Crypto for Advisors: Bitcoin ETF vs Direct Ownership

The arrival of spot bitcoin ETFs in the US has driven a lot of interest and inflows, especially from institutions. As client interest grows, advisors are hearing more questions from their clients about whether they should own the underlying asset directly or if ETF ownership is suitable for them. D.J. Windle, founder and portfolio manager of Windle Wealth, created the “advisors guide” to help navigate these questions.

Miguel Kudry, CEO of L1 Advisors, answers questions about ETH ETFs. Will they be the same or different?

–S.M.

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As digital assets continue to gain traction, financial advisors are increasingly encountering questions from clients about the best ways to invest in bitcoin. Two primary options dominate the conversation: investing in a spot bitcoin Exchange-Traded Fund (ETF) and buying bitcoin directly. This article aims to provide financial advisors with a detailed comparison of these investment vehicles, addressing key aspects such as management, custody, trading, and tax implications to inform both advisors and their clients better.

Bitcoin ETF

A spot bitcoin ETF is managed by professional fund managers who handle the buying, selling and custody of bitcoin, simplifying the investment process for investors who may be unfamiliar with the technical aspects of cryptocurrencies. This professional management reduces the burden on investors but comes with management fees that can reduce overall returns over time. Additionally, investors do not have control over the underlying bitcoin, as decisions are made by the fund managers.

Direct Bitcoin Ownership

When clients buy bitcoin directly, they own the cryptocurrency outright, providing a level of control and flexibility that ETFs cannot match. Direct ownership eliminates the need for paying ongoing management fees, but investors must manage their own purchases, sales, and custody, which can be complex and time-consuming. Mismanagement can lead to significant losses, especially for inexperienced investors as managing bitcoin holdings can require specialized knowledge.

Bitcoin ETF

ETFs typically utilize institutional-grade custody solutions provided by third-party custodians, which often employ advanced security measures such as cold storage and multi-signature wallets. This reduces the risk of theft and loss, but investors rely on third-party custodians, introducing counterparty risk. Advisors and their clients also do not have direct control over the custody arrangements, which can be a concern for those who prioritize control.

Direct Bitcoin Ownership

Direct bitcoin ownership requires investors to manage their own custody solutions, ranging from using digital wallets to storing private keys. This offers greater control but also increased responsibility for securing the assets. Poor security practices or lost private keys can result in irreversible loss of funds. Advisors should educate clients on best practices for protecting their Bitcoin, such as using hardware wallets and enabling two-factor authentication.

Bitcoin ETF

Bitcoin ETFs are traded on major stock exchanges, providing high liquidity and ease of trading during regular market hours. This regulated market offers additional investor protections. However, trading is limited to stock exchange hours, unlike the 24/7 crypto market. Markets often move a lot outside of traditional exchange hours and advisors or clients wouldn’t be able to do anything about it. Also, ETF shares may trade at a premium or discount to the net asset value (NAV) of the underlying bitcoin.

Direct Bitcoin Ownership

Bitcoin can be bought and sold on various cryptocurrency exchanges, providing access to a global market that operates 24/7. This offers high liquidity, and investors buy and sell at market prices without premiums or discounts. However, the liquidity and trading experience can vary significantly across different exchanges, and some may charge higher fees for transactions and withdrawals. For advisors, many may not want to manage client funds with a trading day that is 24/7. That puts a large responsibility to ensure you are paying attention when you may otherwise not be.

Bitcoin ETF

Investing in a bitcoin ETF can have different tax implications compared to holding bitcoin directly. ETFs may offer more straightforward tax reporting, as they are treated like other securities. This can simplify tax reporting for investors, and certain ETFs may offer structures that provide tax advantages, such as deferring capital gains taxes. However, selling ETF shares may incur capital gains taxes, which can impact overall returns.

Direct Bitcoin Ownership

Holding bitcoin directly involves different tax considerations, particularly around capital gains and losses. The tax treatment can be complex and time-consuming, with specific rules on reporting and calculation. Direct ownership allows investors to manage their capital gains and losses directly, potentially optimizing their tax strategies. However, tax reporting can be complex and burdensome, requiring careful compliance and often the consultation of a tax professional and/or software to track the transactions. Advisors may need to work closely with tax professionals to ensure compliance and optimize tax outcomes.

