With the recent launch of several Bitcoin and Ethereum ETFs by well-known asset managers, we would expect to see similarly comparable long-term performance in terms of closely tracking the underlying asset class.
As we have researched crypto ETFs, we would draw attention to the fact that Grayscale, a pioneer in the crypto space, sponsors two ETFs that offer investors exposure to Bitcoin as well as two ETFs that offer investors exposure to Ethereum.
Before the SEC approved Bitcoin and Ethereum ETFs, Grayscale originally provided access to these digital assets through a trust structure, similar to a closed-end fund. We discussed the history of Graystone Bitcoin Trust (GBTC) here.
These original vehicles have since been converted to ETFs but retain significantly higher fees relatives to new ETFs that have been created by the manager. Based on our research, Grayscale’s “Mini Trusts” are essentially the same as the original trusts but have substantially lower fees.
(Among reasons that an investor would still use the original higher fee vehicles is that they are sitting on high unrealized capital gains and do not want to sell, or compliance issues require an institutional investor, for example, to be invested with a fund that has a long track record.)
The new lower fee ETFs managed by Grayscale are the Grayscale Bitcoin Mini Trust (BTC) and the Grayscale Ethereum Mini Trust (ETH).
Other major sponsors of Bitcoin and Ethereum ETFs include Blackrock and Fidelity. Blackrock offers the iShares Bitcoin Trust ETF (IBIT) and the iShares Ethereum Trust (ETHA), while Fidelity offers the Fidelity Wise Origin Bitcoin Fund (FBTC) and the Fidelity Ethereum Fund (FETH).
A potentially interesting distinction between the Grayscale and Blackrock products versus the Fidelity products is that Grayscale and Blackrock use Coinbase as the custodian for the funds’ crypto holdings, while Fidelity self-custodies. Self-custody means a business unit within Fidelity is responsible for providing the cold storage of the digital assets held by the funds.
Potential tax strategies
While we do not offer individual investment or tax advice, just general research and information, our understanding is that the IRS has never issued specific guidance as to whether an ETF that tracks a certain underlying index is “substantially identical” to another ETF that tracks the same or a similar index.
The question is relevant in that U.S. investors (with taxable accounts) run afoul of the “wash sale” rule when they realize capital losses in a security but then repurchase the same or a “substantially identical” security within 30 days. The wash sale rule disallows the realization of capital losses for tax purposes under those circumstances.
If an investor were to realize losses in a certain gold ETF, and then immediately purchase a different gold ETF, for example, our understanding is that such a transaction would not automatically trigger a wash sale adjustment by the brokerage firm in which the account was held. By contrast, if an account holder were to sell and then repurchase the same exact security, whether it is an ETF or a stock, the system would automatically flag it as a wash sale.
The fungibility of ETFs for gold and crypto therefore creates the opportunity for investors to realize potential capital losses while immediately being able to transfer their capital into another similar (but not substantially identical) security that offers comparable exposure.
The ability to generate capital losses (which can be carried forward to future years to the extent an investor does not have current year gains to offset) is especially relevant for high volatility investments, like crypto. High volatility investments, by definition, move up and down a lot and therefore have a higher probability of producing large, but hopefully temporary, losses.
Here is a step-by-step hypothetical example of how an investor in a highly volatile Crypto ETF could make “lemons out of lemonade” if the investment were to trade down:
(1) Buy hypothetical Crypto ETF A.
(2) If Crypto ETF A trades down significantly, say 20%, sell Crypto ETF A.
(3) Immediately use the proceeds from the sale of Crypto ETF A to buy similar (but not substantially identical) Crypto ETF B.
(4) Wait 30 days to move the capital back to Crypto ETF A or simply stay invested in Crypto ETF B. (If there are additional losses after 30 days, the investor could flip back to Crypto ETF A, or even purchase Crypto ETF C.)
The general idea here is to derive some benefit from the high volatility of crypto investments that are made in the context of a long-term buy and hold strategy. Gains could be deferred for many years.
Meanwhile, any (hopefully temporary) capital losses could be realized sooner, while the investor maintains his or her exposure to the asset class. These realized losses can then be used to reduce an investor’s overall capital gains tax liability.
These concepts can of course be applied more broadly. Again, we offer these ideas and strategies as food for thought, not investment or tax advice, and encourage readers to do their own research and/or consult with tax experts on these matters.
