Crypto for Advisors: Bitcoin ETF vs Direct Ownership

Miguel Kudry, the CEO of L1 Advisors, discusses the similarities and differences between Ethereum Exchange-Traded Funds (ETFs) when responding to inquiries.

–S.M.

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To ETF or Not to ETF

As the significance of digital assets escalates, financial consultants are frequently fielding queries from clients regarding the most effective methods to invest in bitcoin. Two primary avenues for investment have emerged as popular topics of discussion: purchasing a bitcoin Exchange-Traded Fund (ETF) through a reputable exchange or acquiring bitcoin directly. In this article, we delve into an in-depth analysis of these two investment alternatives, focusing on essential aspects such as management, safekeeping, trading, and tax consequences to equip financial consultants with the knowledge required to guide both themselves and their clients with confidence.

Management

Bitcoin ETF

As a researcher studying investment vehicles, I’d describe a Bitcoin Spot ETF this way: I manage an Exchange-Traded Fund (ETF) that specializes in Bitcoin. This fund is run by experienced professionals who take care of purchasing, selling, and safekeeping the digital currency on behalf of investors. This simplifies the process for individuals new to cryptocurrencies, as they no longer need to worry about the complexities involved with handling Bitcoin directly. However, there are fees associated with this professional management which can diminish overall returns over time. Furthermore, investors don’t have direct control over their underlying Bitcoin holdings since decisions are made by the fund managers.

Direct Bitcoin Ownership

When individuals purchase bitcoin directly, they obtain full ownership of the digital currency, granting them greater control and versatility compared to investing in ETFs. This eliminates the continuous expense of management fees, but it also necessitates taking care of transactions and safekeeping on their own. Managing bitcoin investments can be intricate and demanding, and any errors could result in substantial losses, particularly for those new to the process as handling bitcoin requires specialized expertise.

Custody and Security

Bitcoin ETF

ETF investments usually depend on secure custody services offered by external custodians. These custodians apply sophisticated security methods like cold storage and multi-signature wallets to minimize the likelihood of theft or asset loss. However, this dependence on third parties introduces counterparty risk, meaning investors trust the custodian’s ability to safeguard their investments. Additionally, advisors and clients have no direct control over these custody arrangements, which may be a worry for those who place great importance on having full control over their assets.

Direct Bitcoin Ownership

Investing directly in Bitcoin means that individuals are in charge of securing their own assets through various custody methods, including digital wallets or safeguarding private keys. This level of control comes with heightened accountability for ensuring the safety of your funds. Negligent security measures or misplaced private keys can lead to permanent fund loss. It is crucial that advisors instruct clients on optimal Bitcoin protection strategies: utilizing hardware wallets and activating two-factor authentication.

Trading and Liquidity

Bitcoin ETF

Bitcoin Exchange-Traded Funds (ETFs) can be bought and sold on significant stock markets, ensuring substantial liquidity and convenience during normal business hours. The regulated marketplace provides extra investor safeguards. However, trading is confined to the hours of operation for these exchanges, in contrast to the continuous crypto market. Markets frequently experience considerable fluctuations beyond regular exchange hours, leaving investors powerless to respond. Moreover, shares of Bitcoin ETFs might deviate from the underlying bitcoin’s net asset value (NAV).

Direct Bitcoin Ownership

As an analyst, I would explain it this way: I can purchase or sell Bitcoin through multiple cryptocurrency exchanges, granting me entry to a non-stop, worldwide marketplace. This results in excellent liquidity, enabling investors to buy and sell at current market prices without any additional fees. However, the degree of liquidity and trading experience may fluctuate considerably among various exchanges. Some platforms might charge higher transaction and withdrawal fees. Furthermore, managing client funds on a 24/7 trading platform can be challenging for advisors, requiring constant vigilance to ensure that transactions occur when desired.

Tax Implications

Bitcoin ETF

Holding bitcoin through an ETF comes with distinct tax consequences compared to owning the cryptocurrency outright. ETFs are categorized as securities and therefore might provide more streamlined tax reporting for investors. Certain ETF structures could even offer tax benefits, like postponing capital gains taxes. Nevertheless, selling shares of an ETF can trigger capital gains taxes, which could affect overall profits.

Direct Bitcoin Ownership

Owning bitcoin directly comes with unique tax implications, primarily concerning capital gains and losses. The tax regulations surrounding these digital assets can be intricate and laborious, necessitating precise reporting and computations. By managing your own bitcoin holdings, investors can have greater control over their capital gains and losses, potentially enhancing their tax plans. However, the process of reporting taxes on these transactions can be intricate and onerous, necessitating meticulous adherence to regulations and often seeking advice from tax experts or utilizing specialized software. Financial advisors may need to collaborate closely with tax professionals to ensure compliance and maximize tax benefits.

Using Institutional Platforms

As a researcher studying digital asset investment solutions, I’ve come across an intriguing option for individuals who want the benefits of Bitcoin ownership without dealing with its complexities directly. Institutional platforms managed by advisors provide a viable alternative to self-management. These services offer professional management similar to Exchange Traded Funds (ETFs), but with the added advantage of direct ownership.

So what now?

When it comes to investing in bitcoin, clients have two main options: purchasing it directly or investing in a spot bitcoin Exchange-Traded Fund (ETF). Each approach has its advantages and disadvantages, which financial advisors should help their clients weigh carefully. Ultimately, the choice between these two methods often hinges on what level of control and exposure to the cryptocurrency market the client desires.

As an analyst, I would advise that for certain investors, merely gaining exposure to specific assets through an ETF might suffice. This approach offers convenience and simplicity, making it an attractive choice for those who prioritize ease of access over direct ownership. However, there are other investors for whom holding the underlying assets personally is a necessity. In such instances, it becomes crucial for the advisor to assess whether the investor possesses sufficient knowledge to manage self-custody or if they would benefit more from professional institutional custody services, considering its advantages.

– D.J. Windle, founder and portfolio manager, Windle Wealth

Ask an Expert

“Could you please explain the major distinctions between Bitcoin and Ethereum ETFs, and how these investment vehicles diverge from directly holding the underlying cryptocurrencies?”

Q: How should advisors think about the entire spectrum of custody options?

In the traditional financial world, advisors often work with multiple custodians to meet the diverse requirements of their firm and clients. The landscape for digital asset custody is even more complex. Therefore, it’s advisable for advisors to adopt a hybrid approach when selecting custody options. Each type of custody caters to various investor profiles. For some, digital assets represent a significant portion of their investment portfolio. Others may already self-custody and want to integrate these assets into their financial planning or advisory relationship. Some investors seek direct ownership through qualified custody solutions, while others prefer exposure via exchange-traded funds (ETFs) or other publicly traded vehicles.

– Miguel Kudry, CEO, L1 Advisors Inc.

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Note: The views expressed in this column are those of the author and do not necessarily reflect those of CoinDesk, Inc. or its owners and affiliates.