Trading and Investing

Should You Invest in Crypto or Crypto Funds?

Published
October 5, 2020
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Most people invest their retirement savings in index or mutual funds. While many funds charge asset management fees, these costs pale in comparison to time and effort required for stock picking, allocating assets, placing trades, periodically rebalancing and everything else required to build and maintain a portfolio of individual stocks.

Let’s take a look at the differences between investing in cryptocurrencies and crypto funds, and how to decide on the best option for your portfolio.

Why Invest in Funds?

Crypto funds are an easy way to gain exposure to crypto assets. Rather than buying cryptocurrency on an exchange, investors can purchase a security in their existing brokerage account and own crypto alongside their other investments. You also don’t have to worry about the complex taxes associated with buying and selling individual cryptocurrencies.

There are two types of crypto funds:

  • Single asset funds hold a single cryptocurrency. For example, a fund may hold an amount of cryptocurrency (or crypto futures contracts) that is equal to the total market capitalization of the fund in order to provide investors with exposure.
  • Diversified funds hold a basket of cryptocurrencies weighted by market capitalization. For example, a fund may hold 80% Bitcoin since Bitcoin far outweighs other cryptocurrencies in terms of market capitalization. These allocations are typically rebalanced on a regular basis to account for differing levels of performance.

Crypto funds charge an annual fee, or expense ratio, in exchange for managing the fund. For instance, the Grayscale Bitcoin Trust (GBTC) charges a fee equal to 2% of the assets under management. An investor that holds $1,000 worth of GBTC would pay $20 per year in fees to cover the fund’s expenses in building and maintaining the portfolio.

In addition to expense ratios, investors should be aware that the price of a fund may differ from its net asset value. Most exchange-traded funds have a net asset value that closely mirrors the value of funds’ underlying assets, but some crypto funds have market prices in excess of net asset values due to the limited liquidity and other factors.

Investors should carefully consider the expense ratios and structures of crypto funds before investing in them since they can have a material impact on returns over time. For instance, if you max out your IRA every year and realize an 8% return over 30 years, a 1% expense ratio could end up costing upwards of $230,000 in opportunity cost over time.

Where to Invest in Funds

The crypto market has experienced many regulatory challenges when bringing crypto funds to market. While the SEC has thus far prevented most crypto exchange-traded funds and mutual funds, several companies have offered exposure to cryptocurrencies or blockchain-friendly companies through other methods.

Grayscale is the largest crypto fund provider with six publicly traded offerings that trade on the OTC Markets in the United States. Most of these funds aren’t registered with the SEC or any other regulatory agency, don’t use a redemption program, and are not subject to the same regulatory requirements as SEC-registered exchange-traded funds or mutual funds.

Crypto Funds

Grayscale Digital Large Cap Fund Price vs. NAV - Source: Grayscale

Grayscale’s six publicly traded funds include:

  • Grayscale Bitcoin Trust (GBTC)
  • Grayscale Bitcoin Cash Trust (BCHG)
  • Grayscale Ethereum Trust (ETHE)
  • Grayscale Ethereum Classic Trust (ETCG)
  • Grayscale Litecoin Trust (LTCN)
  • Grayscale Digital Large Cap Fund (GDLC)

In addition to these publicly traded options, the Bitwise 10 Private Index Fund provides exposure to the top ten cryptocurrencies by market capitalization with a $25,000 minimum investment and weekly liquidity. The expense ratio is around 2.5% with no performance fees.

A handful of other funds track public companies that operate in the crypto space, which provides investors with indirect exposure to the market. For example, the Amplify Transformational Data Sharing ETF (BLOK) provides exposure to companies that are planning on adopting blockchain technologies in their businesses.

Building a Portfolio

The high expense ratio associated with many crypto funds—relative to conventional funds—has led some investors to build their own crypto portfolios. While these assets cannot typically be held in conventional brokerage accounts, investors may hold them in offline cold storage in the same way that they might store physical gold or other investments.

There are several steps to build a crypto portfolio:

  1. Determine Allocation: You must determine how much cryptocurrency to purchase based on your investment thesis, risk tolerance and other factors.
  2. Select Cryptocurrencies: You must determine what cryptocurrency(ies) to invest in based on fundamentals, market capitalization or other factors.
  3. Setup a Wallet: You must set up a wallet to hold the cryptocurrencies. Typically, offline cold storage is best to maximize security.
  4. Make the Investments: You must make the investment into the wallet, and optionally, create a schedule for regular investment.
  5. Adjust Allocations: You must regularly determine if there’s a need to adjust the investment amounts or cryptocurrency allocations.

In addition to these processes, investors must ensure that they properly pay taxes on any cryptocurrency sales. Investors must record every transaction, determine the cost basis, compute the capital gain and pay the appropriate tax on the total capital gain—or deduct any capital loss from your other capital gains or up to $3,000 of ordinary income.

Crypto Funds

ZenLedger’s Crypto Tax Platform - Source: ZenLedger

ZenLedger simplifies the process by aggregating transactions across wallets and exchanges, computing the capital gain or loss and auto-populating popular IRS tax forms. In addition, the platform makes it easy to identify tax loss harvesting opportunities to help reduce your overall tax burden for the year.

The Bottom Line

Most people invest their retirement savings in funds rather than building and maintaining a portfolio of individual stocks. When building crypto exposure into a portfolio, investors can choose from holding individual cryptocurrencies and investing in a growing number of crypto funds—but there are pros and cons to consider for each approach.

If you would like to simplify your taxes, try ZenLedger today!

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