Trust Wallet to swap and buy ETH.
However, if you’re keen on investing in an ETH ETF, read on to learn what crypto ETFs are, the emergence of crypto ETFs, how they function, and how Ethereum (ETH) ETFs differ from Bitcoin ETFs.
Remember, this guide is purely informational and should not be used as financial advice. Always do your own research.
What Are ETFs?
An ETF is an investment vehicle that functions similarly to a mutual fund. A mutual fund is an investment fund that can hold bonds, stocks, and other securities and is managed by a professional money manager. ETFs track a specific index, commodity, sector, or additional assets.
However, unlike mutual funds, investors can purchase and sell ETFs on a stock exchange just like they would with a regular stock. ETFs can be designed to track anything from a stand-alone commodity to a diverse portfolio of securities. They can also be used to keep track of particular investment strategies.
ETFs feature all kinds of investments, such as bonds, commodities, stocks, and a mix of other investment types. For example, a stock ETF can comprise hundreds of stocks covering several industries or be limited to one specific sector or industry. For instance, you could have an ETF with stocks in the banking, manufacturing, and medical sectors or an ETF with stocks in the banking industry only.
Moreover, an ETF can potentially be more liquid and cost-effective than mutual funds because they are trading on securities exchanges and are typically passively managed, reducing the need for high annual management fees.
ETFs can be sold and bought throughout the day on various exchanges, which means their prices also fluctuate throughout the day. The SPDR S&P 500 was the first-ever ETF to be launched and remains active today.
It’s no wonder that with the emergence of cryptocurrencies, it was only a matter of time before crypto ETFs were created.
The Emergence of Crypto ETFs
While ETFs have been around in the traditional financial markets for decades, the United States didn’t have a crypto ETF until the first Bitcoin futures ETF - ProShares Bitcoin Strategy ETF (BITO) - was introduced and started trading in the New York Securities Exchange in October 2021. Since then, there have been other Bitcoin ETFs that have followed.
But what exactly is a Bitcoin ETF?
A Bitcoin ETF is an exchange-traded fund that exposes investors to Bitcoin (BTC) or other Bitcoin-related assets without them having to own BTC directly.
Currently, Bitcoin ETFs don’t own Bitcoin themselves. Instead, they own Bitcoin futures contracts or shares in Bitcoin companies.
Investing in a Bitcoin ETF eliminates the need for investors to set up a crypto wallet or deal with a cryptocurrency exchange. Bitcoin ETFs have become a preferred financial investment instrument for traditional investors who would want to gain exposure to Bitcoin without dealing with all the hassles of buying, storing, and managing BTC.
Remember, while you can buy, store, and manage your Bitcoin using Trust Wallet if you lose access to your crypto wallet, you will permanently lose your Bitcoin and other digital assets.
This is one of the reasons why Bitcoin ETFs have been making waves and gaining traction with traditional investors, as they don’t have to worry about losing their funds if they forget their secret phrase.
Moreover, similar to stocks, Bitcoin ETFs are traded on securities exchanges, unlike Bitcoin, which is traded exclusively on crypto exchanges.
Bitcoin ETFs are also regulated by the US Securities and Exchange Commission (SEC), which gives investors the security that their investment is regulated by an acknowledged financial regulator.
The launch of Bitcoin ETFs, the first of their kind, was considered a game-changer and a significant milestone in the crypto industry. This is because it offered investors an accessible and regulated approach to investing in Bitcoin, which, in turn, could lead to the mass adoption of Bitcoin as an investment asset.
And just recently, the crypto industry witnessed the launch of Ethereum ETFs, which is the next step in this development.
Ethereum ETFs, just like Bitcoin ETFs, are targeted at traditional investors who want to diversify their portfolio to include Ethereum without owning ETH directly.
We’ll discuss more on Ethereum ETFs below.
How Do Crypto ETFs Function?
Now that we know what cryptocurrency ETFs are, let's discuss how they function. To begin with, it’s important to note that crypto ETFs offer several benefits to investors. For instance, because crypto ETFs are issued and managed by various investment firms, they alleviate the need for the steep learning curve required to invest in cryptocurrencies outright. Moreover, crypto ETFs are regulated, which means all types of investors can purchase them, and they custody the underlying assets on behalf of their customers.
To understand how crypto ETFs function, we’ll need to discuss the two types of crypto ETFs that exist.
The first crypto ETF is one that’s backed by “physical” digital currencies like Bitcoin or Ether. In this ETF, the investment company managing the crypto ETF buys the cryptocurrencies, after which the ownership of the coins is represented as shares. Investors can purchase these shares and indirectly own cryptocurrencies. This way, they gain exposure to cryptocurrencies such as BTC and ETH without dealing with the risks and expenses of owning crypto outright. However, we are yet to see spot crypto ETFs in the US.
