The New ETFs - Exposure to Cryptocurrencies, Part 3

Australian investors can now gain direct exposure to “physical” crypto assets such as Bitcoin (BTC) and Ethereum (ETH) with three new ETF options listed on the CBOE exchange in May:

1. ETFS 21Shares Bitcoin ETF (CBOE: EBTC).
2. ETFS 21Shares Ethereum ETF (CBOE: EETH).
3. Cosmos-Purpose Bitcoin Access ETF (CBOE: CBTC).

ETFs providing secondary exposure by investing in companies participating in the crypto and digital asset space have been available for a while, such as ETF Securities’ Fintech and Blockchain ETF (CHX: FTEC) or Betashares’ Crypto Innovators ETF (ASX: CRYP). But it has been a long time coming for listed managed fund options providing access to the underlying assets, also known as “spot” access.

The ETF Securities’ funds provide investors with a beneficial interest in the underlying BTC and ETH which are secured in “cold storage” by Coinbase, the world’s largest crypto asset custodian. Investors are exposed to the BTC and ETH spot price rather than a secondary exposure to companies involved in the crypto industry via ETF Securities’ Fintech and Blockchain ETF mentioned earlier, which was launched in 2021.

The Cosmos Asset Management fund is a “feeder” fund that provides local investors with access to the world’s first physically-settled BTC ETF, launched by Canada’s Purpose Investments in early 2021 on the Toronto Stock Exchange. Canada’s 3iQ Digital Asset Management has also filed applications to list two such feeder funds on the CBOE for access to its 3iQ CoinShares Bitcoin ETF and 3iQ CoinShares Ether ETF which also trade on the Toronto Stock Exchange.

Recent market gyrations have meant that assets under management in both funds are modest, but this could change once market conditions improve:

These managed investment vehicles provide investors with exposure to BTC and ETH in return for a management fee. The ETFS funds hold direct exposure to BTC and ETH, while the Cosmos and 3iQ funds access other ETFs trading on foreign exchanges whose exposure is also direct to the physical asset.

ETFs over spot crypto assets, or that provide on-ramps to other ETFs with spot exposure, are targeted at investors who prefer to rely on a custodian to manage the acquisition and storage of crypto assets, rather than taking on the risks of self-acquisition and custody. A professional custodian employed by the fund manager can:

• Store crypto in a “cold wallet” (that is not connected to the Internet and therefore better protected from the risk of hacking).
• “Shard” the private key by storing portions of the wallet’s private key in separate locations for added security (meaning that each portion needs to be brought together to form the private key).
• Employ technical measures such as a “Faraday cage” to protect the wallet hardware from electromagnetic interference.
• Require “multi-factor authentication” from multiple approvers to initiate the transfer of crypto assets out of the ETF.

ETFs might be able to acquire the underlying crypto at a lower cost through over-the-counter (OTC) and other professional arrangements. ETFs also provide exposure to SMSFs which otherwise might find it difficult to open a trading account with a crypto exchange. Ease of tax reporting and administration is another significant benefit offered by ETFs compared to direct custody, especially for SMSFs.

Given the many benefits that ETFs offer, investors might consider whether self-custody is worth the effort and risk. Why not leave the hard work to the ETF issuer?

Perhaps the most important consideration is that ETFs provide exposure via a beneficial interest in the underlying crypto asset, but not direct ownership. Should an ETF be hacked or the underlying crypto otherwise lost, investors might not have any recourse from the ETF issuer.

Self-custody of crypto assets means that the private keys to the wallet are held by the investor directly. Notwithstanding a failure in the underlying blockchain itself, self-custody of wallet private keys provides assurance to the investor that their crypto is safe (aka “not your keys, not your coins”). The proviso to this is that the investor is solely responsible for their own actions and the safe storage of their wallet private key. Should the investor make a mistake, there is nobody to call for assistance.

The ETF space continues to evolve as crypto markets develop.

Even the ASX is getting in on the act, announcing “Amendments to ASX Operating Rules and Procedures to facilitate AQUA Products holding Eligible Crypto-assets” which became effective on 30 May.

The ASX has defined “eligible crypto-asset” to mean BTC and ETH specifically, but also other digital assets that meet a range of criteria such as wide institutional support and acceptance, approval by regulators in other comparable jurisdictions and are held by other financial products with a proven track record.

VanEck announced back in October 2021 that it intends to launch a BTC spot ETF on the ASX as a result of the ASX’s amendments to its operating rules. It hopes  to leverage its “global reach, expertise and infrastructure in offering Australian investors the best-in-class cryptocurrency solution” as well as the ASX’s broader access to investors as the nation’s leading exchange.

This is all to the benefit of investors who have an increasing array of ETF options to consider if self-custody isn’t desirable, or if a combination of self-custody and managed exposure is preferred for administrative purposes.