10 minuti di letturaCrypto can be a beneficial addition to dynamic portfolios, thanks to its decorrelation from other assets and interesting volatility, as we explain in our article Why diversify with crypto.
Once you have decided to introduce crypto in your portfolio, 3 main paths open up:
Spot trading on exchanges
Crypto-asset derivatives
Exchange Traded Products
Each comes with very different security and compliance levels, and it’s important to fully grasp this before you choose an investment vehicle. We’ll cover all three in this article, so keep reading to find out the best option.
Spot Trading on Exchanges: Simplicity May Come with Risks
Crypto exchanges allow traders to easily buy and sell crypto “on the spot”, with quick delivery of assets to the buyer. This is called direct exposure, because investors directly own the assets.
When simply browsing crypto exchange websites, it can be easy to think all exchanges are similar when it comes to investor’s protection and regulation. This couldn’t be further from the truth.
First, there are unregulated (or underregulated) offshore exchanges, which usually operate in jurisdictions with low regulatory constraints. This makes them attractive to some investors as they might offer a wider range of products or more exotic ones compared to other jurisdictions, and their identity checks can be less stringent.
But this flexibility comes at a very high price. Regulations are actually put in place to protect investors’ funds. Platforms that do away with them leave users stranded when things go wrong. This is what happened with crypto exchange FTX, which was legally located in the Bahamas. Unlike US-based exchanges like Coinbase, the company didn’t have to follow strict rules, and mismanaged funds as a result. Investors who had stored their assets on the platform are now locked out, and are unsure whether they will be able to recover them.
Regulation levels therefore depend on several factors: is the exchange located in a country with strong regulations in place, is it listed… However, in most countries, the regulatory framework for cryptocurrency exchanges is still in its infancy, and many jurisdictions have not yet developed a specific legal framework to regulate them. Moreover, spot crypto exchanges often operate across borders, making it difficult for regulators to enforce laws and regulations.
Without clear legal guidance, spot crypto exchanges are then free to set their own rules, policies, and standards. As a result, they might not offer a strong level of consumer protections, such as segregation of client assets, insurance or guarantees against fraud. They might also not follow obligations to publicly share information, keeping investors in the know of both their structure and their legal status.
This lack of regulation can lead to severe consequences for investors, from loss of capital in case of a hack or embezzlement, to legal uncertainty regarding the nature of their investment.
Exchanges might therefore be an attractive option at first sight, but you should make sure to properly research the platform you wish to trade on. In addition to exchange-related risks, direct exposure also carries custody risk, as you are in charge of keeping the assets secure - whether you store them directly on the exchange or in a cold wallet.
With this in mind, you might want to look into indirect exposure through derivatives and exchange-traded products (ETPs).
Crypto-Assets Derivatives: A Complex, Uneven Environment
A derivative is a financial contract whose value is based on an underlying asset. Derivatives can be applied to a great variety of assets, including crypto. There are two main channels available to trade these types of derivatives: over-the-counter and listed derivatives.
An Over-the-Counter (OTC) derivative is privately negotiated and traded directly between parties, rather than on a regulated public exchange. Currently, most trading takes place on unregulated crypto-asset exchanges, leading to more liquidity for OTC derivatives. This type of derivative can be attractive to investors because it has low margin requirements, allowing traders to enter positions with less capital. In addition, OTC derivatives such as perpetual swaps do not have an expiration date. This means that traders can hold them indefinitely, which can be beneficial for those who want to hold a position for a long period of time. OTC derivatives therefore enable access to a wide range of products and customised risk management strategies.
However, OTC derivatives are typically traded on offshore platforms: with OTC derivatives, you are exposed to the credit risk of the other party involved in the transaction. And the counterparty to an OTC trade may not be regulated, leading to limited transparency in the pricing and execution of these trades. As a result, these derivatives can carry a higher level of risk for investors.
Listed derivatives, on the other hand, are traded on regulated exchanges, the largest one being Chicago Mercantile Exchange (CME), whose 15 % market share for Bitcoin futures (measured by open interest) could drive liquidity for this type of derivatives.
Listed derivatives are subject to oversight by government agencies such as the Commodity Futures Trading Commission (CFTC) in the US or the Financial Conduct Authority (FCA) in the UK. They have to follow strict rules and regulations designed to protect investors and ensure market integrity.
