Navigating Cryptocurrency Investments in Europe and the UK for Institutional Investors

In the rapidly evolving world of financial markets, institutional and professional investors alike are exploring how to invest in cryptocurrencies(crypto) in the UK. Exchange-Traded Funds (ETFs), Exchange-Traded Notes (ETNs), and Exchange-Traded Products (ETPs) have garnered attention for their unique structures, regulatory implications, and their role in portfolio diversification, especially in the context of cryptocurrencies. Here, we unpack the intricacies of these products, so that you can understand the key comparisons between each including their risks and opportunities.

Understanding ETFs, ETNs, and ETPs

At their core, ETFs, ETNs, and ETPs provide exposure to a variety of assets, but they do so in distinctly different ways.

• ETFs are investment funds traded on stock exchanges. An ETF holds assets such as stocks, commodities, or bonds and generally operates with an arbitrage mechanism designed to keep its trading close to its net asset value, though deviations can occur.
• ETNs, on the other hand, are unsecured debt securities, typically issued by an underwriting bank. Similar to bonds, ETNs have a maturity date and are backed only by the creditworthiness of the issuer. They do not own underlying assets, but promise to pay a return based on the performance of a market index or other benchmark.
• ETPs encompass a broader category that includes both ETFs and ETNs. ETPs can be structured as notes issued by banks (bank-issued ETPs) or set up through a Special Purpose Vehicle (SPV) to mitigate risk by isolating the investment from the issuer's balance sheet. SPV’s are the main way for most European(EU) crypto ETP’s to be issued.

Key differences and risks

When it comes to ownership, ETF investors hold a share of the underlying assets, providing direct exposure to the performance of the asset pool. ETNs, being debt instruments, expose investors to the credit risk of the issuer without actual ownership of the underlying assets. ETPs issued via an SPV are designed to reduce credit risk, focusing on the operational integrity of the SPV. EU ETP vehicles are usually structured with a 3rd party trustee appointed to step in to protect the interests of note holders, where a probable declared or actual event occurs. Crypto ETPs normally hold the direct underlying Crypto on a “Delta 1” basis in a 3rd party regulated custody, with no leverage or usage of derivatives.

The regulatory landscape for these products also varies significantly. In the UK, ETPs are mandated by legislation by UK authorities under frameworks like the Financial Services and Markets Act (FSMA). This contrasts with the evolving regulations within Europe, Markets in Financial Instruments Directive (I & II), and also the potential influence of Markets in Crypto-Assets (MiCAR), parts of which are shortly coming into force.

Institutional investment considerations

For institutions considering these investment vehicles, especially in the context of cryptocurrencies, there are three key factors to consider.

1. Regulatory compliance: Navigating the regulatory environment is crucial, as compliance can significantly impact the viability and security of investments in these products.
2. Market and credit risk: Understanding the differences in exposure to market volatility and issuer credit risk between ETFs, ETNs, and ETPs is vital. This understanding helps in aligning investment choices with the institution's risk tolerance and investment strategy.
3. Liquidity and market access: ETFs typically offer greater liquidity and simpler access to various market sectors compared to ETNs and ETPs, which may target more niche or complex investments.

What are the pros and cons for institutional investors?

• ETFs generally offer high liquidity and are generally considered safer due to their structure and regulatory standards. They are less suited for exposure to bespoke or more niche markets.
• ETNs offer exposure to a wide array of assets, including hard-to-access markets. However, they carry the issuer's credit risk, which can be a critical drawback during financial instabilities.
• ETPs, particularly those structured through SPVs, provide a balance by offering exposure to niche markets while mitigating issuer-related credit risks. However, they can be complex and less transparent compared to ETFs. Generally within the current UK & EU offerings, ETP’s are structured as straightforward exposure via the custody of the underlying on a 1 to 1 basis. These structures are without the use of leverage or derivatives (each ETP Issuer Base Prospectus will outline the structural risks clearly pursuant to UK & EU Prospectus regime).

How to invest in cryptocurrency in the UK with ETFs, ETNs, and ETPs

Institutional and professional investor interest in cryptocurrencies has necessitated adaptations in these instruments. ETFs with direct crypto exposure in the UK & EU are still in development due to regulatory hurdles. We expect that as the US will normalise its regulatory relationship with Crypto, the environment in the UK and EU will similarly normalise, with MiCAR being a material step forward, though its fractured implementation may be a drag on development. ETPs on the other hand, have emerged as a popular vehicle for institutional and professional crypto investments in the UK and Europe. Further, ETPs provide a structured product note approach to handling digital assets without the operational complexities of direct handling, like wallet management.

Says Keith O’Callaghan, CEO Archax Capital: “By investing in ETP’s professional and institutional investors gain exposure to crypto in a structured, bankruptcy-remote and compliant manner.

Investing in crypto in Europe and the UK: Institutional and high-net-worth paths

For institutions and high-net-worth individuals in the UK, navigating the cryptocurrency investment landscape requires a strategic approach that balances accessibility, regulatory compliance, and risk management. One of the most effective ways to invest in cryptocurrencies without the complexities of direct ownership — like wallet management and direct trading — is through Exchange-Traded Products (ETPs).

Archax specialises in providing a range of ETPs that are tailored to meet the needs of institutional and professional investors. These ETPs are designed to be bankruptcy remote by utilising Special Purpose Vehicles (SPVs) that isolate investment risks from the issuer's financial health. This structure significantly reduces the counterparty risk typically associated with direct cryptocurrency investments. For investors who are concerned about direct exposure to the volatile crypto market, ETPs offered by Archax present a prudent option. They facilitate investment in digital assets while providing the security and oversight that come with traditional financial market practices.

Furthermore, Archax's and the Issuers compliance with UK & EU regulations aims to ensure that all offered products are in line with current UK & EU financial and crypto-regulatory frameworks. Archax looks to offer a seamless and reliable platform for high-net-worth individuals and institutions looking to explore the burgeoning field of digital assets.

This method of investing not only adheres to stringent regulatory standards, it also offers the convenience and familiarity of traditional securities trading. As such, ETPs are an attractive option for those looking to diversify into cryptocurrencies without dealing with the operational complexities of the crypto market directly.

Final thoughts

As the landscape of financial instruments continues to adapt to new market realities(including the integration of cryptocurrencies), institutional investors are tasked with thoroughly understanding these instruments' structures, risks, and regulatory implications. ETFs, ETNs, and ETPs each offer distinct advantages and challenges, making them suitable for different investment strategies and risk profiles.

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