Original author: Diana Biggs, 1kx partner
Original compilation: Luffy, Foresight News
Exchange-traded products (ETPs) provide retail and institutional investors with a convenient, regulated and low-cost way to access a range of underlying investments, cryptocurrencies being one of them.
Since Sweden launched the first Bitcoin tracking product in 2015, cryptocurrency ETPs have grown from Europe to around the world. There were only 17 cryptocurrency ETP products at the end of 2020, but now there are about 180. As more traditional financial institutions join the ranks of cryptocurrency native companies, ETPs not only play a role in expanding investor access to cryptocurrencies, but also drive overall cryptocurrency acceptance in global financial markets.
This article provides an overview of cryptocurrency ETPs, including currently available product types, operating models, regions, and our focus in this rapidly growing space.
Cryptocurrency ETP Overview
What is a cryptocurrency ETP?
Exchange-traded products (ETPs) are a class of financial products that are bought and sold on a regulated stock exchange during regular trading hours each day and track the returns 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). ETFs are investment funds, while ETNs and ETCs are debt securities, with ETCs tracking physical commodities like gold and oil and ETNs used for all other types of financial instruments. Thirty years since the first ETF was created in 1993, ETPs have evolved from stock market tracking products to one of the most innovative investment product categories, offering investors access to a range of innovative underlying assets. Investment Opportunities.
Note: Although ETP is the general term for this type of product, the term ETP is sometimes used to refer to debt stock exchange traded products.
Especially in the past 20 years, ETP has continued to grow, reaching 11,859 products and 23,931 listings among 718 providers on 81 exchanges in 63 countries/regions around the world; among them, ETF shares The largest, approximately US$10.747 billion, accounting for 98% of the total ETP assets of US$10.99 billion (data from ETFGI, end of November 2023). Oliver Wyman expects ETF growth to accelerate in recent years, with the market growing 13% to 18% annually from 2022 to 2027.
Source: ETFGI
The convenience and accessibility of ETPs have made them a popular tool for opening up new asset classes (including cryptocurrencies) and investment strategies to investors.
The first Bitcoin ETP was launched on Nasdaq in Sweden in 2015 by XBT Provider (later acquired by Coinshares). Growth in the market had been relatively modest until the second half of 2020, when the number of offerings, both from new cryptocurrency-native corporate entrants and traditional issuers, began to grow strongly, a situation that continues today. In February 2021, Canadas Purpose Investment launched Purpose Bitcoin on the Toronto Stock Exchange, becoming the worlds first Bitcoin ETF. While cryptocurrency ETPs structured as debt securities still far outnumber cryptocurrency ETFs in volume and AUM, we expect this to begin to change, particularly as the U.S. spot ETF market opens up.
Source: ETFGI
The number of cryptocurrency products has grown steadily, especially over the past three years. According to ETFGI data, as of November 2023, there are 176 cryptocurrency ETFs and ETPs. Assets invested in these products grew 120% in the first 11 months of 2023, from $5.79 billion at the end of 2022 to $12.73 billion at the end of November 2023.
Why Choose Cryptocurrency ETP?
The idea of a cryptocurrency ETP may seem counterintuitive to those native to the cryptocurrency space: ETPs introduce intermediaries, and the very goal of cryptocurrency technology is to eliminate intermediaries. However, as an easy-to-understand and regulated investment product, ETPs provide exposure to cryptocurrencies to a wider audience of investors who may not have access to the asset class for various reasons. For example, retail investors may lack the tools, time, risk tolerance, and expertise to invest directly in cryptocurrencies. ETPs are structured as traditional securities and are open to institutional investors who may be limited to investing in these types of instruments or avoid direct holdings of cryptocurrencies for regulatory, compliance, technical or other reasons.
There are also potential disadvantages and considerations with ETPs compared to buying cryptocurrencies directly (not all investors will consider these to be disadvantages). These include crypto ETP fees to date being much higher than other ETP fees (although these fees have come down with increased competition), limited trading access hours on traditional exchanges compared to the cryptocurrency 24/7 market, trading counterparties , exchange rate risk and settlement time, etc.