The second kind of crypto ETF is known as the synthetic variant. A synthetic ETF is an interesting variation of the physical or traditional ETFs as it’s designed to mimic the return of a particular index similar to any other ETF. However, synthetic ETFs achieve their desired results by using financial engineering instead of actually owning the underlying asset or securities.
Synthetic ETFs track crypto derivatives, such as cryptocurrency futures contracts. The ProShares Bitcoin Strategy ETF (BITO) is a good example of a synthetic ETF as it tracks the price of Bitcoin futures. The ETF’s share price imitates the price changes of derivatives rather than the price of an actual cryptocurrency.
This means that the shares of a given crypto ETF surge with an increase in the futures contract prices. It also declines with a correlated decrease. However, synthetic ETFs carry some additional risk as the futures price of an asset doesn’t always move in line with the underlying asset.
Ethereum ETFs: What Makes Them Unique?
Ethereum is an open-source blockchain that was created to allow for the development of smart contracts and decentralized applications (dApps). The blockchain was proposed by Vitalik Buterin, a computer programmer and the co-founder of Ethereum, in 2013, and its work commenced in early 2014, after which the network went live in July 2015.
Ethereum is the largest blockchain ranked by total value locked (TVL) according to CoinMarketCap data and the most widely used blockchain. The blockchain’s TVL currently stands at over $47 billion. The Ethereum blockchain also has its own native crypto token, Ether, which is the second largest cryptocurrency by market capitalization, one position behind Bitcoin.
Similar to Bitcoin ETFs, Ethereum ETFs offer investors a labor-saving means of gaining exposure to cryptocurrencies without having to own or hold Ether directly. Thus, an Ethereum ETF is an exchange-traded fund that tracks the price of ETH by investing in a futures contract with Ether as the underlying asset.
This way, investors don’t have to buy, manage, or store ETH. The majority of Ethereum ETFs hold ETH futures contracts. However, some, like those launched by Bitwise and ProShares, hold a mixture of Bitcoin and Ether futures. Still, whether you hold a Bitcoin ETF or Ethereum ETF, cryptocurrencies are volatile in nature, making investing in their futures ETF risky.
While Ethereum ETFs are somewhat similar to Bitcoin ETFs, the two have some notable differences, including their benchmark assets, expenses, time on the market, and trading volume. When it comes to benchmark assets, an Ethereum ETF purely tracks the price of ETH, while a Bitcoin ETF tracks the price of BTC.
As stated, the first Bitcoin ETF in the US was launched on October 19, 2021, but the first Ethereum ETF was launched on October 3, 2023. Given the length of time that each ETF has been in the market, the Bitcoin ETF has a higher trading volume compared to Ethereum ETFs as they just recently launched.
When it comes to expenses, while the two crypto ETFs have somewhat high expenses, the Ethereum ETF has a relatively low expense ratio of 0.65% compared to that of Bitcoin ETFs, which ranges from 0.65% to 1.59%.
The US SEC has been in an ongoing legal tussle with various investment firms over their application for a Bitcoin spot ETF. Grayscale Bitcoin Trust, for instance, sued the SEC after the regulator rejected its application to turn its Bitcoin Trust into a Bitcoin spot ETF.
However, the SEC’s approval of nine different Ethereum ETF products that were launched into the market indicates that Ethereum ETFs got the green light from the SEC. Since Ethereum ETFs function similarly to Bitcoin ETFs, they also share the same regulatory demands as they are futures contracts.
However, Ethereum spot ETFs, like Bitcoin spot ETFs, are yet to get the SEC’s approval. In fact, the SEC has a long list of crypto spot ETF applications to approve from some of the major investments first, such as Blackrock, Fidelity, and Grayscale. Grayscale is currently also considering converting its existing Ethereum Trust into an Ethereum spot ETF.
Despite the launch of nine different Ethereum ETFs early this month, the ETFs failed to dazzle and started out trading lower than expected following their launch. Of course, it’s still too early to predict what lies ahead . Moreover, only nine Ethereum ETFs have been launched since October 2, 2023, with many more expected to launch in the coming months.
Just like the launch of Bitcoin ETFs pushed the crypto industry forward, the launch of Ethereum ETFs is expected to potentially impact the crypto industry positively and boost the adoption of Ethereum.
Bitcoin ETFs and Ethereum ETFs could potentially elevate the liquidity of the underlying cryptocurrencies, making them a lot more accessible to a wide range of traditional investors. With this, the large inflows into ETH could potentially lead to an increase in the price of the cryptocurrency.
While the launch of Ethereum futures ETF has had some positive sentiments in the crypto world, it’s not grounds for investors to have a go at it blindly. While ETFs have been around for years, and they may appear promising, they aren’t devoid of risks. The risks are significantly higher for crypto ETFs as they’re very volatile, with sudden price swings that can be severe and swift. All that said, watch this space as the story on Ethereum ETFs develops, and always remember to do your own research (DYOR).
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Note: Any cited numbers, figures, or illustrations are reported at the time of writing, and are subject to change.