Exploring Ways to Gain Exposure to Cryptocurrency

You've researched cryptocurrency and decided to add some to your portfolio, but you're not sure how to get started. Here's what you need to know to evaluate the different ways to invest.

Direct ownership of crytpo means holding the cryptocurrency directly.  It means you own actual token on the blockchain. To own crypto directly there are few things to consider. First, you will need an exchange or payment processor that allows individuals to convert traditional fiat currency (e.g., dollars, euros, etc.) into cryptocurrencies like bitcoin and Ethereum. To start, you'll need to find one of these on-ramps to act as your entry point.

Once you've picked an exchange or payment processor, you will need to follow the basic steps of creating an account, depositing fiat currency and purchasing cryptocurrency. You'll want to keep in mind a few important considerations. First, the initial fees for direct ownership tend to be higher than for other investment methods. These fees will vary by exchange or payment processor but are generally in the range of 0.5% to 1.5% per transaction—typically higher than you'll find with other types of cryptocurrency investments; for example, some crypto ETPs charge annual fees as low as 0.25%. And please note that these higher fees would apply to any transaction thereafter—so for active traders, direct ownership may be the most expensive option, depending on trading frequency. Make sure the advantages of direct ownership (see below) are worth it given your situation.

But if you're a buy-and-hold investor, with direct ownership you won't have to pay an annual fee for someone to manage the cryptocurrency, as you potentially would with an ETP. For example, let's say you want to invest $10,000 in bitcoin. You could make a direct purchase, costing you $150 initially (assuming an exchange or payment processor fee of 1.5%), but you would have no ongoing management fees. On the other hand, if you were to purchase $10,000 in a bitcoin ETP with an annual management fee of 0.25% it would cost you $25 per year. In this scenario, the breakeven point is six years, so if you directly held the bitcoin for six years or more direct ownership would be the less-expensive option.

Security is another factor to consider. Be sure to use a trusted company with robust security measures, like two-factor authorization and secure storage for digital assets.

Holding crypto directly can be done in either a "hot" or "cold" storage wallet, if you choose to self-custody. The key distinction between these is their connection to the internet. Hot wallets are online and always connected, while cold wallets remain offline. Each has potential advantages and disadvantages. Being connected to the internet gives hot wallets the benefit of convenience and accessibility, and they are typically free to download and use. However, they are far more susceptible to cybersecurity threats like hacking or malware.

Cold wallets are generally more secure, but often involve purchasing a hardware device, making them more expensive to set up than hot wallets. These devices can also be lost or stolen, adding to security concerns. Plus, software and firmware updates are often required to access new features, a process which introduces the chance something may go wrong. Often investors find that their preferred option of direct ownership is through a combination of the two wallet types.

A key advantage of holding cryptocurrency directly is that the spot market trades 24/7, so if something happens outside market hours, over the weekend or on a holiday, you're able to react. With some other investment options, you would have to wait until regular trading hours resumed to act. 

Exchange-traded products (ETPs) can offer exposure to many different types of cryptocurrencies. If direct ownership doesn't appeal to you but you would like to invest in something that can closely track bitcoin or Ethereum prices, then ETPs may be considered by investors who have evaluated them thoroughly based on their own situation and goals.

Crypto ETPs are based on either the cryptocurrency's "spot" price (the current market price) or its nearest futures contract price (a futures contract is an agreement to buy or sell cryptocurrencies at a future date and price). Futures-based bitcoin ETPs launched several years before the Securities and Exchange Commission approved spot bitcoin ETPs, but the futures product has not been as appealing to investors for reasons including their weaker ability to track spot market prices and their relatively high management fees compared with spot crypto ETPs.

On the other hand, spot crypto ETPs offer exposure to the cryptocurrency itself, rather than trying to track its price via futures. Spot ETPs generally have lower fees compared to futures-based ETPs, as well.

ETP custodians play an important part, too. The custodians for traditional ETPs tend to be large banks, while the custodians for cryptocurrency ETPs are often trust companies managed by cryptocurrency exchanges. Investors should keep this third-party risk in mind when investing in crypto ETPs. Most of the trading in these funds happens during regular market hours, but they also can be traded during extended sessions, unlike some other bitcoin investment options.

Cryptocurrency futures and options let investors gain exposure to bitcoin and Ethereum without having to buy and hold any actual cryptocurrency in their portfolios. Futures contracts are standardized agreements to buy or sell an asset at a set price on a specific date in the future. An option offers the buyer the right, but not the obligation, to buy or sell an asset at a specific price during a certain time frame.

