What is an ETF?
An ETF involves trading a collection of assets, what is often referred to as a basket. It is traded on the stock market in the same way as ordinary stocks and shares. The basket might track the performance of a specific commodity or index, such as crude oil or the Dow Jones. More recently, ETFs for cryptocurrencies have become available. Trades in ETSs can be fast moving, with prices changing throughout the day due to the continuous creation of new shares and as existing shares are redeemed. They often have lower fees than mutual investment funds, making them an appealing option for many traders, although commissions usually apply. They can be traded at any time of the day and tend to be a tax-efficient method of trading. As they are traded like stocks, traders have the ability to place a variety of order types, including stop-loss orders and limit orders. Some investors have raised concerns about ETFs, noting the role they have played in a number of market flash-crashes. However, ETFs are here to stay, bringing the investor the possibility of significant profit. As is often the case however, this possibility of profit is accompanied by the risk of significant losses.
Top 3 ETF Broker Comparison
A brief guide to cryptocurrency
A cryptocurrency is a digital currency, but it can be spent on goods and services. However, its most popular use is for trading. As stated above, cryptocurrency burst onto the market in 2009 with the launch of bitcoin, and although still considered a newcomer to the world of trading, it has become a popular product. While bitcoin was the first cryptocurrency to be successfully traded, attempts at digital currency had been made as far back as the 1990s. Bitcoin is the best-known cryptocurrency, but it is not the only one. Others include:
- Litecoin (LTC) – Launched in 2011, it has faster transaction times than bitcoin.
- Ethereum (ETH) – This is an open-sourced, platform-based cryptocurrency launched in 2015.
- Ripple (XRP) – Released in 2012, this acts as both a cryptocurrency and a digital payment network.
- Bitcoin cash – This was created as a version of bitcoin that allows larger size of blocks, therefore increasing the transaction speed.
- Ethereum classic – This is a version of the Ethereum blockchain, which runs smart contracts – these are applications that act as programmed without fraud, downtime, censorship or a third-party interface.
While these are some of the most popular, there are many other types that a cryptocurrency ETF guide might include. If you trade directly in cryptocurrency, you will need to find a place to store it, and a number of options exist for this. However, trading your cryptocurrency as an ETF takes away this need.
Why trade cryptocurrency as an ETF
When trading in cryptocurrency was first launched, it was a confusing way to trade, and while it is easier now, there are still difficulties. One such difficulty is storage. Just as physical cash needs to be stored in a wallet, so cryptocurrency also needs to be stored. This requires you to set up and maintain a digital wallet, and there are many different types depending on whether you are storing just one type of cryptocurrency or several, as well as what level of security and abilities you require. Receiving and sending cryptocurrency can be confusing, and even with the highest security levels, nothing on the internet is completely secure, so hacking and theft cannot be ruled out. A cryptocurrency ETF avoids this, as the cryptocurrency is never actually owned. There are two ways to trade cryptocurrency as an ETF:
- Physical-backed crypto ETFs: In this, the actual cryptocurrency is owned by the fund, and you own shares in this fund. If the value of the cryptocurrency rises, profit is made.
- Futures-backed crypto ETFs: This does not trade on actual cryptocurrency but on the cryptocurrency futures contract, an agreement that sets a fixed date and price for selling or buying an asset. With this type of ETF, investors can profit in all kinds of markets, and as the fund does not own the cryptocurrency, there are no issues with hacking or theft.
While there are costs involved, these tend to be lower than traditionally managed funds.
Disadvantages of a cryptocurrency ETF
While there are plenty of advantages of a cryptocurrency ETF, there are also some drawbacks that the new trader needs to consider before investing. Cryptocurrencies are notoriously volatile, with large price fluctuations possible within a short space of time. While this may cause a handsome profit, it may also represent a significant loss. While other types of ETFs have a high level of diversification, using a range of securities to reduce the risk, this tends to be more limited with cryptocurrency ETFs. Although you do not physically own the cryptocurrency, the fund may. As a result, you cannot assume you will not have your trading affected by hacking and theft. If the ETF is located in another country, you may find foreign tax applies when you buy or sell units. There will also be other fees, including management fees and brokerage fees, although typically these compare favourably with other trading methods. At present, there is limited choice in cryptocurrency ETFs, although more are being created, so this is certainly an expanding market. ETF sales are not settled for two days following a transaction, meaning you may have to wait before reinvesting your funds. As there is no such thing as a completely simple, risk-free trading method, it is up to the individual investor to decide how serious these disadvantages are.
