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Holding ETFs vs Bitcoin: Pros and Cons of Both

Last Updated February 11, 2024 1:12 PM
Teuta Franjkovic
Last Updated February 11, 2024 1:12 PM

Key Takeaways

  • Bitcoin ETFs are proving popular for investors who want exposure to Bitcoin without holding crypto directly.
  • Some Bitcoin ETFs use leverage to amplify price movements.
  • However, the ETF’s performance may not perfectly mirror Bitcoin’s price due to fees, trading, and rebalancing, resulting in tracking errors.

The growing popularity of cryptocurrency investment is forcing traditional finance to consider new financial avenues.

Digital currencies such as Bitcoin and Ether are continuing to attract considerable interest from investors, mainly because of their potential for significant profits and their ability to serve as a hedge against the volatility of conventional financial markets.

Understanding the Risks Before Entering the Cryptoverse

This interest is driven by several factors. The decentralized nature of cryptocurrencies offers enhanced security and autonomy beyond the reach of traditional banking systems. Moreover, the widespread adoption of blockchain technology across various sectors underscores the transformative impact of cryptocurrencies on financial dealings and payment methodologies.

The allure of swift financial gains in the crypto market has captivated both seasoned investors and newcomers alike. However, the inherent risks and volatility demand prudent investment strategies and a thorough understanding of the market dynamics before diving in.

Direct BTC Investment: High Risk, High Reward

Investing in Bitcoin directly entails buying and holding the cryptocurrency through an exchange, subjecting investors to the direct impact of BTC price movements.

Indirect investment routes like mutual funds, exchange-traded funds (ETFs), or futures contracts offer exposure to the crypto market without owning the digital currency itself. These options involve investing in crypto derivatives or a collection of cryptocurrencies, providing a diversified and often regulated investment approach.

Aspect of Comparison Direct Investment in Bitcoin Investment in Other Cryptocurrency Vehicles
Type of Exposure Direct Exposure Indirect Exposure
Management of Assets Managed by Investor Managed by Professionals
Access to Markets Specific Cryptocurrency Exchanges Wide Range of Financial Markets
Level of Regulatory Oversight Minimal Oversight Enhanced Oversight
Diversity in Investment Focus on a Single Cryptocurrency Diverse Portfolio of Cryptocurrencies or Derivatives

Pros of investing in Bitcoin ETFs

Investing in Bitcoin ETFs presents several key advantages for those looking to gain cryptocurrency exposure without direct ownership. The primary benefits include:

  • Simplified Investment Process

Bitcoin ETFs offer an easier entry point into cryptocurrency investments, allowing individuals to use their existing brokerage accounts. This approach is particularly advantageous for those less familiar with cryptocurrency trading platforms. It means that someone with a background in traditional stock trading can diversify into Bitcoin ETFs without needing to understand the technical aspects of cryptocurrencies, such as managing private keys or digital wallets.

Bitget Research Chief Analyst Ryan Lee explained to CCN readers that investing in ETFs can feel more convenient compared to opening a separate account for buying Bitcoin on platforms like Coinbase.

“Investors can hold Bitcoin ETFs through traditional brokerage accounts, managing Bitcoin and other assets in the same account.”

He added:

“Investors don’t have to worry about losing or having their passwords stolen for cryptocurrency exchange accounts, reducing the risk of potential asset loss.”

  • Enhanced Protection Through Regulation

Bitcoin ETFs benefit from operating in regulated financial environments, which bolsters investor safety. The regulatory framework ensures transparency and compliance, providing a more secure investment landscape. The SEC’s approval of the first U.S. Bitcoin futures ETF in 2021 and the later approval of spot Bitcoin ETFs in January 2024 highlight significant strides toward incorporating digital currencies into the mainstream financial system.

  • Portfolio Diversification Benefits

Offering access to a novel asset class, Bitcoin ETFs enable investors to diversify their portfolios effectively. Since Bitcoin’s performance often diverges from traditional assets like stocks and bonds, incorporating a Bitcoin ETF can distribute risk more evenly. This diversification can be particularly valuable during periods when traditional markets are struggling, offering a potential buffer against broader market dips.

  • Higher Liquidity for Investors

Compared to direct cryptocurrency holdings, ETFs generally provide higher liquidity, facilitating the easy buying and selling of shares at prevailing market prices during trading hours. This aspect is essential for promptly responding to market movements, an important consideration in the fast-paced crypto market.

