In today’s newsletter, Sarah Cummings of Morgan Stanley Investment Management provides insights and considerations when evaluating cryptocurrency exchange-traded funds.
Then, in “Ask an Expert,” Ryan Tannahill of iA Private Wealth USA answers questions about lending against bitcoin assets.
Crypto ETP Evaluation in an Evolving Market
When evaluating exchange-traded funds (ETFs), investors often focus on factors such as fees, liquidity, and tracking. Spot bitcoin exchange-traded products (ETPs) introduce additional dimensions of due diligence that investors may be less accustomed to evaluating. First launched in January 2024, these vehicles, structured as grantor trusts under the 1933 Act, seek to track bitcoins. performance using a designated price benchmark. Understanding how their structure, escrow arrangements, and benchmarks work is critical to evaluating these products.
Basic ETF Considerations
As with any ETF, overall costs and trading features are important.
Fees and exemptions. While fee compression has occurred since the first bitcoin ETPs entered the market, expense ratios still vary significantly between products. Investors may want to distinguish between gross and net expense ratios, particularly when fee waivers exist. Such exemptions may be subject to asset thresholds or expiration dates that could affect costs over time.
Liquidity and execution. Trading volume, bid-ask spreads, and overall fund liquidity remain important inputs when evaluating total cost of ownership. However, because bitcoin itself is a highly liquid underlying asset, the liquidity of the fund on display may not fully reflect the quality of execution. In practice, similar price execution can be achieved across products despite differences in visible business activity. Engaging with a fiduciary sponsor or liquidity provider before a trade can help manage execution costs.
Monitoring and design of funds. Given their passive single-asset structure, spot bitcoin ETPs tend to exhibit limited sources of tracking error. Expense ratios are usually the main factor, and products with lower fees are generally expected to track more closely over time. In-kind creation and redemption mechanisms can also support tighter monitoring by reducing frictional costs.
Crypto ETP Specific Considerations
Beyond traditional ETF metrics, several factors are more specific to cryptocurrency-based products.
Custody of digital assets. Holding bitcoins requires specialized escrow arrangements, a relatively new feature within the asset service. While early infrastructures were largely developed by crypto-native companies, traditional custodians have increasingly entered this space. Custody practices, regulatory status, and bankruptcy protections may differ between providers, so it is prudent to understand how and where digital assets are held.
Sponsor profile. The background of the issuer may also warrant consideration. Crypto-native sponsors and traditional financial institutions may operate under different regulatory frameworks and governance standards, which may influence risk management, operations, and investor protection.
Reference methodology. The growth of digital asset products has led to the emergence of new flagship providers. It may be important to evaluate the construction of a benchmark index, such as exchange inclusion criteria, pricing methodologies, and review processes. A poorly designed benchmark may differ from the broader bitcoin price, which could affect tracking results.
Putting it together
In a developing asset class, the structure and design of an ETP can be as important as the exposure it seeks to provide. Beyond general fees, evaluating custody frameworks, sponsor profiles, benchmark methodologies, and execution characteristics can help investors better understand potential costs and risks. As the crypto ETP market continues to evolve, a disciplined and holistic due diligence process remains essential.
– Sarah Cummings, CEO, ETF Strategist, Morgan Stanley Investment Management
Important Risks and Disclosures.
ask an expert
Q: Do I need to move my bitcoins to get a loan?
In many cases, yes: centralized lenders typically require custody of your bitcoins for the duration of the loan. However, structures vary between platforms, so it’s worth understanding who owns your assets and how they are protected before you commit.
Q: What are the main risks that advisors should highlight?
Margin calls. If bitcoin falls sharply, clients may be forced to post additional collateral or face liquidation, often at the worst possible time. That forced sale can also trigger a taxable event, compounding the loss.
Q: Should I do this instead of selling part of my position?
It depends on the conviction. If you believe Bitcoin is appreciating, lending preserves that advantage while meeting liquidity needs. But if you are unsure of the position, adding leverage is not the answer; Sometimes a clean sale is the easiest decision.
– Ryan Tannahill, Investment Advisor Representative, iA Privabecoming
Keep reading
- The US Senate Banking Committee on Thursday advanced its crypto market structure bill, the Clarity Act, to the full Senate, bringing it one step closer to passage into law.
- Japan’s Financial Services Agency recognizes foreign-issued stablecoins as electronic payment methods under national law, effective June 1.
- Bank of England Deputy Governor Sarah Breeden says the Bank of England will publish draft rules for stablecoins next month and finalize them by the end of the year.