NOTE: Examples of geographic restrictions include European cryptocurrency ETPs generally not being registered under the U.S. Securities Act of 1933 and therefore not available to U.S. investors; the UK FCA prohibiting the sale of cryptocurrency ETPs to retail investors.
product structure
Broadly speaking, cryptocurrency ETPs are divided into two product categories and types: ETFs and ETPs, and real and synthetic assets.
Cryptocurrency ETF Structure
ETFs are structured as funds, and ETF holdings are fund shares. The fund is usually legally separated from its issuing entity through a trust, investment company or limited partnership to ensure that investors holdings are protected in the event of the bankruptcy of the parent company/issuer. ETFs are often subject to additional rules and transparency requirements depending on their jurisdiction; for example, ETFs registered in the EU and marketed to EU investors are often subject to UCITS (Undertakings for Collective Investment in Transferable Securities) regulations, which bring diversity requirements, for example, the proportion of a single asset cannot exceed 10% of the total fund amount.
Most cryptocurrency ETFs today are spot or futures products. Spot ETFs have direct ownership of the underlying crypto assets and are guaranteed by an independent custodian. With futures ETFs, the issuer does not hold the underlying cryptocurrency but instead purchases futures contracts on the asset. As a result, these products do not directly track the spot price of the underlying asset, are often seen as introducing greater complexity and cost, and are less transparent and intuitive for investors.
Cryptocurrency ETP Structure
Cryptocurrency ETPs (in this case, the term used to refer to products other than ETFs) are structured as debt securities. While their structural requirements are less stringent than ETFs, their disclosure requirements are very similar.
Physical cryptocurrency ETPs are secured debt contracts that are 100% backed by the underlying cryptocurrency holdings they track. Crypto assets are physical objects purchased and held by an independent third-party custodian under the supervision and control of a designated trustee. The trustee holds the rights and interests on behalf of ETP holders and is responsible for organizing redemptions in the event of the issuers bankruptcy.
Synthetic ETPs are unsecured debt contracts, meaning the issuer does not hold the underlying asset that the product is tracking, but instead uses derivatives and swaps to track the asset (the exact structure and terms may vary). Synthetic ETPs therefore carry greater counterparty risk, as there is no legal requirement that the product be fully backed by the underlying physical asset. XBT Provider (and Valour) are two cryptocurrency ETP issuers that offer synthetic products.
Overall, the majority of cryptocurrency ETPs on the market are physical ETPs, as many investors prefer the transparency and reduced counterparty risk that this structure provides.
Cryptocurrency Product Issuers
Cryptocurrency ETPs initially began by tracking single digital assets. Today, the range of cryptocurrency ETPs available on the market also includes asset baskets, staking, shorting and leveraged products, as well as certain indices designed to manage volatility.
In terms of basic assets, according to data recently compiled by BitMEX Research, excluding stocks and over-the-counter funds, we found that among the 162 cryptocurrency ETPs, Bitcoin, Ethereum, and basket products accounted for 58%, and the other 42% were long-tail single products. Digital assets, as well as short selling, volatility, and leveraged products.
Data for 162 crypto ETPs (excluding stocks and OTC funds); Source: BitMEX Research, 1kx Research
Among these 162 products, 121 are ETPs and 41 are ETFs, of which 16 are futures ETFs and 11 are US spot Bitcoin ETFs waiting to be launched. There are currently 14 types of staking products (meaning investors can benefit from the staking proceeds of assets): 13 ETPs and 1 ETF.
Largest product by AUM
The largest cryptocurrency ETP by AUM (asset under management) is the ProShares Bitcoin Strategy ETF, a U.S. futures ETF product with $1.68 billion in assets held as of January 2, 2024. As shown in the table below, 9 of the 14 top cryptocurrency ETPs by asset size track Bitcoin (64%); of the remaining five, 3 track Ethereum, 1 tracks Solana, and 1 tracks BNB.
Source: BitMEX Research, 1kx Research
Of these 14 products, 4 are registered in Switzerland (the issuers are all 21 Shares), 3 are registered in Canada, 2 are in Jersey, 1 is in Germany, 1 is in the United States, and 1 is in Liechtenstein.
