8 min readExchange Traded Products (ETPs) are a convenient, cost-efficient solutions for investors looking to access crypto within a regulated framework. How do they work, exactly? Could they be a worthwhile addition to your portfolio? This is what we will cover in this article.
What are ETPs?
An exchange-traded product (ETP) is a type of financial instrument which is bought and sold on a regulated stock exchange that allows investors to gain exposure to the price movements of an underlying benchmark or asset without having to own the asset itself.
Initially created to provide investors with access to equity indices, ETPs have expanded to become the primary vehicle for listed exposure to almost every asset, including crypto. Just like stocks and shares, you can buy and sell ETPs through your broker.
ETPs are not a new invention. In fact, the world’s first ETP recently celebrated its 30yr birthday. Asset under management (AUM) in ETPs have been steadily rising in value as they become increasingly popular with investors across the globe. According to research firm ETFGI, 2,937 ETPs were listed at the end of December 2022.
How are ETPs structured?
‘ETP’ is an umbrella term covering several types of exchange-traded financial products, and can include exchange-traded funds (ETFs), exchange-traded commodities (ETCs), and exchange-traded notes (ETNs).
An ETP’s aim is to provide or replicate the return of an underlying benchmark or asset. To do this, they employ one of two replication methods: physical or synthetic.
Physical ETPs physically buy and hold the underlying assets they are designed to track, such as stocks, cryptocurrency, or commodities. The performance of a physical ETP is therefore directly linked to the performance of the underlying asset(s).
Synthetic ETPs use swap agreements with a counterparty, typically a bank, to provide the return of the underlying assets. To ensure the return is delivered each day, the swap counterparty is often required to deposit liquid and diversified collateral (usually in the form of treasuries or blue chip equities) with the issuer, held by an independent custodian. The amount of collateral required fluctuates with the value of the asset the ETP is designed to track.
In recent years, investors have generally favoured Physical ETPs due to their transparency, lack of counterparty risk, and relative simplicity. Synthetic ETPs have their place, however. For example, sometimes the underlying asset is impossible or very costly to physically hold and store (like oil, which evaporates, or corn, which rots), or the index being tracked is so large or illiquid that the costs involved in physically replication are more than the cost of replicating synthetically using derivatives.
Given the simplicity of holding crypto for experts, its underlying liquidity, and investor preference, most crypto ETPs are physically backed.
What benefits do crypto ETPs provide?
ETPs open up access to a variety of asset classes in a liquid, exchange traded, secure wrapper.
Gold is a good example of how ETPs have helped investors access a difficult asset class. Prior to the introduction of gold ETPs, owning gold cost-effectively was no easy task: you either needed to buy (and store) physical bars, or buy shares in mining companies. Direct investment was something mostly done by large institutions. But investing in a gold ETP is an entirely different process - investors simply have to buy the product via their broker and add it to their existing portfolio.
How do Crypto ETPs Work?
While you might think that crypto, as a digital asset, has little in common with gold, it can benefit from ETPs in many of the same ways.
We’ll only focus on physical ETPs in this section to analyse how they work. In the same way Physical Gold ETPs derive their value from the physical metal bars held securely in a high-security vault, Physical Crypto ETPs derive their value from coins held in a secure wallet by an independent custodian.
Crypto ETPs, or cryptocurrency exchange-traded products, have seen an exponential rise of their own. According to a Bloomberg Intelligence report published in April 2022, crypto ETPS are likely to grow beyond $120 billion by 2028. In Europe alone, the number of crypto ETPs has more than increased tenfold between 2019 and 2022, rising from 15 to 166 available products. And this market segment is thriving despite falling crypto prices: a total of over 180 active crypto Exchange Traded Products and trust products have been released globally since the bitcoin bear market started.
Similar to other ETPs, crypto ETPs are investment products that provide exposure to the performance of an underlying asset - in our case, a specific cryptocurrency, such as Bitcoin or Ethereum, or even an index of various cryptocurrencies. And they are also listed and traded on a securities exchange.
Crypto ETPs: Design & Structure
Let’s picture a Physical Bitcoin ETP. How would it be set up?
A Physical BTC ETP works with a variety of partners, most importantly:
ETP Issuer - who establishes a stand-alone special purpose vehicle to issue a BTC ETP. This will be listed on a regulated exchange (e.g. Xetra in Germany, Euronext in France or the Netherlands…).
Trustee - who will represent the interests of investors and to whom the issuer assigns all its rights to the physical assets backing the ETP. The trustee’s role is to act as an independent entity that safeguards the assets of the ETP and ensures that the ETP is being managed in accordance with the terms and conditions
Custodian - who will hold the underlying physical crypto.
Administrator - who helps the issuer manage the ETP, providing operational support and participating in overseeing the day-to-day operations of the ETP
Authorised Participants - who are responsible for creating and redeeming shares of the ETP, managing the liquidity of the product. They do this by acquiring or disposing of the underlying assets of the ETP, such as Bitcoin, in exchange for shares of the ETP.Investors can buy and sell the BTC ETP on a stock exchange through their regular broker during the trading day, just like a stock.
Watch it in action: this is how a Buy Order from an investor is working:
The value of the crypto ETP is based on the value of the underlying assets it tracks. If the value of the assets (here, BTC) increases, the value of the crypto ETPs will also increase. If the value of the assets decreases, the value of the crypto ETP will also decrease.
Do I Actually Own Crypto When I Buy Crypto ETP?
When you buy a crypto ETP, you do not own the physical cryptocurrency directly. Instead, you generally own a debt security from the issuer, which is backed by the crypto and secured by the relationship with the trustee (this is why we refer to crypto ETP issuers as bankruptcy remote).
Different crypto ETPs types
Crypto ETPs allow a variety of uses, depending on the exposure seeked by the investor:
Tracking a specific crypto: these ETPs follow the value of a single asset (blue-chip coins like BTC and ETH, or altcoins). They are designed as a simple way to replicate the market for this underlying asset.
Tracking a basket or an index of cryptos: this is an interesting option to gain exposure on several thematics and diversify risk by simultaneously investing in multiple assets.
Where Can I Buy Crypto ETPs?
You can buy crypto ETPs in the exact same way you would buy an ETP or a share: through your regular broker. You can then incorporate them into your portfolio alongside your other investments in stocks and funds.
How to buy an ETP via your online investment platform?
Login to your online broker’s account or app
Search for the product name, ISIN code, or ticker symbol of your chosen ETP
Choose the notional amount or number of securities you wish to buy
Place the execution order
What are the benefits of an ETP for crypto?
We have seen crypto ETPs offer security, as they are regulated securities with a bankruptcy-remote structure. They are also easy to access, and then integrate into one’s portfolio. But that’s not all: ETPs are a great option to own crypto without the complexity of self-custody, and they typically enjoy greater liquidity levels than some crypto. All these advantages are listed in our bite-size analysis: Why Buy Crypto through ETPs?
Interested in adding crypto ETPs to your portfolio? You can check CoinShares current ETP offering, fees and prices on our website.