One of the first lessons you’ll learn when you start investing is that diversification is key. Put all your hard-earned cash in one sector at your peril.
On the other hand, investors know that where there is risk, there is money to be made. Long-term portfolio management is all about managing that risk-reward balance.
Gaining exposure to individual cryptocurrencies is relatively risky.
Reducing that risk means you can invest in cryptocurrency without the threat of losing your house, bankrupting your 401k, or infuriating your significant other.
The Big Why
This is where Exchange Traded Products (ETPs) and Exchange Traded Funds (ETFs) come in. They offer exposure to the entire market without you having to worry about custody or even own the underlying asset.
In short, investors who aren’t normally comfortable with the volatility that crypto affords can gain exposure at a lower risk profile.
That’s is why there is such fierce interest in the first mainstream US exchange to list a crypto-backed ETP or ETF.
The SEC has repeatedly delayed decisions on Bitcoin ETFs from Van Eck and Bitwise.
Van Eck, for its part, makes the top seven list for the firms with the largest ETP market share in the US.
Statistics tracker Statistia rates its assets under management approaching $36 billion. iShares ETPs top the list with a staggering AUM over $1.32 trillion.
New York State’s BitLicense is one of North America’s original attempts at offering a kind of regulatory stamp of approval. Circle won the first BitLicense in 2015.
But in certain regards the US is behind the curve compared to the likes of Malta or Switzerland, especially when we consider institutional investors.
These might be pension funds, brokers, hedge funds: those that control many millions of dollars on behalf of banks, governments and large organizations.
“The vast majority of our volume is institutional,” says Hany Rashwan. “You can tell that by the order sizes.” Hany is the founder of Amun AG. He’s also a Forbes 30 Under 30 A-Lister and fintech entrepreneur.
As we speak, it’s approaching midnight in Hong Kong. Outside, it’s a humid 75 degrees in the city that never sleeps.
Amun’s Crypto Basket ETP is the world’s first, and at time of writing, the only physically-backed crypto exchange traded product.
ETPs are always 100% backed by the assets whose prices they are tracking. In that, they differ from ETFs.
With the canny addition of the ticker name $HODL, Hany’s ETP gained worldwide press when it was launched on Switzerland’s SIX exchange on 21 November 2018.
HODL is consistently in the top five most traded ETPs on SIX, alongside competitors tracking traditional commodities like gold, soybeans or cocoa.
So how did they do what serial ETF proposers have failed to: get the regulators on side?
“We are not an ETF,” says Hany.
“Our thought was to treat it like trading commodities. We would argue the Swiss ETP structure is perfect for that.
“We were actually in talks with the Swiss regulators for 18 months before we launched,” he said.
Switzerland came top of the list after Hany and his team considered 25 similar jurisdictions.
“The arguments we used to get regulators comfortable were to parallel crypto with commodities, especially gold.
“We argued that crypto should be treated like digital gold. The final structure was modelled on a gold exchange-traded commodity setup.”
Single-asset trackers – Bitcoin (ABTC), Ethereum (AETH) and Ripple (AXRP) soon followed.
Six to eight more products are coming out of Amun’s crypto division by the end of 2019, with a Bitcoin Cash tracker next on the slate.
“HODL today is the only way to buy a listed crypto index that allows you to buy the market, not worry about custody, and it rebalances monthly,” Hany adds.
When the market moves, the amount allocated to each asset in an ETP might shift, too. So a product that rebalances automatically is generally a good thing.
Amun deals in big money. Institutional money. International, impressive, the sharpest-suits-in-the-room kind of money. But what about the little guys down at the other end of the bar?What’s the difference between a Bitcoin ETF and an ETP?
Bitcoin ETF vs ETP
While the financial press sometimes uses these terms interchangeably, there are notable differences, so let’s define our terms.
The best-known ETF is the SPY ETF, the world’s biggest exchange traded fund. It tracks the overall level of the Standard & Poor 500 stock market index.
Think of a crypto ETF as drawing a circle around the top 20 cryptocurrencies and following their prices up and down wherever they go. The price of an ETF is comprised of the average prices of these combined assets. If you think the prices of the biggest cryptos is going down, you can short an ETF.
An ETP is classed as senior structured debt. Senior debt takes priority over other forms of debt, like unsecured debt. If everything goes horribly wrong, and the company you’re investing with goes out of business, there’s a better chance to get your money back.
The funny thing about ETFs is that they beat active investment portfolios most of the time.
Filling in the gaps for us is Anthony Xie, a former ETF trader who set up Binance trading bot HODLBot with his best friend in Vancouver.
“What we set out to do is create a way to automate all of the boring stuff that comes with passive investing, for cryptocurrency. From the very beginning we built just the top 20 index, index by market cap, capped at 10% maximum initially, as basically a way to capture the performance and the risk of the entire cryptocurrency market.”
Active traders hiding behind ETFs
Anthony says there’s a bunch of insider secrets that the retail investor might never find out, if they don’t know who to ask.
“In Canada I worked for a consulting company called ETFInsights. One thing that was very interesting is just how many fees funds will pass on to their customers, and then how much financial advisors will charge on top. A lot of then time on an after-fees basis, a simple ETF in an index will beat these active traders.
“We also learned that there was this phenomenon going on called ‘closet indexing’.
“So you actually had a lot of these closet indexers. For the majority of those people you could just replace them with an automated solution, say an ETF, and give an investor exposure to the entire market, and do much better on an after-fee basis in the long run.”
That’s a pretty hefty secret which undercuts everything we think we know about the benefits of running an active portfolio.
“I saw that that was going on in the traditional equity markets so when I went over to cryptocurrency, the space was much more immature there were really no portfolio solutions just people actively trading on their own exchange account.”
Anthony has been working out of the University of Waterloo’s Velocity tech incubator. He claims HODLBot has seen $45 million in transaction volume and that an unnamed top five exchange has already offered to acquire them.
“As someone who’s like a big believer in indexing and ETFs, I didn’t really see a ton of existing solutions out there that was very friendly for the retail investor and basically I set out to build this,” Anthony says.
HODLBot integrates the cryptocurrency exchange and uses the underlying API to trade orders and sort out requests to get portfolio values.
“We aggregate all of that information to our own portfolio trackers, so people can see what assets they have,” says Anthony.
And what’s the tech stack?
“We use Django for the backend framework, most of the trade logic and the calculations are done in just vanilla Python, we use Celery as the job scheduler and then the front end is built with a combination of React and Redux for state management.”
Immortal cryptos are killing the market
One other interesting point Anthony makes is the massive correlation between cryptocurrencies that we’ve talked about before.
As an alternative asset class, cryptocurrencies aren’t particularly correlated with the mainstream equity markets, which makes crypto investments an attractive portfolio diversifier.
But, and this is a big but, so many altcoins are too closely linked to the Bitcoin price.
“Cryptocurrencies individually are too robust and that’s causing them to stay alive forever.
“It’s not like the companies during the dotcom boom, so when you have a bunch of these robust individual coins that like don’t end up going away, it makes the market pretty unhealthy and everything super correlated together.
When you see EOS raise $4 billion from its ICO, you get what we mean.
Anthony concludes: “There’s very little economic pressure for these projects to create value and they raised an insane amount of money, so developers can live off that warchest for a very long time.”
Investors – retail or institutional – will continue to want exposure to the cryptocurrency markets without having to hold EOS, or even ETH or BTC.
These assets, as we’ve seen, could well be hugely overpriced. Only time will tell us that. But for now, ETPs and ETFs hold the key.