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Digging into Australia’s first crypto ETFs

Emma Rapaport  |  13 May 2022Text size  Decrease  Increase  |  
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The race for Australia’s first cryptocurrency ETFs is over – and it’s a tie!

ETF Securities in partnership with 21Shares launched two products with direct ownership of Bitcoin and Ethereum on Thursday, ending a drawn-out contest among providers which has embroiled both the regulator and senior members of the Morrison government.

Cosmos Asset Management also commenced trading its Bitcoin ETF on the same day securities exchange Cboe confirmed on Tuesday following months of delays.  

Australian investors with a hankering for the volatile asset class but trepidation about the process of acquiring it (or misplacing their password) can now trade Bitcoin and Ethereum via a regulated financial product as they would a normal share. It represents an important milestone for crypto’s creep into the mainstream – for retail investors, intermediaries and institutions alike.

In a conversation with Morningstar, ETF Securities’ Kanish Chugh acknowledged these funds are unlikely to appeal to the digital currency fanatics, the die-hard fans, the purists and the maximalists. Rather, he expects them to appeal to mum and dad investors with nerves about trading on unregulated exchanges.

“This product is not going to be there for the crypto enthusiasts. They’ve already bought Bitcoin and Ethereum, they’re doing that themselves,” he says.

“Hany and Ophelia founded 21Shares because their parents wanted to invest in Bitcoin and there was no easy way for them to do it. So, they said why isn’t there an ETF form?

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“The concept of an everyday investor that wants to invest in Bitcoin easily via their CommSec account – this is their way to do it.”

While the day-to-day trading quirks ETFS 21Shares Bitcoin ETF (Cboe: EBTC) and ETFS 21Shares Ethereum ETF (Cboe: EETH) are yet to be seen, documentation is available for each. Below we delve into the details.

The nuts and bolts

Not all cryptocurrency ETFs are alike. Cosmos Asset Management’s fund Cosmos Purpose Bitcoin Access ETF (Cboe: CBTC) is a “feeder fund” meaning it feeds - purchases units – in the Purpose Bitcoin ETF trading on the Toronto Stock Exchange, which itself invests directly in bitcoin.

The world’s largest cryptocurrency ETF with almost $1 billion in assets - ProShares Bitcoin Strategy ETF (BITO) – doesn’t invest directly in bitcoin, but rather in bitcoin-pegged futures contracts.

MORE ON THIS TOPIC: These aren't the Bitcoin ETFs you're looking for

ETF Securities’ directly holds Bitcoin and Ether in its newly minted funds. Here’s how it works. An investor applies for ‘coin interests’ in EBTC or EETH via their broker. These funds are quoted on Cboe Australia, an alternative securities and derivatives exchange to the ASX. Cboe requests an authorised participant such as Jane Street or Nine Mile to purchase the Bitcoin or Ethereum assets and lets the exchange know once the order is filled. 

Chugh says chose Cboe for their funds for two reasons: to diversity the exchanges they work with and put themselves ahead in the race to launch.

“We understand there’s a benefit to having competition within the Australian market in all aspects,” he says. “We also felt that we were able to be first to market by going down that path and working with Cboe.”

ETF Securities has selected US exchange Coinbase for safe storage. Crypto assets are held in wallets offline (in what’s known as ‘cold storage’) in Faraday cages (which block electromagnetic radiation) to minimise the risk of hacking.

“It’s very different to gold, for example, which you can physically hold and you’ve got an armoured truck that puts it in,” says Chugh, noting the firm’s Physical Gold ETF (GOLD) which is backed by gold bullion and held in a vault in London.

“For crypto, our whole concept was to try and minimise the time it was ‘online’. When it’s online, there’s that risk of hacking and Coinbase gives us a structure and security systems.”

Now it gets a little tricky.

The legal owner of the crypto assets held by Coinbase is the ETFS 21Shares Wholesale Bitcoin Trust (the Sub-Fund). HSCB holds that ownership in custody on behalf of the ETFS 21Shares Bitcoin ETF. The trust is a bare trust to ensure that investors have direct ownership of the cryptocurrency.

ETF Security head of Product Evan Metcalf explains that this complex structure exists to “simplify compliance at the registered scheme (ETF) level”. It also allows investors to redeem their Bitcoin or Ether at any time, as they are the direct owners, although there’s a hefty fee involved.  

“For the end investor, this is essentially the same as owning Bitcoin directly,” Chugh explains.

To summarise, providers are jumping through regulatory hoops behind the scenes while making it as simple as possible for retail punters.

Fund sturcture

How Coin Interests in the Fund are created by Authorised Participants in the primary market and offered for sale to investors in the secondary market

Fund strctureSource: ETF Securities ETFS 21Shares Bitcoin ETF Products Disclosure Statement

It’s expensive, right?

