ETPs: Expanding Investor Access to Crypto

Exchange-traded products (ETPs) offer a convenient, regulated, and low-cost way for both retail and institutional investors to access a range of underlying investments — and crypto is no exception.

Since the launch of the first bitcoin tracker in Sweden in 2015, crypto ETPs have grown from a largely European phenomenon to an expanding global footprint and from a range of just 17 products at the end of 2020 to circa 180 trading today. As more TradFi institutions join the crypto-native firms in their issuance, the role of ETPs in not only expanding investor access to crypto but in crypto’s overall acceptance and integration in global financial markets is becoming increasingly clear.

This article provides an overview of crypto ETPs, including the types of products currently available, the operating model, regional overviews, and developments we’re watching in this rapidly evolving landscape.

Exchange-Traded Products (ETPs) play a crucial role in expanding investor access to the crypto market. ETPs are financial instruments that are traded on stock exchanges, providing investors with exposure to various assets, including cryptocurrencies. Here are some ways in which ETPs contribute to expanding investor access to the crypto space:

Convenience and Familiarity:
ETPs make it easier for traditional investors to gain exposure to cryptocurrencies without directly dealing with the complexities of purchasing and storing digital assets.
They provide a familiar investment vehicle similar to traditional stocks, bonds, or commodities, making it more accessible to a broader investor base.

Regulatory Oversight:
ETPs are subject to regulatory oversight and must adhere to certain standards, providing investors with a level of protection and assurance in a market that has historically been associated with regulatory uncertainties.

Diversification:
Crypto ETPs allow investors to diversify their portfolios by adding exposure to digital assets alongside traditional investments. This diversification can potentially enhance risk-adjusted returns.

Liquidity:
Being traded on traditional stock exchanges, crypto ETPs benefit from the liquidity of these markets. This can be appealing to investors who value the ability to buy or sell their investments quickly at prevailing market prices.

Institutional Participation:
ETPs can attract institutional investors who may have restrictions or concerns about directly holding cryptocurrencies. This influx of institutional capital can contribute to increased market stability and maturity.

Simplified Investment Process:
Investing in crypto ETPs is often more straightforward compared to directly buying and storing cryptocurrencies. This simplicity can attract a broader range of investors, including those who might be hesitant to navigate the complexities of crypto exchanges and wallets.

Market Education:
ETPs contribute to market education by providing investors with a structured and regulated way to learn about and participate in the crypto market. This educational aspect can help demystify cryptocurrencies for a wider audience.

Custodial Services:
Crypto ETPs typically involve custodial services, which means that the responsibility of securely storing and managing the underlying assets lies with professional custodians. This can address concerns related to the security and safekeeping of digital assets.

Market Maturation:
The introduction and success of crypto ETPs can be seen as a sign of the market's maturation, attracting more sophisticated investors and paving the way for further innovation in the financialization of digital assets.

Overview of crypto ETPs

What are crypto ETPs?

Exchange-traded products (ETPs) are a category of financial products bought and sold on regulated stock exchanges daily throughout regular trading hours, tracking the return of an underlying benchmark, asset, or portfolio.

There are three main types of ETPs: exchange-traded funds (ETFs), exchange-traded notes (ETNs), and exchange-traded commodities (ETCs). While ETFs are investment funds, ETNs and ETCs are debt securities, with ETCs tracking physical commodities such as gold and oil and ETNs used for all other types of financial instruments. Since the creation of the first ETF in 1993, thirty years ago this year, ETPs have grown from equity market trackers to arguably one of the most innovative categories of investment products providing investors with exposure to a range of innovative underlying.

Note: While ‘ETPs’ is the umbrella term for this category of products, the term ETP is sometimes used as a category term for debt security exchange-traded products.

Particularly over the past twenty years, these types of products have experienced continued growth, reaching 11,859 products and 23,931 listings globally from 718 providers listed on 81 exchanges in 63 countries; of these, ETFs make up the lion’s share of assets, accounting for $10,747 Bn or 98% of the total $10,990 Bn in ETP assets (data from ETFGI as of end Nov 2023). Oliver Wyman expects growth in ETFs to accelerate in growth from recent years, forecasting the market to grow at 13 to 18% p.a. from 2022 to 2027.

