Investing in Crypto ETFs: A Look At The Pros and Cons

Crypto ETFs offer some advantages, but they aren't the right option for every investor.

2021 has been an extraordinary year for cryptocurrency investing. The total crypto market cap rose from around $775 billion on Jan 1 to $2.1 trillion at the time of writing.

Over 14% of American adults now own crypto.

When the SEC approved the first U.S. Bitcoin futures ETF in October, it was heralded as a big step forward for the industry as it made Bitcoin (BTC) more accessible to a wider group of investors. However, as you'll see when we unpack some of the pros and cons, many investors would be better off buying cryptocurrency directly.

What is a crypto ETF?

An ETF -- or exchange-traded fund -- is essentially a basket of assets such as stocks, commodities, cryptocurrencies, or bonds. ETFs are traded on exchanges, just like normal stocks. It's a popular way to build a diversified investment portfolio.

Crypto ETFs hold cryptocurrencies. However, so far, the SEC has only given its blessing to Bitcoin futures ETFs. Futures are a type of derivative -- you're essentially buying a contract to buy or sell Bitcoin at a fixed price in the future.

Three Bitcoin futures ETFs have been approved:

• The Valkyrie Bitcoin Strategy ETF
• ProShares Bitcoin Strategy ETF
• VanEck Bitcoin Strategy ETF

Pros of investing in a crypto ETF

1. You can invest in crypto from an ordinary brokerage account: A crypto ETF gives investors exposure to Bitcoin from their ordinary brokerage account. This will appeal to anyone who's reluctant to use a crypto exchange that doesn't follow the same regulations as a normal stockbroker. That said, ETFs are not their only option -- several online brokers already offer a limited selection of cryptocurrencies.
2. There's less risk of hacking or exchange fraud: Another reason would-be crypto investors hold back is a fear of hacks or fraud. And here, ETFs offer a layer of protection. For a start, a Bitcoin futures ETF does not own the underlying asset, so there's less risk of theft. Plus, the platforms that trade ETFs are regulated and their activities are monitored. In many cases, you'd also be protected through SIPC coverage if the brokerage went bankrupt.
3. There are tax advantages: Crypto taxes can be cumbersome and there's still some uncertainty over new rules that are due to come into effect in 2023. While there are tax implications for the new Bitcoin ETFs, reporting should be much more straightforward. A key tax benefit is that it's easy to hold a crypto ETF in tax-advantaged accounts such as a Roth IRA or 401(k). Whether you'd want to put a high-risk asset like crypto into your retirement fund is another question, but if you do, an ETF may be a good way to do it.

Cons of investing in a crypto ETF

1. You don't actually own the crypto: Bitcoin futures ETFs don't directly own any Bitcoin. And the ETF won't necessarily track the price of Bitcoin. Be aware that derivatives are complex financial instruments. If someone is nervous to buy cryptocurrency because they don't completely understand the mechanics, chances are, they also don't completely understand how derivatives work either.
2. You'll pay ETF fees: Whether you're buying ETFs or cryptocurrencies, there are always fees involved at some point. Most cryptocurrency exchanges charge fees to deposit, withdraw, or trade -- or a combination of all three. However, very few reputable crypto platforms will charge you an annual fee for holding or managing your funds. In contrast, ETFs charge something called an expense ratio to cover the costs of administering and managing the fund. For example, if an ETF charges an expense ratio of 0.95% -- so for every $1,000 you invest, you'll pay $9.50 each year in fees.
3. You can't spend or earn passive income on your crypto: Many people view cryptocurrency as an investment vehicle. But it is also a currency -- and crypto platforms offer various ways for users to spend their crypto assets, such as crypto credit or debit cards, or payment apps.

Plus, there are several ways for buy-and-hold investors to earn passive income that aren't open to Bitcoin ETF investors. One is to stake cryptocurrencies and contribute to the overall security of the network. Rewards vary from token to token, but it is not uncommon to find APYs of 5% to 20%.

Bottom line

There are all kinds of ways to invest in cryptocurrencies, whether you buy directly from a cryptocurrency exchange, buy a Bitcoin ETF, or buy into funds or stocks with crypto exposure.

Whichever option you chose, be prepared for volatility. Cryptocurrency investment is risky, however, you invest in it. Don't invest the money you need to meet other financial goals -- whether it's saving for your retirement or paying down debt.