Are crypto ETPs right for you? 10 things you should know before investing

The popularity of crypto investments is growing fast, leading to greater demand for products offering exposure to this new asset class. One that’s experiencing significant inflows, mainly due to its convenience compared with buying and holding crypto directly, is exchange-traded products (ETPs). Crypto ETPs, which track the performance of an underlying asset such as bitcoin or ether, are listed on mainstream exchanges including the Nasdaq Stockholm, which means they trade like shares and investors can hold them in a portfolio alongside traditional asset classes. For anyone seeking to add crypto ETPs to their portfolio, here are ten important things to know.  

Prior Trading Experience Can Be Beneficial 

Previous experience of trading shares or ETPs gives investors a head start because it demonstrates an understanding of how these products work and the returns they offer. It also helps if investors understand how different types of ETPs are structured. Physical ETPs buy and hold the underlying assets and store them with a digital custodian (Komainu in CoinShares’ case), whereas synthetic ETPs use complex financial instruments called derivatives to replicate performance. 

Understanding Investment Objectives 

As with any asset class, investors need to understand their goals before adding a crypto ETP to their portfolio. For those seeking long-term capital growth, a hedge against inflation or a store of value, an ETP tracking bitcoin or ether might be suitable. But cryptocurrencies are volatile despite their impressive performance over the last decade. Investors have to make sure their risk appetite can handle price fluctuations, which can be extreme at times. And just like any other asset, capital is at risk when investing in a crypto ETP. Investors might not get back all of their money.   

Crypto ETPs Are Non-Leveraged 

Some ETPs are leveraged, which means they borrow money through the use of derivatives to amplify returns. For example, when the underlying asset rises by 1%, the value of a 2x leveraged ETP aims to increase by 2%. Of course, leveraged products also amplify losses. However, unleveraged crypto ETPs are less risky and easier to understand as they generally deliver returns on a one-to-one basis, so a 1% rise in the underlying asset leads to a 1% increase in the value of the ETP (minus fees).

Crypto Exchanges vs. Traditional Exchanges 

Traditional exchanges like the Nasdaq Stockholm or Xetra in Germany must stick to rules introduced by financial authorities to protect investors, and do not hold any customer funds themselves.They’ve also established long-standing reputations- the Stockholm stock exchange opened in 1863, and it became part of the Nasdaq group (one of the world’s leading index providers) in 2008. In contrast, crypto exchanges directly control customer funds, are typically unregulated or underregulated, and are vulnerable to security risks like hacks and breaches targeting user funds. They face operational risks too, including outages or system failures which affect trading. Investors without experience of the crypto markets may have difficulty assessing and mitigating these risks. 

Market Manipulation Concerns 

Market manipulation occurs when a bad actor attempts to deceive investors by affecting the price of an asset. There are various ways this impact can be achieved, for example issuing false statements about a company or order spoofing, a process which involves placing multiple orders to buy or sell an investment and then cancelling them at the last minute after the price has moved. Crypto is vulnerable to manipulation too, especially as efforts to supervise the markets are at an early stage and inconsistent around the world. One of the most common methods is a pump and dump scheme, where someone promotes a token to encourage others to buy it and then sells the holding for a profit once the price rises. 

Price Movements Even After Hours 

Some markets have set operating hours. For example, the Nasdaq Stockholm opens between 9am and 5.25pm from Monday to Friday. That’s why shares have what are known as opening and closing prices, although after hours trading means they don’t always match. On the other hand, cryptocurrencies trade 24/7 because there’s no central authority to introduce and enforce rules, like when traditional markets operate. So the price of an ETP, which derives its value from a cryptocurrency, can change even when the exchange listing it is closed.

Valuation Challenges 

When it comes to valuing shares, investors use time-honoured methods, such as the price-to-earnings and price-to-book ratios favoured by legendary stock picker Warren Buffet. But the same techniques can’t be applied to cryptocurrencies because of their unique nature. Instead, a range of different models are used, including Total Addressable Market (TAM) and The Memetic Theory of Bitcoin Demand. The CFA Institute, one of the biggest global associations for professional investors, even launched a guide to valuing crypto assets at the end of November 2023. Until a standard emerges, investors will need to be careful about which models they rely on and recognise that some are more speculative than others.

No Government Backup for Private Keys 

Many governments provide insurance for bank deposits. The Swedish Deposit Protection Scheme protects up to SEK1,050,000 per person if a Swedish bank fails. But this insurance doesn’t cover custodians holding cryptocurrencies on behalf of ETP issuers. They face the same risks as traditional custodians, such as hacking, fraud, extortion, technical and human errors, theft and sabotage. So it’s important to choose an ETP issued by a provider with a long track record of protecting investors. In CoinShares’ case, the underlying assets are held by Komainu, a joint venture between CoinShares, Japanese investment bank Nomura and Ledger, a leading manufacturer of hardware crypto wallets. Proof of Reserves - evidence that the provider has sufficient assets to meet its liabilities such as withdrawals- is supplied by The Network Firm, a registered certified public accountant (CPA). 

Unique Considerations and Risks 

Crypto ETPs are subject to the same non-market risks as other investment products: 

• Issuer risk- the possibility that investors could experience losses because the issuer defaults or fails to meet its obligations, for instance due to insolvency

• Liquidity risk- the possibility that large trades in the underlying asset may impact an ETP’s price

Investors should conduct their own due diligence and research to make sure they understand how an ETP is structured and explore different ways to mitigate these risks.  

Always Dive Into the Documentation 

As with mainstream asset classes, crypto ETPs must publish a range of documentation to educate investors about how a product works, such as a factsheet, a key information document (KID), a prospectus and final terms. Investors should take the time to read these documents carefully, so they fully understand how the ETP is structured, what it aims to achieve, how much it charges in fees, the risks involved and more. It’s also important to remember that past performance doesn’t guarantee future results. 

Conclusion: How to Select a Crypto ETP 

Investing in ETPs is a convenient way to gain exposure to the crypto market without having to hold the underlying asset directly. These products make crypto more accessible because they trade like shares on mainstream exchanges, and they can be held in portfolios alongside traditional asset classes. However, choosing the right ETP is crucial, which means understanding the issuer’s track record and expertise, the fees it charges, the measures in place to protect investors and the level of transparency about the underlying assets. Learn how to choose a crypto ETP.