Crypto asset markets have new visitors these days. Besides popular currencies like Bitcoin or Ethereum, actors from the traditional side of the financial systems, like asset management companies and fund managers, are looking for different tools. The new reflection of research will be flamed on a new form of an old friend; Exchange Traded Funds (ETFs).
ETFs are smart mixes of investment funds and Exchange-traded products. An ETF holds very different kinds of assets like stocks, bonds, currencies, and/or commodities and they operate with an acceptable arbitrage range. On the traditional side of finance, they are very popular as well because of having very low operational costs, providing high tax efficiency and having very flexible tradability. These advantages attracted also the disruptive side of financial markets and made them ask if ETFs will be raised on blockchain platforms. The answer appeared quickly: Why not!
Even if the answer is easy, execution is a very different journey! This thin line was also seen by the biggest digital currency asset management company in recent weeks and started to found a strong team for understanding the ability of ETFs on blockchain-based platforms. Like almost all financial innovative initiatives, the source is in the U.S.A. and the responsible body is Security Exchange Commission (S.E.C.).
The idea behind crypto ETFs is very simple. The traditional version is based on stocks, bonds (bond ETFs), derivatives (with index ETFs) commodities (like precious metals, agricultural products, or hydrocarbons such as petroleum), currencies (any major currency or a basket of currencies), long-term or societal trends, such as disruptive technologies, climate change, or shifting consumer behaviors (thematic ETFs) etc. So, the new version will cover a crypto currency basket instead of a traditional one.
The main risks with crypto ETFs come out as tracking error and liquidity risks. The ETF tracking error is the difference between the returns of an ETF and its reference index or asset. If the real values are more volatile than reference values, tracking error risk increases more than risk appetite of investors. Within this perspective, tracking error will be appear as the main risk with crypto ETFs while the volatility of crypto assets is higher than traditional investment tools. Other side of risk exposure clusters on liquidity side. ETFs have a wide range of liquidity. The most popular ETFs are constantly traded, with tens of millions of shares per day changing hands, while others trade only once in a while, even not trading for some days. For the crypto asset side, the liquidity risk of crypto ETFs will be more manageable when exchange possibilities, platforms and transaction security will be expanded quantitatively and qualitatively in following terms.
Another issue that makes investors think more on the credibility of crypto ETFs is counterparty risk! Within a traditional ETF product, counterparty is contractually obligated to match the return on the index. Financial adequacy of counterparties are monitored by financial markets regulatory bodies like S.E.C. in U.S.A. or E.S.M.A. (European Securities and Markets Authority) in Europe. Even if crypto markets still do not have an up & running capital adequacy framework and the ownership of responsibility on monitoring crypto asset markets is not clear yet, counterparty risk is rising continuously and is waiting for inexperienced investors!
We will touch on more points about crypto ETFs and its potential on investment markets in the following articles. For any further questions, please reach us via firstname.lastname@example.org or visit our CryptoIndexSeriesTM Platform for a better analysis of the crypto market space.
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