Investment Primer: Cryptocurrency Composite

What, Why, and How of Cryptocurrency Funds

The Digital Assets – Cryptocurrency composite includes funds that provide exposure to cryptocurrencies like Bitcoin and Ethereum. The “why” for investing in this asset class is primarily for high-growth speculation and diversification. As a new and developing technology, cryptocurrencies offer the potential for significant returns, and their performance is often driven by factors different from traditional stocks and bonds, such as network adoption, technological developments, and regulatory news.

The “how” is critical, as these funds come in two fundamentally different structures, which dictate their risk and return characteristics:

Physically Held (Spot): These funds, which became available for assets like Bitcoin and Ether in 2024, purchase and hold the actual cryptocurrency in secure, institutional-grade “cold storage” with a regulated custodian. Their value is directly tied to the spot price of the underlying crypto asset.
Futures-Based: These funds do not hold the physical cryptocurrency. Instead, they invest in futures contracts—agreements to buy or sell a cryptocurrency at a predetermined price on a future date. This was the first structure approved for crypto ETFs and remains a common way to gain exposure.

Deconstructing the Cryptocurrency Fund Market

To effectively use cryptocurrency funds, it’s essential to understand the unique mechanics of each structure and the strategies they employ.

The Two Core Structures

Physically Held (Spot) ETFs: The investment case for these funds is straightforward. They aim to provide a direct, one-to-one exposure to the price of a specific cryptocurrency, less the fund’s expense ratio. By holding the asset directly, they avoid the complexities of the futures market. The primary considerations for these funds are the security and reputation of the custodian holding the assets and the fund’s ability to closely track the spot price.
Futures-Based ETFs: These funds are more complex. Because futures contracts have expiration dates, the fund must continuously sell its expiring front-month contract and buy a contract with a later expiration date. This process, known as “rolling,” is a major driver of the fund’s return, and its cost or benefit is determined by the shape of the futures curve:
- Contango: This is when the price of a longer-dated futures contract is higher than the front-month contract. In this scenario, the fund is forced to “sell low and buy high” each time it rolls, creating a performance drag known as negative roll yield. Persistent contango can cause a fund’s return to significantly underperform the spot price of the cryptocurrency over time.
- Backwardation: This is when the price of a longer-dated futures contract is lower than the front-month contract. In this scenario, the fund “sells high and buys low,” creating a performance tailwind known as positive roll yield.

Unique Strategies

Beyond the two core structures, some funds employ more complex strategies:

Tactical Rotation: Some actively managed funds use proprietary models to tactically rotate their investments between cryptocurrency futures and the safety of U.S. Treasury bonds based on market momentum signals.
Trend Following: Other rules-based funds will be fully invested in crypto futures during established uptrends but will move 100% into cash (T-bills) during established downtrends.

A Practical Guide to Locating Funds in the ETF Action Database

The cryptocurrency universe is growing rapidly. ETF Action’s classification system allows users to precisely navigate this space.

Foundational Screening: Building the Initial Universe

Step 1: Select the Database. Navigate to the ETF, Mutual Fund, or other desired database.
Step 2: Filter by Asset Class. Select Asset Class = Digital Asset.
Step 3: Filter by Composite. Select Composite = DA: Cryptocurrency.
Step 4: Filter by Segment & Group. Use these fields to drill down to a single cryptocurrency (e.g., Segment = DA: Crypto, Group = Bitcoin) or to find Multi-Asset funds.

Advanced Filtering: Refining Your Peer Group

Sub-Asset Class: This is the most critical filter for structure. Use it to isolate Physically Held funds from Derivatives (futures-based) funds.
Implementation: For futures-based funds, this filter can identify different roll strategies (Expiry: Near, Expiry: Scored). For physically held funds, it will be Specialty: Spot Price.
Brand (Issuer), AUM, Expense Ratio, Liquidity: Use these standard filters to narrow the list to viable candidates. High liquidity is particularly important in this volatile asset class.

A Framework for Evaluating Cryptocurrency Funds

Evaluating a cryptocurrency fund requires a different approach than for traditional assets. The analysis must focus on the fund’s structure, its effectiveness at tracking the desired asset, and its associated risks.

Risk/Return Analysis: The Importance of Benchmarks

The foundational step is to analyze a fund’s historical risk and return profile. ETF Action assigns a Beta Tracker to each category (e.g., IBIT for Bitcoin) to provide a relevant peer for comparison.

Total Return: How has the fund performed over various time periods compared to its benchmark and, critically, the spot price of the underlying cryptocurrency?
Standard Deviation (Volatility): Cryptocurrencies are an extremely volatile asset class. It’s important to understand a fund’s volatility relative to its peers and the broader market.
Correlation: Does the fund provide uncorrelated returns to stocks and bonds or simply act as a high beta play on technology stocks?

Quantitative Analysis:

For crypto funds, “look-through” analysis is about understanding the structure of the exposure.

For Physically Held Funds: The analysis is straightforward. The key is to measure the fund’s tracking error relative to the spot price of the cryptocurrency. A well-run fund should closely track the spot price, with the only deviation being its expense ratio.
For Futures-Based Funds: The analysis is more complex. The goal is to assess how effectively the fund’s roll strategy has managed the impact of contango and backwardation. Comparing the fund’s long-term return to the spot price of the cryptocurrency can reveal the extent of the performance drag (or lift) from roll yield.

Qualitative Analysis?

Analyzing cryptocurrency qualitatively blends technology, economics, and powerful narratives. This makes the asset a bit of a Rorschach test; what you see is a reflection of your own research and conviction. The interpretation is yours.

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