Three Points Of Difference Between Bitcoin ETFs And Commodity ETFs

The introduction of bitcoin ETFs is “nearly certain” or will happen sometime next year. The debut of bitcoin ETFs is expected to transform cryptocurrency markets. Institutional investors, such as pension funds and hedge funds, will lead a flood of capital into the industry and stabilize volatile crypto prices. They are also being touted as an investment vehicle that will make bitcoin accessible to average investors. (See also: Top ETFs And What They Track). 

Bitcoin is often referred to as digital gold because it shares similar characteristics with the precious metal. Both are mined and are scarce. For the most part, investors are expecting exponential increases in bitcoin markets as were observed for gold and other commodities, when funds to track their prices were introduced.

But those rosy prognostications assume similarities between the structure and compositions for commodity ETFs and bitcoin ETFs. Bitcoin’s digital provenance makes it a unique case. For one, it already has a defined mining schedule. Then, there is the fact that its custody and storage ecosystem is yet to mature. Transaction fees and miners are also expected to play an important role in its evolution as a store of value. All of these factors are expected to play an important role in ETFs designed around cryptocurrencies. Here are three ways in which crypto ETFs could be different from conventional ETFs. 

The VanEck SolidX ETF application, which was filed in June of this year, proposes holding 25 bitcoins per share. Taking into account current and possible future prices for bitcoin, that could translate into fairly expensive prices for retail investors. As an example, the price per bitcoin is $6,951, as of this writing. The per share price of the ETF translates into $205,712 based on this price. Joshua Gnaizda, founder of Crypto Fund Research, says the per share price of a bitcoin ETF could be comparable to the world’s highest share price, Berkshire Hathaway Class A shares. To be sure, the net asset value (NAV) of an asset is a function of other factors, such as number of shares outstanding, as well. But the point of this is that institutional investors will have to step up to the plate in a major way to make ETFs accessible to retail investors. This is not impossible, but the crypto ecosystem will require significant institutional money. 

According to Gnaizda, cryptocurrencies present unique risks that are not present in commodity and gold ecosystems. “Keys (used to access bitcoin holdings) not in cold storage can be hacked, private keys can be lost, and stolen money be moved nearly anonymously,” he says. Insurance for cryptocurrency holdings presents another significant risk. Crypto insurance has become a lucrative industry for existing insurers primarily because they can charge high premiums. A dearth of clients for custody solutions, which can help spread risk over a large number of clients, has not helped matters. Gnaizda estimates that insurance prices could be as much as 5% of overall holdings and remain expensive unless several billion dollars in assets is reached. “The larger the fund gets, the higher the likelihood of counterparty risk in the insurance policy,” he says. (See also: Cryptocurrency Insurance Could Be A Big Industry). 

Expense ratio is the fee charged by fund managers for administration and storage of assets. However, it might be significantly higher for cryptocurrency holdings. “Given the issues with custody, insurance, and compliance, it wouldn’t surprise me if it ends up being 1% or higher,” says Gnaizda. For context, expense ratios for most funds is between 0.2% to 0.4%; gold ETFs average between 0.25% to 0.40% as expense ratios.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns small amounts of bitcoin and litecoin.