The convenience and accessibility of ETPs make them a popular tool for opening new asset classes and investment strategies to investors — here, crypto is no exception.

The first ever Bitcoin ETP was launched in 2015 on the Swedish NASDAQ by XBT Provider (later acquired by Coinshares). Growth in the market remained relatively modest until the latter half of 2020, when a strong uptick in the number of products began, which continues today, both from new crypto-native entrants and traditional issuers. In February 2021, Canada won the race for the world’s first Bitcoin ETF, with Purpose Investment’s launch of its Purpose Bitcoin ETF on the Toronto Stock Exchange. While crypto ETPs, structured as debt securities, still far surpass crypto ETFs both in number and AUM, we expect to see this start to shift, particularly as the market for US spot ETFs opens.

The number of crypto products has grown steadily, particularly within the last three years, reaching 176 Crypto ETFs and ETPs as of November 2023, based on data from ETFGI. Assets invested in these products rose 120% in the first 11 months of the year, growing from $5.79 Bn at the end of 2022 to $12.73 Bn at the end of November 2023.

Why crypto ETPs?

The idea of a crypto ETP may seem counterintuitive to crypto natives: introducing intermediaries, which this technology enables us to remove. However, as well-understood and regulated investment products, ETPs open up the opportunity for crypto exposure to a much larger investor audience who, for various reasons, may otherwise be unable to access the asset class. For instance, retail investors may lack the tools, time, risk tolerance, and technical expertise to invest directly in crypto. The structure of ETPs as traditional securities opens them to institutional investors who may be restricted to only investing in these types of instruments or who wish to avoid directly holding crypto assets, be that for regulatory, compliance, technical, or other reasons.

There are also potential disadvantages and considerations (as not all investors would consider these to be disadvantages) with these products in comparison with purchasing crypto directly. These include the fact that crypto ETPs to date have had much higher fees than is typical for these products (although these are already falling with increasing competition), the limited trading availability of traditional exchanges vs. crypto’s 24/7 markets, access restrictions based on jurisdiction and investor type as per regulatory approvals, counterparty, tracking error, and exchange rate risks, and settlement times.

Note: examples of geographical restrictions include that European crypto ETPs are generally not registered under the US Securities Act of 1933 and therefore cannot be offered to US investors; the UK FCA prohibits the sale of crypto ETPs to retail investors

Types of Crypto ETPs:

Cryptocurrency Exchange-Traded Funds (ETFs): These are investment funds that are traded on stock exchanges, tracking the performance of one or more cryptocurrencies. ETFs are designed to closely mimic the price movements of the underlying assets.
Cryptocurrency Exchange-Traded Notes (ETNs): Unlike ETFs, ETNs are debt instruments that are backed by the issuer's promise to pay the return linked to the performance of a specific cryptocurrency index or asset.
Cryptocurrency Trusts: These are trusts that hold a certain amount of cryptocurrency and issue shares to investors. Grayscale Bitcoin Trust (GBTC) is an example of a crypto trust.

Underlying Assets:

Crypto ETPs can be linked to various underlying assets, including Bitcoin (BTC), Ethereum (ETH), and other major cryptocurrencies. Some ETPs track a specific cryptocurrency, while others may offer exposure to a diversified basket of digital assets.

Regulatory Environment:

The regulatory status of crypto ETPs varies by jurisdiction. Some countries have approved and regulated these products, while others may have restrictions or uncertainties surrounding their legality. Regulatory approval provides a level of investor protection and can contribute to market confidence.

Listings on Traditional Exchanges:

Crypto ETPs are typically listed on traditional stock exchanges, making them accessible to a broader range of investors who are familiar with conventional investment platforms. This also enhances liquidity and transparency.

Custody and Security:

Many crypto ETPs involve third-party custodians responsible for securely storing the underlying digital assets. Custodial arrangements are crucial for ensuring the safety of investors' funds.

Market Performance and Liquidity:

The performance of crypto ETPs is directly linked to the price movements of the underlying cryptocurrencies. Liquidity is influenced by factors such as market demand, trading volumes, and the efficiency of the underlying market.

Fees and Expenses:

Investors should be aware of the fees associated with crypto ETPs, including management fees, administrative costs, and other expenses. These fees can impact the overall return on investment.

