Why ETPs are poised to become the most practical exposure to crypto?

One of the catalysts driving bitcoin’s rally in June was asset manager BlackRock filing an application with the US Securities and Exchange Commission (SEC) for an exchange-traded fund (ETF) tracking the spot price (for immediate delivery) of bitcoin.

ETFs are financial products that expose the holder to an underlying index or asset class. They broaden access to assets such as cryptocurrencies because they’re publicly traded on the stock market like shares. They’re also a passive investment, allowing providers to keep costs to a minimum. Along with exchange-traded commodities and notes, ETFs are a type of exchange-traded product (ETP).

Demand for crypto exposure is rising- research by CoinShares shows bitcoin funds received $742 million in the four weeks up until mid-July, the highest inflows since the final quarter of 2021. As demand continues to grow, retail and institutional investors alike need a safe and convenient way to access the asset class. ETPs meet these needs.

Evolving Regulatory Landscape

Some traditionalists believe regulations contradict the founding principles of cryptocurrencies, which were designed to be decentralised. However, stricter supervision of the industry should improve the experience for investors:

• Regulations reduce the amount of speculation and subsequently bring greater stability to the market

• They protect investors by reducing the likelihood of manipulation and ensuring the safeguarding of assets

• They guard against criminal activity in the crypto ecosystem, such as fraud and ‘rug pulls’ where a founder launches a project and then disappears with user assets

Greater regulatory clarity should, in turn, support crypto prices. Analysts at investment research firm Fundstrat believe bitcoin could soar to $180,000 by April 2024 if the SEC approves BlackRock’s ETF.

The regulatory landscape is constantly evolving, as demonstrated by the recent cases brought by the SEC against Binance and Coinbase. But the EU is one of the most advanced jurisdictions in terms of its supervision of the crypto industry. The Markets in Crypto Assets regulation (MiCA), which came into force in June 2023, aims to protect investors by introducing rules covering how stablecoin issuers manage reserves and how custodians segregate client funds. It’s a harmonized regulatory framework, meaning it applies to all member states.

‘Although not perfect, MiCA will be largely welcomed by the crypto industry since it will provide clarity on becoming regulated and therefore the ability to provide services into a large consumer marketplace,’ according to Nick Du Cros, CoinShares’ Head of Compliance and Regulatory Affairs in the UK. ‘The EU is potentially positioned to set the global standards for crypto. It’s now far ahead of other potential competitor countries like the US and the UK, which are still consulting about many aspects of their crypto regulatory frameworks.’

Convenient access

ETPs offer convenient access to crypto for several reasons.

As they’re traded on the stock market, investors can purchase ETPs through a broker and hold them in a portfolio alongside other mainstream products. Brokers including DeGiro and Saxo Bank list the CoinShares Physical Crypto ETP.

As explained in the previous section, financial authorities supervise ETPs in certain jurisdictions. In the EU, they’re subject to the same regulations as traditional products and listing rules governing mainstream exchanges, so they must follow the same accounting and disclosure procedures.

Finally, ETPs address the challenges of trading on crypto exchanges. Many exchanges are either unregulated or under-regulated, so investors aren’t protected. To make matters worse, underdeveloped infrastructure makes them vulnerable to hacks, while complex custody means direct crypto holdings are incompatible with conventional portfolios.

Gold as a proxy

Gold ETPs are a relatable example of an investment vehicle providing exposure to an underlying asset without needing to physically possess it. Just 20 years after the first product appeared on the market, assets under management total nearly $211 billion. The biggest ETP is the SPDR Gold Shares (launched by State Street in 2004) which holds 827.77 tonnes of the precious metal worth $53.5 billion (as of September 27th 2023).

Gold investors turn to ETPs for some of the same reasons as those seeking exposure to crypto. Firstly, holding physical gold is inconvenient. It needs secure storage, which also increases the cost of the transaction. Secondly, gold ETPs are liquid as investors can trade them through brokers at any time of the day.

Similarities between gold and crypto ETPs

Physical Crypto ETPs

While BlackRock’s ETF, not to mention other prospective providers, has garnered plenty of media attention lately, these products aren’t new to the financial markets. CoinShares launched the world’s first crypto ETP in 2015, and Fidelity introduced its own version targeting European investors in February 2022.

Incidentally, both of these products are physical ETPs. Unlike synthetic ETPs, which use derivatives like swap agreements to track the price of bitcoin, physical ETPs purchase and hold the underlying assets. The crypto purchased by CoinShares is held by Komainu, a specialised digital asset custodian regulated by the Jersey Financial Services Commission.

While synthetic ETPs have their place in some portfolios, physical ETPs offer several advantages:

• Holding ‘physical’ bitcoin means performance more accurately reflects the spot price

• Physical ETPs are transparent, so they’re easier to understand

• Investors don’t face counterparty risk, where the derivative provider defaults on its contractual obligations

Conclusion

Compared with the trillions of dollars invested in traditional securities, the amount of capital which has flowed into crypto so far is relatively small. With demand increasing, investors need a safe and convenient way to access the asset class. ETPs are well positioned to meet this demand because they’re subject to regulatory supervision in some jurisdictions and investors can trade them on mainstream exchanges and store them alongside conventional assets in their portfolios. When choosing between the different types of ETPs, investors should consider physical over synthetic as they more accurately reflect the spot price of bitcoin, they're easier to understand, and they don’t carry counterparty risk.

Learn more about CoinShares Physical Crypto ETP.