Yes. At 1.25% per annum, ETF Securities’ pair of ETFs will be the most expensive passively managed funds in the Australian market. For every $50,000 investor have with the fund, fees are levied at $625 annually. In contrast, Australia’s largest passive fund charges fees of just 0.10%.

Fees for passive ETFs have been on a downward trend. The net flow weighted average cost of equity ETFs has dropped from 0.45% to 0.37% (approximately) over the past three calendar years.

Investors may balk at these fees, given ETF Securities is merely issuing and managing the fund. They’re not making ‘active’ decisions about which digital currency to trade and when. However, Metcalf argues that a lot of work goes into the management of this newer and risker asset class, with lots of checks and balances involved.

The assets are also insured by Coinbase up to a limit of US$320 million per wallet. Hacking can happen, even to the big players. Earlier this year, international cryptocurrency exchange Crypto.com admitted that a hacker stole $30 million worth of cryptocurrency from 483 users' digital wallets, WIRED reported.

“A lot of the fee is around the security of those assets,” Metcalf says adding that their fees are in line with or lower than other listed crypto funds around the world.

“You’ve got an individual that has access to institutional-grade custody which if you’re just opening your own account at a crypto exchange that’s not necessarily the case. And the other big element is the insurance piece that you wouldn’t normally have – that’s a large part of the cost.”

Metcalf anticipates costs will come down as the crypto market matures.

Plagued by delays

ETFs are a popular investment vehicle as they trade like a share on an exchange. But crypto ETFs have thrown up complications that limit their access.

A ruling by the clearing authority ASX Clear requires clearing participants to stump up a 42% margin as collateral for Bitcoin, and 50% for Ethereum. All listed securities require some level of collateral, large equities a couple of percentage points, but the requirement for the crypto ETFs is notably higher due to the volatility of digital currencies. For example, if a broker is clearing $1 million in a Bitcoin ETF per day, with a two-day settlement period, they need to post 42% of $2 million to the ASX. Fewer brokers were willing to participate, causing a multi-month delay in launches.

Today, four market participants have agreed to meet these requirements including Australia’s largest retail stockbroker CommSec, and trading, execution and clearing house FinClear which operates as a market participant for smaller brokers including Superhero and Stake. Nabtrade is a notable holdout.

The volatility of cryptocurrencies has no parallel to any other measurable asset classes.

Standard Deviation

Does it matter who got in first?

To someone like you and me, no. To an ETF provider, yes. History shows providers first to market with a new asset class often command the lion’s share of media attention, hype and flows. With several providers all jostling to be number one – ETF Securities, Cosmos, 3iQ Digital, Monochrome, BetaShares and Van Eck – being first matters.

Some estimates put early flows at $1 billion for the first cab off the rank, referencing the $30 million record set by the BetaShares Crypto Innovators ETF in November 2021 and US-listed ProShares Bitcoin ETF topping over $1 billion in assets in just two days. But first-day trading volumes disappointed on Thursday. ETF Securities’ 21Shares Bitcoin ETF enjoyed the highest volume of $955,000 while 21Shares Ethereum ETF saw $604,000 in traded volume, The Australian reported. On Superhero, EBTC was the third most traded security on Thursday and EETH made the top ten.

“There is interest in crypto from investors but it’s notable that when the BetaShares Crypto Innovators ETF launched in November 2021 that it was significantly more popular – as our most-traded security and with only one investor selling the ETF on the day,” says John Winters, chief executive and co-founder of Superhero.

ETF Securities’ Metcalf anticipated flows would be somewhat muted given the access issues which have dogged the sector. He expects interest from large institutions and advisers longer-term – but not on day one.

“It’s not going to be a massive bonanza on day one. Given it’s a new asset class, there are certain parties that aren’t going to be involved initially,” he says.

“[We think impediments in the early days of trade will be] having that coverage, having everyone who is interested in buying the product being able to access it.”

Chugh adds: “Because of ASX Clear’s margin and capital requirements, that created limitations because not every clearer will be ready on day one.”

Tepid interest may reflect the price of bitcoin hitting its lowest point in six months and the crash of stablecoin Luna. Bitcoin and Ethereum have dropped by more than 20% over the last seven days with Bitcoin falling below $29,000 for the first time since December 2020.

"Couldn't have imagined a more challenging day for Australia's new crypto ETFs to debut," tweeted City Index market analyst Tony Sycamore.

Investors may also remember the fate of the BetaShares Crypto Innovators ETF: down almost -60% since its launch last November.

Do crypto ETFs belong in your portfolio? Read more from Morningstar specialists:

The bull case for Bitcoin

Does Your Portfolio Need Bitcoin?

The promise and peril of Ethereum

The role of Ethereum in an investment portfolio

The Conventional Investor’s Guide to Bitcoin

Cryptocurrency, or the art of buying what you don't understand

is the editorial manager for Morningstar Australia. Connect with Emma on Twitter @rap_reports. You can email Morningstar's editorial team editorialAU[at]morningstar[dot]com

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