The Case For and Against Investing in Crypto ETFs

Charles Schwab recently launched a new exchange-traded fund designed for retail investors who want indirect exposure to the crypto market without the direct risk of holding cryptocurrencies. The new Schwab Crypto Thematic ETF (STCE -0.94%) will invest in companies that may benefit from the development or utilization of cryptocurrencies, such as cryptocurrency mining companies and cryptocurrency exchanges. But it will not take a position in any cryptos directly.

For investors who might be wary of buying crypto now, this could be a more diversified way to get exposure to crypto during a volatile and uncertain market. The ETF tracks the Schwab Crypto Thematic Index, which is comprised of companies active in the crypto and digital asset space. However, just keep in mind that you won’t get the same upside potential that you would get from investing in cryptocurrencies directly.

What’s in the Schwab crypto ETF?

Like any standard ETF, the Charles Schwab crypto ETF blends together a large number of investments in a wide range of companies, all in the name of hedging away risk while also giving investors exposure to companies whose business model is based to a large degree on crypto. As a result, there are only a handful of companies currently in the ETF blend in which Charles Schwab has taken a larger than 5% allocation. 

In addition, there are about 30 other companies active in the crypto and digital asset space, with no allocation in any of them exceeding 5%. These include financial services firms and cryptocurrency mining stocks. But there are also some companies you might not expect, in sectors such as e-commerce.

Risk management

It is easy to see how investing in this ETF could be one way to reduce your overall risk as a crypto investor. You might love the idea that MicroStrategy, Inc. has a huge Bitcoin position on its balance sheet or that its chairman Michael Saylor is known for his extremely aggressive stance on Bitcoin. But since MicroStrategy comprises only 7.91% of the total crypto blend in the ETF, you won’t have to worry about the price of Bitcoin taking a steep dive and wiping out your investment.

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Or, if you’re having a hard time making sense of which crypto mining stock is the best investment right now, you no longer have to worry about making that call. There are a handful of different mining stocks in the current ETF composition, including Marathon Digital Holdings, Inc. and Riot Blockchain, Inc., both of which rank among the top-five holdings.

Upside potential

However, it is important to note is that you simply will not have access to the upside potential of a direct investment in cryptocurrency via this new ETF. For example, if the price of Bitcoin spikes up by 10% within a relatively short time period, it does not imply that the price of the ETF will also spike up 10% in the same time period.

This inability to track the Bitcoin market precisely was one of the concerns of the first official Bitcoin ETF, the ProShares Bitcoin Strategy ETF. When it first launched in October 2021, it attracted quite a bit of buzz because retail investors finally had a way to invest in crypto without, well, investing in crypto. Instead of buying Bitcoin directly, you bought shares in the Bitcoin ETF, which used derivatives contracts to create what can best be called “synthetic” Bitcoin. 

A fully diversified crypto portfolio?

Looking through the holdings of the Schwab crypto ETF, it appears that the only holdings that will get you anything close to heavy exposure to Bitcoin are the mining stocks. Moreover, if you are looking for ways to get exposure to other cryptos beyond Bitcoin, you would most likely need to open up an account at a cryptocurrency exchange in order to purchase them directly.

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It will be interesting to see what happens next in the crypto ETF space. There are now a growing number of crypto ETF options for investors who don’t want to get involved directly in holding cryptos. Each of them has a slightly different risk-reward profile. Once the regulatory environment becomes more favorable for crypto, one can imagine that future crypto ETFs will become even more creative in how they track overall market performance.