Among the top 14 products ranked by asset size, 4 are ETFs, including 3 spot and 1 futures; among the remaining 10 ETPs, eight are real asset ETPs and two are synthetic asset ETPs.
Product Innovation
There are several limiting factors to consider when launching a new cryptocurrency ETP. These include regulatory and stock exchange requirements and permissions, liquidity requirements, investor needs, and accessibility of public price data and fiat trading pairs. That said, as more players enter the market and seek to capture market share and differentiate, and as regulatory, service provider and investor understanding and acceptance of this asset class increases, we See continued product innovation by issuers and index providers.
Cryptocurrency ETP operating model
The process of creating an ETP begins with the issuer, the investment company or trust issuing the product, who writes a prospectus for regulatory approval. These may vary by jurisdiction, but generally the documentation will need to include details of the issuer, directors’ identities and financial statements, product and scheme design, as well as an overview of the underlying assets, intended markets and service providers, comprehensive Overview of potential risks, asset valuation (NAV) and details of NAV calculation methodology, fees and redemption process.
After obtaining regulatory approval and successfully engaging the necessary service providers, the issuer must apply for listing on the required stock exchange. Rules regarding which types of products and underlying assets are eligible for listing vary from exchange to exchange.
A service providers operating model and scope may vary depending on product type, jurisdiction and issuers program design. An overview of a typical model is as follows:
In the primary market, the issuer exchanges product shares with APs (authorized participants) in exchange for the underlying crypto-assets (in kind) or cash equivalents, and delivers the underlying crypto-assets to or from the designated custodian as needed Delivered everywhere. Depending on the structure, transfer agents and trustees may be involved in liquidating collateral and transferring funds.
While AP manages primary market creation and redemption, market makers provide liquidity in the secondary market to ensure continuous, efficient trading.
Investors buy and sell products on the secondary market, typically placing orders through a bank or broker, which in turn executes the order on the relevant stock exchange, either directly or through other intermediaries.
Stakeholders and service providers
Issuer
The issuer is responsible for the overall design and creation of the ETP, coordinating and managing relevant intermediaries throughout the product life cycle. Regulation of issuers varies by jurisdiction. Regulators assess issuers during the prospectus approval process, as do exchanges during the listing process, where requirements may include corporate governance, capital requirements and regular audits. Issuers usually set up independent special purpose vehicles (SPVs) to issue products. Initially, most cryptocurrency ETP issuers were native crypto companies, such as Coinshares, 21 Shares, 3 iQ, Hashdex and Valour. In recent years, more and more traditional financial companies have joined them, including WisdomTree, Fidelity, Invesco, VanEck, as well as Franklin Templeton and BlackRock pending SEC approval.
custodian
The custodian holds the underlying cryptocurrency behind the physically backed ETP product. Custodians used by ETP issuers include Coinbase, Fidelity Digital Assets, ital Assets, Komainu, BitGo, Copper, Swissquote, Tetra Trust, Zodia Custody and Gemini.
market maker
Market makers (MM) are liquidity providers hired by the issuer to provide necessary liquidity for ETPs by providing two-way quotes on the exchange in accordance with the agreed terms stipulated in the contract. Market makers mainly include Flow Traders and GHCO.
authorized participant
Authorized participants (usually banks or brokers) have the authority to create and redeem product shares directly with the issuer on a daily basis. They deliver underlying assets or cash equivalents to the issuer in exchange for newly created ETP shares, or return shares to the issuer in exchange for underlying assets or cash. Participants interest in cryptocurrencies, particularly in assets other than BTC and ETH, may vary based on factors such as regulatory uncertainty and market conditions. Authorized participants active in cryptocurrency ETPs include Flow Traders, GHCO, Virtu Financial, DRW, Bluefin and Enigma Securities. JPMorgan Chase, Jane Street, and Cantor Fitzgerald Co were recently designated as authorized participants in a U.S. spot Bitcoin ETF filing.
index provider
Index providers are responsible for creating, designing, calculating and maintaining the indices and benchmarks tracked by ETPs, providing transparency and reliability to issuers and investors. In some jurisdictions, index providers are regulated. In the EU, for example, there is the European Benchmark Regulation (BMR). Index providers active in cryptocurrency ETPs include MarketVector Indexes, CF Benchmarks (acquired by Kraken in 2019), Vinter (crypto-native index provider), Bloomberg, and Compass.