Market Demand and Adoption:

The success and adoption of crypto ETPs depend on market demand and investor sentiment. As more institutional and retail investors seek exposure to cryptocurrencies, the demand for these products may increase.

It's important to conduct thorough research and consult with financial advisors before investing in any financial instruments, including crypto ETPs. Additionally, stay informed about the latest regulatory developments and product offerings in the cryptocurrency space.

Product structure and offerings

The structure and offerings of crypto Exchange-Traded Products (ETPs) can vary, and the specific details depend on the type of ETP and the issuer. Here are some common features and offerings associated with crypto ETPs:

Underlying Assets:

Crypto ETPs can be linked to various underlying assets, with the most common ones being major cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH). Some ETPs may focus on a single cryptocurrency, while others provide exposure to a basket of digital assets.

Product Types:

Exchange-Traded Funds (ETFs): ETFs are investment funds that are traded on stock exchanges. They aim to track the performance of a specific cryptocurrency or a cryptocurrency index. ETFs are typically passively managed, meaning they replicate the performance of the underlying assets.

Exchange-Traded Notes (ETNs): ETNs are debt instruments that are backed by the issuer's promise to pay a return linked to the performance of a particular cryptocurrency or index. Unlike ETFs, ETNs do not own the underlying assets; instead, they represent a debt obligation.

Cryptocurrency Trusts: These are investment trusts that hold a specific amount of cryptocurrency and issue shares to investors. Investors indirectly own a share of the underlying digital assets. Notable examples include the Grayscale Bitcoin Trust (GBTC) and Grayscale Ethereum Trust (ETHE).

Regulatory Considerations:

The regulatory environment for crypto ETPs varies by jurisdiction. Some products have received regulatory approval and are subject to oversight, providing a level of investor protection. Others may operate in a regulatory gray area or face restrictions.

Listing on Exchanges:

Crypto ETPs are typically listed on traditional stock exchanges, making them accessible to a broader range of investors. Common exchanges for listing include the NYSE Arca, NASDAQ, SIX Swiss Exchange, and others.

Custody and Security:

Many crypto ETPs involve third-party custodians responsible for securely storing the underlying digital assets. Custodial arrangements are crucial for ensuring the safety of investors' funds and are often a key consideration for regulatory approval.

Management Fees and Expenses:

Investors should be aware of the fees associated with crypto ETPs. Management fees, administrative costs, and other expenses can impact the overall return on investment. Different issuers may have varying fee structures.

Liquidity and Trading Volumes:

The liquidity of a crypto ETP is influenced by factors such as market demand, trading volumes, and the efficiency of the underlying market. Higher liquidity generally results in tighter bid-ask spreads and more favorable trading conditions.

Dividends and Distributions:

Some crypto ETPs may distribute dividends or income to investors based on the performance of the underlying assets. The distribution policies can vary among different products.

Broadly speaking, crypto ETPs fall into two product categories and types: ETF or ETP and physical, also referred to as asset-backed, or synthetic.

Crypto ETF structures

ETFs are structured as funds, with ETF holdings being shares in a fund. There is typically a legal separation of the funds from their issuing entities through the use of trusts, investment companies, or limited partnerships to ensure that investors’ holdings are protected in the event of the parent company/issuer’s bankruptcy. ETFs are typically subject to additional rules and transparency requirements depending on their jurisdiction; for example, ETFs domiciled in the EU and marketed to EU investors are generally required to comply with UCITS (Undertakings for Collective Investment in Transferable Securities) regulations, which brings diversification requirements, such as that no single asset can represent more than 10% of the fund.

Most crypto ETFs today are either spot or futures products. Spot ETFs have direct ownership of the underlying crypto assets, secured with independent custodians. With the futures ETFs, the issuers are not holding the underlying crypto but instead purchasing futures contracts for the assets. As such, these products don’t directly track the spot price of the underlying assets and are generally considered to bring greater complexity and cost, and to be less transparent and intuitive for investors.

Crypto ETP structures

Crypto ETPs (in this instance, using the term to refer to products other than ETFs) are structured as debt securities. While their structuring requirements are less stringent than those of ETFs, their disclosure requirements are very similar.