Where to trade
To trade cryptocurrency as an ETF, you will need to find an online broker who offers this service. Different brokers offer different products, and while cryptocurrencies are gaining in popularity, not all brokers will offer them, and even if they do, the range may be limited. The next step is to separate a reputable broker from a scam. A good place to start is to use a broker comparison site and read reviews, both from experts and ordinary traders. Factors to look out for when researching a broker is how they are regulated. A reputable broker will be regulated on one or more countries, displaying that they follow the guidelines the regulator specifies. Brokers are regulated in the UK by the Financial Conduct Authority (FCA), which has strict rules and a compensation scheme in the event of the broker going bust. You will also want a firm with good customer services. Everyone needs support at times, and someone new to cryptocurrencies is likely to be particularly in need, so a helpful, easy-to-reach customer services team is a must. It is also worth checking the fee structure. Not all brokers are transparent, so there can be hidden charges. When reading reviews, check what users say about how effective the platform is and what tools are available. If you are likely to be trading away from your home or office computer, you will also want to see how their mobile platform performs.
Getting started with your account
Once you have chosen a broker, you will need to set up an account. This is usually straightforward, and the process can often be completed in minutes. Once your account is open, you can deposit money and start trading straight away, but if you are new to trading, it is well worth having a practice first. Many brokers now offer demo accounts, giving new customers the chance to experience their platform and real-time market conditions without risking any real capital. There is also no obligation to trade for real, so it can be good way to check whether the broker you have chosen is truly the right one for you. In a demo account, you will be given virtual funds that you can invest in a cryptocurrency ETF. Free from the worry of losing any real capital, you can experiment with trades, learn how to place buy and sell orders and make use of the other features. With cryptocurrency ETFs often changing rapidly, being completely familiar with the mechanics of trading and the platform you are using is certainly an advantage when you start trading for real. Some brokers offer unlimited demo accounts, allowing you to practise for as long as you wish and even keep the demo account alongside your real account.
Trading for real is different from trading on the demo as you will be risking real capital. Successful trading on a demo does not always transfer into successful trading for real, so start with small amounts of money you can afford to lose. The simplest type of order for an ETF is a market order, which instructs your broker to place an order immediately. However, this is a risky type of order that will not get you the best price. Furthermore, with a cryptocurrency ETF likely to change at any time, a flash crash or a technical glitch removes the control you have over when the trade is executed. A limit order is a much safer way of trading small amounts. This states the maximum price you will pay if you are buying or the minimum if you are selling. As well as helping you get the best price, this also protects you from sudden market fluctuations – if the price changes from what you are prepared to pay, your order will simply not go through. As ETFs mostly trade in a similar manner to stocks, if you are already experienced in trading, you will already be familiar with trading and may have trading strategies already in place.
What are authorised participants?
When you start trading ETFs, one of the terms you might hear is ‘authorised participants’ (APs), and you may be wondering who they are and what role they play. APs provide the liquidity that gives them the right to modify the supply of ETF shares available. If there is a shortage, they can create more, while if there is a surplus, they can reduce the number, using the creation/redemption mechanism. At least one AP will have been appointed to the fund before launch, and more can be appointed over time. The exact number will vary between ETF, with the larger ones requiring more APs. By being able to create and redeem shares, APs can help keep ETFs at a fair value. It can often be found that the more APs there are, the better, as the competition helps keep ETFs close to their value. How easy their task is will depend very much on which market they are tracking. With cryptocurrencies being a relatively new market for ETFs to track, the APs are likely to have their work cut out for them. You will likely not know the identity of the APs on the cryptocurrency ETFs that you invest in, but you will be glad they are there.
Cryptocurrency ETFs – our verdict
As a newcomer to the ETF market, you may currently be limited for choice in cryptocurrency ETFs in the UK, but this is something that is likely to change. The main drawback to cryptocurrency ETF trading is the price fluctuations. While you may see increased profits, the volatility can also mean significant losses incurred in a short period of time. However, if you are confident in your ability to trade despite or perhaps even because of these drawbacks, you may well consider a cryptocurrency ETF a worthwhile investment. With lower costs, it is an attractive option for the new trader, and trading cryptocurrency as an ETF does mean you avoid the confusion of having to set up and maintain a digital wallet, freeing you from the fear of hackers and thieves. Choosing your broker carefully and ensuring you fully understand the best trading strategies will be key to achieving success in this volatile but exciting form of trading.