Exchanges and Multilateral Trading Facility (MTF)
The willingness of exchanges and MTFs to list cryptocurrency ETPs first depends on local regulations and regulatory approval of the issuers prospectus. After that, it will become a business decision of the exchanges and MTFs, and the outcome depends on the issuer and products of the ETP. Eligibility Requirements. This typically involves an assessment of parameters such as liquidity, compliance, public pricing information and risk mitigation of the underlying asset. Rules on what types of products can be listed vary by trading venue; for example, Germanys Xetra only lists asset-backed ETPs, while the six Swiss exchanges have specific rules for eligible crypto-based assets.
trustee
The trustee is responsible for protecting assets and representing the interests of ETP holders or investors. Their specific roles and responsibilities may vary depending on the specific structure and legal arrangements of the ETP. Trustees active in cryptocurrency ETPs include Law Debenture Trust Corporation, Apex Corporate Trust Services, Bankhaus von der Heydt and Griffin Trust.
administrator
Administrators support the overall operational management of ETP. Their services may include accounting, regulatory compliance, financial reporting and shareholder services. Administrators active in crypto ETPs include State Street, JTC Fund Solutions, CIBC Mellon Global Securities Services and Theorem Fund Services, NAV Consulting, Formidium and Bank of New York Mellon.
Other service providers
Other service providers that may play a role in the ETP program and product life cycle include, but are not limited to, paying agents (responsible for registering new ETP units and obtaining ISINs from local authorities), transfer agents (can be used to maintain records of shareholders and other responsibilities) , calculation agent (for calculating the net asset value of the underlying assets), and registrar (for keeping shareholder records). Depending on the product type, issuer and jurisdiction, these different roles and responsibilities may overlap or be performed by different parties.
A note on fees
ETPs charge a management fee, also known as an expense ratio or sponsorship fee, to cover the costs of managing and operating the product, which is calculated annually as a percentage of the position and deducted from the NAV on a daily or periodic basis. Many early cryptocurrency ETPs were able to charge fees as high as 2.5%, while typical ETP fees range from 0.05% to 0.75%. Crypto ETPs charge 2.5% AUM when alternatives charge as low as 0%, illustrating the stickiness and first-mover advantage of these products.
We expect fees to be a key differentiator for new products in the future, as is currently evident in U.S. spot ETFs. The first companies to announce fees are Invesco, Galaxy, which waives fees for the first six months and the first $5 billion in assets, and Fidelity, which offers a 0.39% fee. As of January 8, announcements from other issuers confirmed that the fee war has indeed begun:
Source: James Seyffart, January 8, 2024
area
Europe
Cryptocurrency ETPs originated in Europe, and the first Bitcoin product was launched in Sweden in 2015. It was an ETP issued by XBT Provider that tracked synthetic assets. In Europe, cryptocurrency ETP issuers benefit from the single market because once an ETP prospectus is approved by one European national regulator, the product can also be listed in other member states (known as a passport prospectus). Sweden’s SFSA remains a popular choice for European cryptocurrency ETP prospectus approval. Germany is another jurisdiction that has approved cryptocurrency ETP prospectuses, and cryptocurrency ETPs have good accessibility across various trading venues, such as leading exchange groups such as Deutsche Boerse, Boerse Stuttgart Group, and others.