Physical crypto ETPs are secured debt obligations 100% backed by holdings of the underlying cryptocurrency they track. The crypto assets are physically bought and held with independent third-party custodians under the oversight and control of a designated trustee, who holds the rights and entitlements on behalf of the ETP holders and the responsibility for organizing redemptions in the event of an issuer insolvency.

Synthetic ETPs are unsecured debt obligations, meaning the issuer is not required to hold the underlying assets the product is tracking and instead uses derivatives and swaps to track the performance (exact structure and terms will vary). Synthetic ETPs, therefore, bear greater counterparty risk as there is no legal requirement for the products to be backed 1-to-1 by the underlying physical asset. XBT Provider (a Coinshares company) and Valour are two crypto ETP issuers offering synthetic products.

By and large, most crypto ETPs on the market are physical products, as many investors prefer the transparency and reduced counterparty risk provided by this structure.

Crypto Product Offerings

Crypto ETPs initially began as single digital asset trackers, and today, the range of crypto ETPs available on the market also includes basket, staking, inverse, and leveraged products, as well as certain indices designed to manage volatility.

In terms of underlyings, using data recently compiled by BitMEX Research, removing equity and OTC-traded funds and adding in additional data, we find that out of 162 crypto ETPs, bitcoin, ethereum, and basket products account for 58%, with the other 42% consisting of the long tail single digital assets, as well as short, volatility and leverage products.

Of these 162 products, 121 are ETPs and 41 are ETFs, of which 16 are futures ETFs and 11 are the US spot bitcoin ETFs awaiting launch. Staking products, meaning investors benefit from the staking yield generated by their holdings, currently total 14: thirteen ETPs and one ETF.

Largest products by AUM

The largest crypto ETP by AUM is the ProShares Bitcoin Strategy ETF, a US-based futures product holding assets of US$1.68 billion, based on available data as of 2 Jan 2024. As shown in the table below, nine of the 14 top crypto ETPs by assets track bitcoin (64%); of the remaining five, they include three ethereum, one solana and one Binance coin tracker.

Of these 14 products, four are domiciled in Switzerland (all from issuer 21Shares), three are domiciled in Canada, two in Jersey, one in Germany, one in the US, and one in Liechtenstein.

Four of the top 14 products by assets are ETFs: three spot and one futures. Of the ETPs, eight are physical and two are synthetic products.

Product innovation

There are several constraints to consider when bringing new crypto ETPs to market. These include regulatory and stock exchange requirements and approvals, liquidity requirements, investor demand, and the availability of public price data and fiat trading pairs. That said, we’re seeing continued product innovation from both issuers and index providers as more players enter the market and look to capture market share and differentiate themselves and as regulatory, service provider, and investor understanding and acceptance of this asset class increases.

Crypto ETP Operating Model

Creating an ETP begins with the issuer, meaning the investment company or trust that will issue the products, writing a prospectus document to be approved by the regulator. These can vary by jurisdiction, but in general, they include the details of the issuer, including the identities of its directors and financial statements, the product and program design, including an overview of the underlying assets, intended markets, and service providers, comprehensive overview of the potential risks, details of the asset valuation (NAV) and NAV calculation methodologies, fees, and redemption processes.

Following approval by a regulatory authority and successful engagement of the necessary service providers, the issuer must apply for listings on the desired stock exchanges. The rules regarding which types of products, i.e. asset-backed or futures, and underlyings, i.e. cryptoassets, are eligible to be listed vary by exchange.

The operating model and range of service providers can vary by product type, jurisdiction, and the program design of the issuer. A high-level overview of a typical model is as follows:

• On the primary market, the Issuer exchanges shares of the product with the APs in return for either the underlying crypto assets (“in-kind”) or the cash equivalent, with underlying crypto assets delivered to and from the designated custodians as required. Depending on the structure, a transfer agent and trustee may be involved in liquidating the collateral and transferring funds.

• As the APs manage primary market creation and redemption, market makers provide liquidity in the secondary market, ensuring continuous, efficient trading.

• Investors buy and sell the products on the secondary market, typically placing their orders via their bank or broker, who in turn execute their orders on the relevant stock exchange, either directly or via other intermediaries.