  • Tax Benefits of Bitcoin ETFs

Bitcoin ETFs may also lead to more favorable tax situations compared to directly holding Bitcoin. Many jurisdictions offer ETFs advantageous tax treatments, such as delaying capital gains taxes until the sale of the investment, in contrast to the immediate tax implications of certain transactions in direct Bitcoin investments.

According to Lee, Bitcoin ETFs can also be held in investors’ retirement accounts, avoiding capital gains tax associated with directly holding Bitcoin. However, this also means that even if the Bitcoin price falls, the tax generated in the retirement account won’t decrease.

Cons of investing in Bitcoin ETFs

While Bitcoin ETFs present appealing advantages for investors seeking cryptocurrency exposure, there are notable disadvantages to consider. The main drawbacks include:

  • Susceptibility to Volatility

A significant downside to Bitcoin ETFs is their exposure to the cryptocurrency market’s high volatility. Bitcoin and its related ETFs can undergo rapid and substantial price swings within very short periods. For instance, daily price shifts of more than 10% are not uncommon for Bitcoin, which can be unsettling for investors unaccustomed to such levels of volatility.

  • Exposure to Market Risks

Investing in Bitcoin ETFs also means facing the cryptocurrency market’s inherent security and regulatory challenges. As a relatively new and evolving market, cryptocurrency faces ongoing regulatory uncertainties and compliance hurdles across various jurisdictions, in addition to being prone to security risks like hacking incidents. Notably, regulatory actions in significant markets, such as China, have previously led to sharp declines in market values.

  • Higher Fee Structures

Bitcoin ETFs typically incur higher fees than traditional ETFs, attributed to the costs associated with maintaining and securing the underlying cryptocurrency assets.

BITCOIN ETF FEE COMPARISON
FUND TICKER FEE
BITWISE BITCOIN ETF BITB 0.20%*
ARK 21SHARES BITCOIN ETF ARKB 0.21%*
FIDELITY WISE ORIGIN BITCOIN FUND FBTC 0.25%*
ISHARES BITCOIN TRUST IBIT 0.25%*
VALKYRIE BITCOIN FUND BRRR 0.25%*
VANECK BITCOIN TRUST HODL 0.25%
FRANKLIN BITCOIN ETF EZBC 0.29%
WISDOMTREE BITCOIN FUND BTCW 0.30%*
INVESCO GALAXY BITCOIN ETF BTCO 0.39%*
HASHDEX BITCOIN ETF DEFI 0.94%
GRAYSCALE BITCOIN TRUST GBTC 1.5%

Credit: CNBC

  • Lack of Direct Ownership

Bitcoin ETF investors do not hold Bitcoin directly; they invest in a fund that owns Bitcoin on their behalf. This indirect ownership means missing out on certain benefits of direct Bitcoin possession, such as using it for transactions or personal custody without intermediaries.

  • Tracking Error Concerns

There can be discrepancies between a Bitcoin ETF’s performance and actual Bitcoin market movements, known as tracking error . This divergence can result from various factors, including fund expenses, the methods used to achieve Bitcoin exposure (like futures contracts), and the timing of market trades versus fund rebalancing.

For example, a futures-based Bitcoin ETF may not accurately mirror real-time Bitcoin price movements, especially in turbulent markets. Tracking error essentially gauges the deviation between the performance of a fund or portfolio and its benchmark index, reflecting the fund manager’s success in mirroring the index’s returns.

Key Advantages: Halving Events and Ecosystem Development

According to Bitget Research Chief Analyst Ryan Lee, one primary benefit Bitcoin ETFs offer relates to the anticipated halving events of Bitcoin itself. The halving mechanism inherently restricts the pace at which new Bitcoins are created, acting as a bulwark against inflation and contributing to potential price appreciation.

Since its inception in 2009, Bitcoin has experienced three such halving occurrences, each leading to notable surges in its price. The next, or fourth, halving event is slated for April 2024, drawing considerable attention from investors.

Another significant advantage comes from the rapid development within the Bitcoin ecosystem.

Lee explained:

“With the exponential growth of Ordinals users, numerous new and existing protocols on the Bitcoin blockchain have emerged, driving strong development of the Bitcoin ecosystem.”

Furthermore, the rise of Bitcoin’s layer 2 solutions has considerably expanded the ecosystem’s capabilities.

Jademont, the founder of Waterdrip Capital, has highlighted  the future expansion of this infrastructure, predicting the launch of at least 10 Bitcoin layer 2 networks in the coming year. This advancement is set to enhance the Bitcoin ecosystem’s efficiency, particularly in handling transactions.

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