ETPs remain the dominant product type in Europe, and the lack of true cryptocurrency ETFs in Europe is largely due to UCITS (Undertakings for Collective Investment in Transferable Securities) regulations. Overall, most European ETFs are UCITS compliant in order to benefit from the pan-European passport, which allows the sale of these ETFs to retail investors in other EU member states in addition to the country of registration. However, UCITS rules and requirements are currently incompatible with single-asset tracking products such as Bitcoin ETFs. For example, UCITS diversification requirements include that any single asset must not exceed 10% of the fund, and the underlying assets must be qualifying financial instruments. In June 2023, the European Commission tasked the European Securities and Markets Authority (ESMA) to investigate the need to update UCITS rules and focus on cryptocurrency assets. However, the purpose of the move appears to be to determine whether more rules and investor protections are needed rather than to expand the types of products that qualify. The deadline for ESMA comments is 31 October 2024.
Switzerland
In 2016, Switzerland became the second jurisdiction after Sweden to approve and launch a cryptocurrency ETP, and Bank Vontobel launched an ETP tracking Bitcoin on SIX Swiss Exchange. Subsequently, the worlds first crypto index product was launched in Switzerland in November 2018, a physically backed basket ETP consisting of Bitcoin, Ethereum, Ripple and Litecoin, issued by 21 Shares. SIX Swiss Exchange has specific rules for cryptocurrency underlyings, including that when applying for a temporary trading license, the cryptocurrency must be one of the 15 largest cryptocurrencies by market capitalization in U.S. dollars, and according to our research, the cryptocurrency is in It is widely used as the underlying asset in products in all trading venues around the world. BX Swiss, the Swiss stock exchange, also allows products that use cryptocurrencies as underlying assets, and its rules require that the underlying assets must belong to the top 50 cryptocurrencies by market capitalization.
U.K.
In October 2020, the UK Financial Conduct Authority (FCA) banned the sale, marketing and distribution of any crypto derivatives to retail investors. Many cryptocurrency ETPs are listed on the UK Aquis Exchange, but are only available for purchase by professional investors.
Canada
Canada was the first country to approve a Bitcoin ETF, with the first product launched on the Toronto Stock Exchange (TSX) by Purpose Investments in February 2021, with the Ethereum ETF following closely behind. In October 2023, 3 iQ launched a staking Ethereum ETF, with staking rewards included in the fund, the first of its kind in North America. Other Canadian cryptocurrency ETF issuers include Fidelity Investments Canada, CI Global Asset Management (CI GAM) in partnership with Galaxy, and Evolve Funds.
Brazil
Brazil follows Canada. The Brazilian Securities and Exchange Commission (CVM) approved Latin America’s first Bitcoin ETF in March 2021. Brazilian cryptocurrency ETF issuers include crypto asset managers Hashdex and QR Capital, as well as Galaxy-partnered Itaú Asset Management.
USA
To date, only cryptocurrency futures ETFs have been approved by the SEC and made available to investors. ProShares launched its first Bitcoin futures ETF on October 19, 2021, becoming one of the most heavily traded funds in history, attracting more than $1 billion in the first few days of trading.
Source: Bloomberg, via Twitter from Eric Balchunas, Bloomberg Senior ETF Analyst
Two years later, on October 2, 2023, ProShares, VanEck, and Bitwise launched the first Ethereum futures ETFs in the United States. Futures products generally require more understanding from investors and come with additional fees and the risk of tracking errors and performance degradation due to frequent rebalancing. In fact, the underlying futures contracts trade on the Chicago Mercantile Exchange (CME) and are regulated by the commodity exchange. This is a popular explanation for why futures ETFs were approved before spot products.
The first U.S. spot Bitcoin ETF application was submitted by the Winklevoss brothers in July 2013, and was submitted multiple times in the following years before being ultimately rejected. Ten years later, on June 15, 2023, BlackRock, the world’s largest asset management company, submitted an application for iShares Bitcoin Trust. The power of the BlackRock brand and stellar track record (it was rejected just once out of 575 ETF offerings, according to Bloomberg Senior ETF Analyst Eric Balchunas) are game-changers and are helping the U.S. Bitcoin Spot ETF Becoming one of the most anticipated products of all time.
On August 29, 2023, the tide turned further, when the U.S. Court of Appeals for the District of Columbia Circuit ruled in favor of Grayscale in Grayscale v. SEC, stating that the SECs decision to block Grayscales proposed Bitcoin ETF was arbitrary and capricious.