Futures and options can be beneficial to investors who want to establish a temporary, short-term trading position versus a buy-and-hold investment strategy. They can also be used as an instrument to "hedge" the future price of bitcoin or Ethereum against potential price drops by locking in a future selling price today. However, futures and options also pose risks, including the possibility that leverage will magnify the effects of market volatility and could cause an investor to lose more than the initial investment.

An advantage of derivatives is choice: There are many different venues, contract types, and time horizons to choose from. Another consideration is that futures and options allow investors to express either a positive or negative outlook on the future price of cryptocurrencies. They can be used to hedge future price changes and can provide exposure in a cost-effective way via the leverage inherent in them. For example, one bitcoin futures contract may have a notional value equivalent to five bitcoins; however, this can vary. To speculate on the short-term price an investor could buy $500,000 of bitcoin directly, or (assuming bitcoin trades at $100,000) buy a futures contract with $500,000 notional value ($100,000 price times five) for a fraction of the cost (e.g., 10% or $50,000).

In addition to futures and options on cryptocurrency directly, derivative contracts can also be traded on other crypto-related investments, like crypto ETPs or crypto-related stocks. As discussed below, these types of investments could be appropriate if, rather than investing in cryptocurrency directly, you'd like to speculate on the future prices of crypto-related stocks.

If direct ownership or trading futures and options doesn't make sense for you given your preferences but you still want exposure to these assets, crypto-related stocks could be a consideration for you. These stocks can come in many different flavors and can operate quite differently from each other, so it is important to understand their relationship to cryptocurrency.

Some stocks might be involved in bitcoin mining, which adds concerns like energy consumption. Mining stocks are often seen as a levered play on the price of crypto because their business model has fixed costs but variable revenue—based on crypto's price—traditionally magnifying profits during a bull run but also amplifying losses in a bear market.

Others are crypto exchanges and would give an investor exposure to cryptocurrency price volatility, with higher prices and transaction volume likely benefiting the crypto exchange. But this could also expose investors to the other cryptocurrencies listed on their platform, many considered lower quality compared to bitcoin and Ethereum. The commissions these firms charge today are also likely to come down in the future, with more entrants into the marketplace.

Still other companies are set up to be bitcoin or Ethereum treasury companies, making them almost entirely exposed to a single cryptocurrency. Investors need to aware of the differential between the cryptocurrency held on these companies' balance sheets, or the net asset value, compared to the market capitalization of the stock. While some of these businesses generate income elsewhere (software, sales, etc.) the value of cryptocurrency held on their balance sheets may reflect most (or all) of the company's value. If the market cap of the stock deviates too much from the value of the crypto held, it could be a concern.

Stocks trade (mostly) during market hours only but are easily accessible in a consolidated account view, alongside your other investments. Additionally, investors can use crypto-related stocks to express a negative outlook on cryptocurrency—for instance, such an investor could short sell the stock of a crypto-related company (i.e., borrow shares and sell them, with the hope of later buying them back at a lower price, returning them to the lender and keeping the difference). Like all these methods, there is activity and innovation happening at a rapid pace. Today's choices may not be the same tomorrow.  Investing involves risk, including loss of principal.

Investing in cryptocurrencies involves risk, including the risk of total loss of principal invested. 
Cryptocurrencies [such as bitcoin and ethereum] are highly volatile, are not backed or guaranteed by any central bank or government; are not deposits; are not FDIC insured; are not SIPC protected; and lack many of the regulations and consumer protections that legal-tender currencies and regulated securities have. Due to the high level of risk, investors should view digital currencies as a purely speculative instrument. Cryptocurrency-related products carry a substantial level of risk and are not suitable for all investors. Investments in cryptocurrencies are relatively new, highly speculative, and may be subject to extreme price volatility, illiquidity, and increased risk of loss, including your entire investment in the fund. Spot markets on which cryptocurrencies trade are relatively new and largely unregulated, and therefore, may be more exposed to fraud and security breaches than established, regulated exchanges for other financial assets or instruments. Some cryptocurrency-related products use futures contracts to attempt to duplicate the performance of an investment in cryptocurrency, which may result in unpredictable pricing, higher transaction costs, and performance that fails to track the price of the reference cryptocurrency as intended. Additional risks apply.

You probably started this article ready to invest, and as you can see, there are multiple avenues open to you and many ways to gain exposure to cryptocurrency at Schwab, including crypto-related stocks and ETPs. Your preferences, investment goals, timeline, and risk tolerance all affect whether an investment option can work for you, so take the time to carefully consider each one.

Want to learn more about specific cryptocurrency ETPs? Clients can log into their Schwab account and then Click the "Research" tab.