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 available4 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 Bitcoin5, 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 products6. 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.