Fast forward to today, and 11 issuers have filed for spot Bitcoin ETFs and are undergoing SEC review of S-1 filings: BlackRock, Grayscale, 21 Shares ARK Invest, Bitwise, VanEck, WisdomTree, Invesco Galaxy, Fidelity, Valkyrie, Hashdex and Franklin Templeton. Meetings between the SEC and issuers have increased in recent weeks, and the SEC is requiring all issuers to move to a cash-minting model, meaning that the exchange of assets for the creation and redemption of ETF shares must occur in cash, rather than in exchange for Bitcoin . Typically, for efficiency reasons, the exchange of assets in issuances and redemptions between authorized participants and ETF issuers occurs in physical form. While the SEC has not publicly stated its rationale for requiring cash, it is likely that the SEC does not want to be seen as approving cryptocurrency trading by authorized participants, typically large banks and brokers.
As of the evening of January 5, 2024, all 11 filers had submitted revised 19B-4s proposing changes to the rules under which exchanges would be able to trade products. These must be approved by the SEC.
Source: Bloomberg via James Seyffart Twitter, January 5, 2024
The final step is for the SEC to sign the final S-1 form. The market currently expects this to happen around January 10, with listing and trading likely to be completed as soon as 24 to 48 hours thereafter.
We will closely monitor fund flows and volume during the first week of trading to assess competitive dynamics among the 11 issuers. Larger ETFs are favored by investors for a variety of reasons, including cost efficiency and liquidity. Therefore, the amount of seed capital in an ETF can provide a competitive advantage. Bitwises S-1 filing on December 29 indicated initial intended funding of up to $200 million, and BlackRock showed seed sales of $10 million. It is worth noting that there was a rumor on January 5 that BlackRock may have prepared $2 billion in the first week of trading. Eric Balchunas, senior ETF analyst at Bloomberg, pointed out that the size of the fund is consistent with BlackRocks brand image given the seed investments from other funds, although the amount will be far larger than any ETF launched before.
BlackRock, VanEck, Ark 21 Shares, Fidelity, Hashdex, Invesco Galaxy, and Grayscale have also submitted Ethereum spot ETF applications, with the first SEC response deadline being May 23, 2024.
Hongkong
One year after the US SEC’s approval, the Hong Kong Securities and Futures Commission (SFC) approved cryptocurrency futures ETFs in October 2022, and asset management company CSOP launched two funds on December 16, 2022. Bitcoin and 1 Ethereum. In December 2023, the SFC and the Hong Kong Monetary Authority issued a joint notice setting out guidelines for cryptocurrency investment products, stating that in light of the latest market developments, the SFC will now accept applications for cryptocurrency spot ETFs. The updated SFC guidance states that both physical and cash creation and redemption models are permitted. Cryptocurrency ETPs issued overseas and not specifically approved by the Securities Regulatory Commission will only be open to professional investors.
What’s Next for Cryptocurrency ETPs?
More and more investors are looking to add cryptocurrencies to their portfolios, and ETPs provide a familiar, convenient and regulated way to access this investment. Driven by this demand, both crypto-native and traditional asset managers are continuing to participate and innovate in these products. The expected approval of US spot ETFs by 2024 could be a catalyst for their growth globally.
As this field continues to evolve, our focus will include:
The impact of increased issuer competition on fees and ETP flows from other regions and issuers, and, in the longer term, smaller players will be consolidated or exited
A shift in consumer and institutional awareness and acceptance of cryptocurrencies, powered by the marketing power of leading global asset managers like BlackRock
An increase in the number of exchanges, asset managers, distributors and other institutions willing to get involved in cryptocurrencies and service providers
Timeline for accepting these products and integrating them into the consulting model
Developments in institutional staking include the growth of staking products available to investors and the development of liquidity solutions by issuers
Growth of on-chain structured products: It’s no secret that we believe the future is on-chain, and the recent collaboration between 21 Shares parent company 21.co and Index Coop shows how ETP issuers are starting to move in this direction
Note: Over-the-counter (OTC) closed-end cryptocurrency funds, such as those offered by Grayscale, were not included in this study.
