Buying cryptocurrency ETFs

Cryptocurrency is the future, cryptocurrency is a scam. Bitcoin makes millionaires, Bitcoin is a waste of money. You can buy a Tesla with cryptocurrency — wait, no you can’t.

Yes, crypto continues to be one of the most controversial new financial products of the past 10 years. As the highest profile member of the group, Bitcoin is often at the centre of the debate, while runner-up Ethereum can also enter the discussion.

There’s a lot about cryptocurrency — or crypto — that can seem mysterious and foreign, even to sophisticated investors. For example, the way cryptocurrency is created is just not that intuitive. Crypto doesn’t resemble other familiar assets, such as commodities that are pulled from the earth like oil or gold, a business started in someone’s garage or even a currency issued by a government.

Cryptocurrency prices can also seem driven by mysterious forces. The spectacular rise and just as spectacular decline of crypto prices in 2021 and 2022 left some investors wondering about crypto’s future.

Also viewed by some as a possible inflation hedge, crypto prices have at times been negatively affected by climbing inflation and the accompanying rise in interest rates.

Despite its volatility, awareness of cryptocurrency continues to grow, along with curiosity about its future and its potential practical uses. While it’s not yet a common investment product, some investors are doing their research and looking for ways to make it part of their investment portfolios.

Which brings us to the reason you may be reading this article. For those who’d like exposure to cryptocurrency but aren’t comfortable purchasing it directly, it’s possible to purchase ETFs that track the two biggest cryptocurrencies¹, Bitcoin and Ethereum, or a combination of the two. New crypto ETFs continue to launch in Canada.

So, let’s review. If you’re already familiar with ETFs and cryptocurrency basics, skip ahead.

An ETF — or Exchange Traded Fund — is an investment product that contains a portfolio of securities or financial instruments. It’s often designed to track a specific index or market sector, or used to produce a specific outcome, such as tracking low volatility stocks.

As the name states, an ETF is exchange traded — you can buy and sell it like a stock on an exchange. It offers an easier-to-use and lower-cost way to invest that simply matches the makeup, and consequently the performance², of a specific index, asset or group of assets, rather than trying to beat that performance.

Bitcoin and Ethereum are types of cryptocurrency. Encryption techniques are used to regulate the generation of units of cryptocurrency and verify the transfer of funds, operating independently of a central bank.

Most cryptocurrencies use a blockchain to record and verify transactions. A blockchain can be thought of as a database or a digital accounting ledger.

The advantage of a blockchain is that it’s decentralized and works on a peer-to-peer framework, without central control or government authority. Once a transaction is recorded, it’s almost impossible to retroactively delete or change it.

A cryptocurrency ETF aims to track the price movements and performance of a single or combination of cryptocurrencies. It’s important to note that while ETFs make it easier to invest in cryptocurrency, they don’t eliminate the risks of cryptocurrency investing — the price history of many cryptocurrencies has been extremely volatile.

There are two ways that currently available³ ETFs are structured. To keep it simple, let’s look at a Bitcoin ETF to illustrate.

1. ETF holds Bitcoin

The ETF holds Bitcoin and buys or sells Bitcoin as investors buy or sell units of the ETF. The price of the ETF rises and falls with the rise and fall of the assets it holds — that is, the price of Bitcoin.

2. ETF holds futures contracts on Bitcoin

Bitcoin futures track the price movements of Bitcoin⁴, and these Bitcoin ETFs hold Bitcoin futures contracts to mimic Bitcoin’s return. Note that the ETF doesn’t actually own Bitcoin and you, as the ETF holder, own a product whose price rises and falls when Bitcoin’s price rises and falls. The ETF generally rises or falls by the same percentage, although there may be some tracking error.

There are a number of ETFs that mimic their reference index or asset group this way, using derivative products⁵. For example, a synthetic S&P 500 Index ETF may purchase futures contracts on the S&P 500, rather than buying all 500 stocks in the index.

In Canada, you can find both ETFs that hold Bitcoin — also known as spot Bitcoin ETFs — and those that hold Bitcoin futures contracts. Canadian regulators have approved both types and both are eligible for tax-advantaged accounts.

As of January 2024, U.S regulators have also approved both types of cryptocurrency ETF for American Investors.

There are advantages and disadvantages to each option.

In Canada, you can hold Bitcoin ETFs in your tax-advantaged accounts, such as your RRSP and TSFA. Canadians can’t directly hold cryptocurrencies in tax-advantaged accounts.

Bitcoin ETFs are available in versions that hedge your currency exposure or leave it unhedged.

If you have a brokerage account — either an investment account or a tax-advantaged account — the purchase and custody of a cryptocurrency ETF is straightforward. It will appear in your account in the same way as other ETFs.

Direct purchase of cryptocurrency requires an account on a cryptocurrency exchange and/or the creation of a cryptocurrency wallet⁶.

Cryptocurrencies trade 24 hours a day, 7 days a week, through various platforms, and not on traditional stock exchanges. ETFs — including crypto ETFs — trade on traditional stock exchanges, which are open Monday to Friday, from 9:30 am to 4 pm Eastern time. If a cryptocurrency makes a big price move while traditional exchanges are closed, you won’t be able to adjust your crypto-based ETF position until the exchange reopens.

Some investors like the relative anonymity of holding crypto; ETFs don’t offer this feature.

Crypto ETFs charge a management fee and investors may have to pay a trading commission to buy or sell an ETF. Also, depending on the ETF structure, the ETF may, at times, trade at a premium or discount to the asset value of the fund.

Some crypto ETFs include a feature called staking, where the fund earns extra rewards by helping process transactions on a blockchain network. These rewards can boost the fund’s return — potentially adding a small amount of yield over time — but they also come with trade-offs. The added complexity may introduce operational or custodial risks, depending on how the fund is managed. You don’t choose whether to stake or not — it’s built into the ETF if the provider offers it — so it’s worth checking the fund’s documents for how staking is handled and whether any additional risks apply.