Source - Investopedia

Exchange-traded funds (ETFs) are among the hottest modes of investment today, with investors pouring trillions of dollars into an ever-growing field of funds. Particularly in comparison with high-fee hedge funds (many of which have failed to live up to expectations on returns in recent years), low-fee ETFs provide a safer, more stable means of investing that has proven enticing for many investors. One of the wonderful things about ETFs is that they are infinitely broad in scope and focus; investors can use ETFs to participate (by proxy) in markets ranging from energy to marijuana. So why haven't cryptocurrency-based ETFs taken off so far?

Cryptocurrencies have been another of the hottest trends in the investment world in the past couple of years. Following the lead of breakout stars like bitcoin and ethereum, digital tokens have proliferated at an astonishing pace. Some of the most successful cryptocurrencies have seen outlandish gains. However, the industry is full of uncertainty and plagued by heavy volatility. For this reason, many investors would prefer to use a vehicle like an ETF to participate in the cryptocurrency space. In this way, they could take advantage of the excellent opportunities that tokens present without having to run the risk of actually owning them. Given that cryptocurrencies and digital token exchanges are still regularly the targets of thieves and scammers, it's understandable why investors might wish to take this extra precaution.

Below, we'll explore what cryptocurrency ETFs are, where they thrive, how they have developed in the U.S. and more. (See also: Are Bitcoin ETFs 'Nearly Certain'?)

What Is a Cryptocurrency ETF?

A cryptocurrency ETF works, in theory, like any other ETF. While most ETFs track an index or a basket of assets, a cryptocurrency ETF would track one or more digital tokens. Like other ETFs, digital token ETFs would trade like common stocks on an exchange, and they would be subject to changes in price throughout the day as investors buy and sell.

In order for a cryptocurrency ETF to work properly, it will need to own the underlying assets that it tracks; the ETF would have to own a commensurate stake of digital tokens. The ownership of these tokens would be divided into shares, and investors in the ETF would indirectly own those tokens. ETF investors would then receive a proportion of the profits generated by those underlying assets.

There are many benefits to a cryptocurrency ETF over a straight-up cryptocurrency investment. First, as indicated above, digital wallets and exchanges are highly susceptible to hacks and thefts. Investors holding digital tokens run the risk of seeing their assets disappear on them with little recourse. An investor in a digital currency ETF, however, has an added layer of security in the custodian bank that supports the ETF. (For more, see: ETFs Can Be Safe Investments, If Used Correctly.)

Another benefit of a cryptocurrency ETF is that it can be used to track multiple digital tokens at once. The cryptocurrency world is highly compartmentalized, and investors looking to hold a basket of, say, 20 different tokens may have to own and operate multiple wallets and accounts across various digital currency exchanges. Very quickly, the process of investing in these tokens and trading regularly becomes one that is perhaps not worth the amount of administrative time and effort required. A cryptocurrency ETF could take out much of the time and hassle for investors by simply tracking those same 20 tokens. Investors could then buy and sell shares of the ETF to gain the same exposure to that pool of tokens without having to worry about individually managing each of them.

Quick History of Crypto ETFs

As of this writing, there are no cryptocurrency ETFs currently listed for trade in the United States. The closest is a fund known as the Bitcoin Investment Trust (GBTC). This trust acts like an ETF in many ways; it owns bitcoins on the behalf of investors and allows them to trade in shares of the trust. However, the sponsor of the fund, Grayscale Investment Trust, charges annual management fees of 2% of the fund's assets, a price point significantly higher than most other ETFs. Furthermore, as the first trust of its kind, GBTC has experienced some odd fluctuations in price relative to the changes in value of bitcoin. While one would expect GBTC to be correlated with the price of bitcoin, this has so far not always been the case. Overall, with a high expense ratio and lofty minimum investment, GBTC is not available to the mainstream investor as of yet. (See also: 2 Cryptocurrency Trusts That Trade Like Stocks.)

So where do cryptocurrency ETFs stand, then? Up to this point, the U.S. Securities and Exchange Commission (SEC) has indicated that it will not approve cryptocurrency ETFs until the markets demonstrable stability and security. Still, that has not prevented many different parties from attempting to launch digital currency ETFs.

The Chicago Board Options Exchange (CBOE), which launched bitcoin futures late last year, has lobbied the SEC to reconsider its earlier blockage of digital token funds. Cameron and Tyler Winklevoss, the founders of popular digital currency exchange Gemini, have twice petitioned the SEC to approve a bitcoin ETF; each attempt has so far been unsuccessful. Coinbase, another immensely popular digital currency exchange, launched an index fund offering exposure to four of the largest digital currencies, but that again is not quite the same as an ETF. Some ETFs even offer small exposure to GBTC, but these are not strictly focused on cryptocurrencies. (For more, see: SEC Rejects Winklevoss Bitcoin ETF Plans.)

The SEC has indicated its openness to the possibility of cryptocurrency funds in the future, and this could perhaps continue to fuel investor optimism if cryptocurrency ETFs thrive in other parts of the world. Various markets in Europe and Asia, for instance, have introduced cryptocurrency ETFs thanks to differing levels of regulation. For the time being, though, U.S. investors will have to wait.

How to Invest with Cryptocurrency ETFs

U.S. investors looking to take part in digital currency ETFs have limited options. If they have access to international ETFs, that is one approach. If they meet the stringent requirements for investing in GBTC, they can do that as well. For the time being, though, these investors may be best off looking toward a related group of ETFs: blockchain funds. (See also: What Is the Difference Between Blockchain ETFs and Bitcoin ETFs?)

Blockchain technology supports the cryptocurrency space and is closely linked with digital tokens. There are a growing number of ETFs focused on blockchain-related companies. These can include cryptocurrency-adjacent names like computer processor developers and manufacturers. ETFs like the Amplify Transformational Data Sharing ETF (BLOK) and the Reality Shares Nasdaq NextGen Economy ETF (BLCN) allow investors access to companies that focus on the blockchain space. Many of these ETFs have seen immense success already.

Looking to the Future

While it's far from a sure thing, many cryptocurrency enthusiasts see it as only a matter of time before the SEC approves digital currency ETFs. If and when this happens, it's sure to have a significant impact on the performance of the cryptocurrency space itself. Earlier this year, the SEC opened up its consideration of two different digital currency ETFs for public comment. While it has yet to go so far as to approve a cryptocurrency ETF, that day may be approaching. (For additional reading, check out: SEC Considers Rule Change to Allow Bitcoin ETFs.)