Why a Bitcoin ETF Might Be the Worst Way to Enter Crypto

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  • On Friday, the SEC spiked an application for a Bitcoin exchange-traded fund (ETF) that would have held the actual digital asset rather than a futures contract.
  • Futures- or spot-based ETFs offer investors the diversity of a mutual fund with the intraday trading flexibility of a stock.
  • Despite their popularity, some ETF attributes make them a lousy way to invest in crypto and Bitcoin.

Because of trading fees, expense ratios, and taxes on short-term gains, there are better ways to buy crypto than a Bitcoin ETF.

On Friday, the U.S. Securities and Exchange Commission rejected the proposal by VanEck for a Bitcoin exchange-traded fund (ETF) that would have held the actual cryptocurrency rather than just Bitcoin futures. Submitted in March, the application sought to buy Bitcoin directly on the "spot" market and hold it in an ETF that investors could then buy into. For clarity, a futures-based ETF invests in indirect contracts to buy or sell an asset at a set date in the future.

SEC rationale for rejecting the latest Bitcoin ETF

While the SEC allowed two Bitcoin futures-based ETFs to begin trading last month, it would not authorize an ETF containing actual Bitcoin, citing in its 51-page report its frequent worries of possible manipulation and fraud, etc within the crypto market. Bitcoin dipped to around $62,000 when the SEC announcement came down, but it has rebounded to more than $64,000 as of this writing.

While many investors like the diversity of an ETF, with its trading flexibility of an equity, it's not a great way to invest in Bitcoin or any type of cryptocurrency for that matter. Here are some reasons why:

Avoidable pitfalls of Bitcoin ETFs

  • Each time you buy or sell a stock, you have to pay a commission, and that holds true when transacting with ETFs. Depending on how often you might trade an ETF, you can rack up some hefty trading fees that eat into your investment gains.
  • In addition to commissions, ETFs have expense ratios. An expense ratio is a percentage of your holdings that the fund charges you annually as payment for the privilege of letting them manage your money. Bottom line, the higher the expense ratio, the lower the returns on your ETF investment.
  • According to IRS rules, cryptos are categorized as personal property, which are taxed at the short- and long-term rates based on the duration you hold them. If you hold a digital asset for less than a year, you trigger short-term gains, which range from 10% to 37% depending on income and filing status in 2020 -- long-term rates are lower. It's critical to know how and when an ETF treats gain disbursements to avoid tax surprises.
  • One of the niftiest aspects of cryptos is that because they're not securities, holders can legally practice tax-loss harvesting. So if a crypto is going through a particularly volatile stretch, you can sell it at the bottom of a drop, register the loss, and then immediately repurchase what you just sold and ride it back up. The Wash-Sale rule doesn't apply to cryptos -- yet. However, you lose that tax-saving maneuver with an ETF.
  • Also, SEC regulations require the currently-approved Bitcoin futures ETFs only hold up to 85% of the fund's net asset value in Bitcoin instruments. The balance has to be in another dilutive asset, allowing you to diversify your investment beyond just crypto.

The SEC did us a favor

Ultimately, there are much better ways to dip your toes into crypto with easy-to-use, consumer-friendly choices such as PayPal or Coinbase. The irony of the SEC's decision to reject the Bitcoin spot ETF is completely consistent and aligned with Bitcoin's ethos and founding principles. Bitcoin was created to remove expense ratios, commissions, hidden fees, and in-betweeners from financial transactions -- not inject them into the crypto purchasing process. So a hearty "thank you" in response to the SEC's most recent ETF thumbs down.

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