If the avalanche of recent headlines about cryptocurrency has you perplexed, you’re not alone. After all, it’s not often that such a confusing new financial instrument plants itself so firmly in the cultural zeitgeist.
Plenty of stories have highlighted those people who have reaped cryptocurrency fortunes and, in some cases, the massive losses cryptocurrencies endured at the start of 2022. And now there are exchange-traded funds, or ETFs, that will allow investors to jump into the market without directly purchasing the “coins.”
The questions for seasoned and new investors are many, including: Are cryptocurrencies a key to quick riches? Are they part of a balanced portfolio? Are they a target for criminals that should be avoided at all costs? Let’s step back from all the froth and noise and start with some basics.
What Are Cryptocurrencies?
At the most basic level, cryptocurrency is a form of digital payment. Like dollars, euros and other types of physical money, cryptocurrency can be used to purchase goods and services—that is, so long as merchants and others involved in a transaction accept cryptocurrency (a growing list of major companies now do).
What’s different about cryptocurrency, however, is that no central monetary authority, such as the Federal Reserve in the United States or the European Central Bank, controls the amount of money in circulation, interest rates and other factors that determine the value of a currency. Instead, cryptocurrency is created digitally and circulated using a tracking system called blockchain, which creates a secure, decentralized and transparent method for processing and monitoring transactions.
The term “Bitcoin” is often used synonymously with cryptocurrency. But Bitcoin, which has been around since 2008, is just one of over 17,000 (and growing) types of cryptocurrency, whose names include Ethereum, Monero and Stellar.
If you’re having trouble wrapping your brain around the mechanics and sheer number of cryptocurrencies—let alone the often complicated mechanics of investing directly in a cryptocurrency—you’re by no means alone. (This article will help to further demystify them.
Cryptocurrency ETFs Emerge
One recent sign of the mainstreaming of cryptocurrency investing was the launch last October of the Proshares Bitcoin Strategy ETF. ETFs are a well-known investment vehicle, which function simultaneously like both mutual funds and individual securities.
ETFs are like mutual funds in that they represent a collection of assets—some are similar to index funds that mirror indices like the S&P 500 while others are actively managed. But ETFs are different from mutual funds because they can be traded daily on a stock exchange. Put simply, ETFs are a hybrid of investing and trading.
What was perhaps most significant about the launch of the first crypto ETF was that it required approval by the U.S. Securities and Exchange Commission. Since then, the SEC has approved more than a dozen cryptocurrency ETFs, and more are sure to follow.
The Implications of Crypto ETFs
While approval by the SEC does provide a new level of legitimacy to cryptocurrency, it does not mean that investments in digital currency are without risk. Like any other investment vehicle that receives a green light from the SEC, crypto ETFs can still lose or gain investors’ money.
There are some features of crypto ETFs that could potentially make them more understandable and attractive to investors. One is the relative ease of investment: Investing in individual cryptocurrencies can require the use of a secure digital wallet where purchased cryptocurrencies are stored. Some demand payments in cryptocurrency, which can be difficult if you are just getting started. Investing in individual cryptocurrencies can also involve hefty custody fees—the term used for storing crypto—as well as transaction costs.
By contrast, ETFs have fees more akin to mutual funds, which can be far lower than the expenses associated with individual cryptocurrency investments. Another possible attraction to investors who are intrigued by cryptocurrencies is that ETFs represent investments in a collection of cryptocurrencies, rather than just one. This inherent diversity can provide protection from wild swings in value that can happen when investing in any single security.
Another possible upside to crypto ETFs is that, like mutual funds, they don’t require the personal involvement of investors; someone else handles the management of the ETF. This can be especially welcome given how novel and frankly arcane and confusing cryptocurrency investing can be to the typical investor.
Prioritize a Balanced Portfolio
None of which is to say that investing in cryptocurrency ETFs won’t involve risk or volatility. After all, the underlying assets in these ETFs are still experiencing large fluctuations in value, which translates to volatility in the ETFs.
Anybody considering investing in cryptocurrency ETFs should remember some basics about investing. In particular, it’s wise to be realistic about the amount of risk you’re willing to take on with any investment and to keep in mind the ultimate timeline and goal for your investments. Overall portfolio diversification is also important, and any investments in cryptocurrency ETFs should be part of a balanced portfolio.
Ultimately, how or whether cryptocurrency ETFs fit into a balanced portfolio is an entirely personal question.
A former editor at Los Angeles magazine, Chris Warren has had work appear in publications ranging from Institutional Investor and Forbes to National Geographic Traveler, Oxford American and Greentech Media.
Learning more about cryptocurrency now can be quite beneficial in the future. Read to learn even more, especially if you’ve recently received cryptocurrency as a gift this past holiday season and are now wondering how to best invest or use the funds.