In terms of risks, listed derivatives are guaranteed by a clearinghouse, which acts as the counterparty to both sides of the trade. This means that the risk of default by the other party is mitigated with listed derivatives.
Derivatives therefore offer different levels of security, product selection and regulation, and they can be a complex market to investigate. This leads us to the third option for crypto-exposure: ETPs.
Crypto Etps: Regulated and Dynamic
Crypto Exchange Traded Products (ETPs) are the last cornerstones for indirect crypto exposure. An ETP is a security (or financial instrument) that trades on a regulated securities exchange, allowing investors to gain exposure to the price movements of an underlying benchmark or asset without having to own the asset itself.
The ETP industry has been around for almost 30 years and has brought many benefits to investors, including transparency, liquidity, exchange listing, and product standardisation. These benefits have been extended to other asset classes beyond equities, including fixed income, commodities, currencies - and cryptocurrencies. Crypto ETPs have seen a strong rise, with a 2022 Bloomberg Intelligence report published in April 2022 estimating they could overcome the USD 120 billion mark by 2028.
ETPs have several advantages for investors looking to be exposed to crypto:
Regulation. ETPs are regulated products, under the supervision of national financial institutions. They trade on regulated securities exchanges, alongside “traditional” assets such as securities and stocks. As a result, ETP issuers follow strict rules - all designed to protect investors' funds.
Transparency. ETPs come with full legal documentation, freely accessible to all prospective and current investors. There are no surprises or grey zones when it comes to their structure and inner workings - this communication and auditing is also controlled by regulators.
Variety. ETPs allow for various types of exposure. There are crypto ETPs replicating the dynamics of a single asset (like BTC and ETH), but also index ETPs tracking a basket of digital assets. ETPs themselves come in many shapes and forms, such as Exchange Traded Funds (ETFs) tracking the market, Exchange Traded Notes (ETNs) which are uncollateralized debt securities, and Exchange Traded Commodities (ETCs) replicating a specific commodity. Read our article for more information on different types of ETPs.
Security. ETPs free investors from the burden of securing their crypto assets themselves, while still enabling accurate exposure to underlying assets. Physically-backed ETPs, like CoinShares Physical offer, notably buy the digital assets that are being tracked, and the assets are held by a custodian, following institutional-class requirements. Others like XBT Provider ETPs stand out for their reliance on digital currency hedge of the ETPs held in either physical or synthetic form by the guarantor (CoinShares Capital Markets). XBT Provider ETPs’ hedge is openly available for scrutiny, ensuring complete transparency for investors and providing them with peace of mind regarding the secure backing of our product.
Smooth integration. You can access ETPs through your broker, bank or investment platform. The ETP is then integrated into your portfolio for standard brokerage and account maintenance procedures. This makes monitoring and asset rebalancing a straightforward task.
ETPs have one drawback: unlike crypto on an exchange (which can be traded 24/7), or some derivatives, they can only be traded when the exchange they are listed on is open. They therefore have a narrower trading window, in line with other financial assets such as stock.
CoinShares is Europe’s largest crypto ETP issuer (listed on Nasdaq Stockholm), presenting investors with a wide-ranging catalogue of ETPs, including several Physical single-asset ETPs (such as CoinShares Physical Bitcoin and CoinShares Physical ETH), Physical Index ETPs, Physical Staked ETPs. Its offering also features XBT Provider Bitcoin and Ether trackers, Europe's pioneering and Nordics' top crypto ETPs, available in SEK and EUR.
Conclusion: Informed Investors Make Smarter Decisions
The world of crypto-investment can feel daunting, with its seemingly endless opportunities… and vastly different security, compliance and convenience levels as shown in the table below.
At the bottom of the regulation column, we find unregulated OTC derivatives and exchanges. They logically come with the highest counterparty risk, as protection for investors are minimal. On top of the regulation column, listed futures follow a high level of regulation, and exhibit a low counterparty risk.
Whatever your decision, it is important to understand the risks and regulations associated with each alternative. Conducting your own research and due diligence before any investment is not an option. It’s the first step of your investment journey.
To help you do so, CoinShares’ ETP catalogue features detailed information on each product we offer.
Please remember, there are still risks associated with the XBT Provider’s ETPs, such as counterparty and volatility risks, that they are complex products, may be difficult to understand and have a high risk of capital loss.