For clients seeking direct bitcoin ownership without the complexities of self-management, institutional platforms through advisors who manage crypto offer a viable alternative and potentially the best of both worlds. These platforms provide professional management, similar to ETFs, but with the added benefit of direct ownership. Holding bitcoin in many different account types, such as a Trust, IRA, and Corporate Account, can make estate and tax planning a bit easier with more flexibility in account types that are a little harder to access when owning the individual coins on a hard wallet. However, this convenience comes at a cost, as these institutions often charge cold storage fees to secure the bitcoin holdings in offline wallets, adding an extra layer of security but also increasing overall costs.

Choosing between a spot bitcoin ETF and buying bitcoin directly involves weighing the pros and cons of each method. Financial advisors should help the client decide what is most important to them when it comes to their exposure to bitcoin. And often, it boils down to just that: exposure.

For some clients, exposure is enough, in which case the ETF may be the best option. It’s quick and easy to grab that exposure. For others, having direct ownership of these assets may be of utmost importance, in which case the advisor should help the client decide if they have the knowledge to handle self-custody or if paying for institutional custody and all its benefits is in their best interest.

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

Q: What are some key differences between the bitcoin and ether ETFs, and how they differ from owning the underlying asset?

In both cases, owning the underlying asset enables full portability, 24/7 liquidity, and the ability to do things on Bitcoin or Ethereum crypto rails (namely global payments, Decentralized Finance, and more). However, the ETH ETF now introduces a key aspect that advisors should consider. Unlike bitcoin, ether can become a yield-bearing asset by staking it to help secure the Ethereum network. It is very unlikely that the first ETH ETFs offer any staking rewards to investors for a number of regulatory and operational reasons of the issuers. Today, owning and holding ether directly (and for that matter, any other yield-bearing digital asset) is the only way to access these staking rewards, so advisors should consider this when talking to clients about Ether. These staking rewards become income-generating opportunities that investors with considerable ETH exposure should, at the very least, consider, or at the very least, understand that they are leaving on the table if they only hold the asset in ETF form.

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

Custody is not a one-size-fits-all solution. In TradFi, advisors typically work with more than one custodian to address their firm's and client's full needs. Digital asset custody is even more nuanced, and advisors would do well to adopt a hybrid approach to custody options. Different custody options cater to different investor profiles. Some clients may have higher exposure to digital assets than others. Some may be already self-custody and want to incorporate those into their financial planning or advisory relationship. Others may want exposure through direct ownership via a qualified custody solution. For others, spot ETFs and other publicly traded vehicles may offer enough exposure. Advisors should also be prepared to support their client’s evolving needs and interests. The price volatility and performance of digital assets usually makes investors lean in and become more educated. Oftentimes, it also makes them prone to adopt new forms of custody as their level of sophistication, risk appetite, and overall knowledge of the space increase.

Q: Unlike bitcoin (BTC), ether (ETH) can be staked to help secure the Ethereum network and generate income from staking rewards. Do custody options impact an investor’s ability to access such rewards?

Advisors should be aware that the custody or investment vehicle used to own or invest in ETH very much impacts an investor’s ability to generate rewards from staking or the net fees they keep in their wallets. Spot ether ETF applicants ditched all staking language from their S-1 filings, meaning that ETH ETF investors will not see any rewards from staking. Qualified custodians effectively operate as walled gardens when it comes to staking. Some offer staking solutions by running their own staking infrastructure and operating the staking programs on behalf of investors who can opt-in to stake their ETH and typically pay the custodian or the staking operator a percentage of rewards. Self-custody enables investors to access a wide range of staking solutions that can be custodial or non-custodial, depending on whether they send their ETH to a third party to be staked or they sign transactions on-chain to stake ETH or mint any of the so-called Liquid Staking Tokens.

- Miguel Kudry, CEO, L1 Advisors Inc.

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.