London Stock Exchange to launch BTC & ETH ETNs. Learn More!

Source: Freepik

The London Stock Exchange (LSE) announced its plan to launch a market for Bitcoin (BTC) and Ethereum (ETH) exchange-traded notes (ETN) on May 28, 2024.

Additionally, LSE has rolled out its strategy to accept applications for the trading of Bitcoin and Ethereum ETNs effective April 8, 2024.

Interestingly, the market will be subjected to the approval of the UK regulator – the Financial Conduct Authority (FCA).

The spokesperson from LSE has stated that the primary aim of this approach is to ensure the “maximum number of issuers to be present in the market.”

So, what are Exchange Traded Notes or ETNs? How are they different from ETFs and ETNs? Is trading with ETNs strategically sound?

Let’s find out!

Revisiting ETFs

Exchange Traded Funds or ETFs are a basket of securities that trades on exchanges similar to stocks. Hence, ETFs are just like individual stocks that can be bought and sold.

ETFs usually track the price of an asset, like gold or a basket of assets, like the S&P 500. Thus, investors can diversify their portfolios by accessing an entire pool of asset classes.

Cryptocurrency ETFs track the price performance of multiple cryptocurrencies by investing in a portfolio linked to their instruments.

If you are investing in crypto ETFs, you can tap into crypto price movements without directly involving yourself on a crypto exchange – thus removing the complexities of directly owned digital assets.

However, you must keep in mind that there are two types of crypto ETFs – spot ETFs and Futures ETFs. Spot ETFs directly hold the cryptocurrency, constructing a portfolio mirroring the performance of the digital assets it contains. Futures ETFs allow you to buy or sell crypto at a predetermined date and price.

Getting to Know ETNs

Exchange Traded Notes (ETNs) like ETFs track the index, and the returns that are paid to investors are based on the performance of the index. Moreover, just like an ETF, an ETN can also be bought or sold on an exchange.

However, ETNs do not own the underlying assets, which make them similar to investments in debt – just like bonds.

Precisely, ETNs are unsecured debt securities that track an underlying index of securities. In fact, ETNs are similar to bonds – without the requirement to pay interest.

Let’s understand it a bit more in depth!

Banks or financial institutions issue ETNs, which are more like bonds – different from the independent pool of securities. These financial institutions promise the ETN holders to pay the return on an index over a certain period of time, thus returning the principal of the investment at the time of maturity.

However, there’s a caveat!

In case such organizations go bankrupt, leading to their inability to make payments, the ETN holders could be left with a worthless investment. Thus, investing in ETNs could be a risky decision.

Differences between ETF vs. ETN

ETFs and ETNs are exchange traded securities designed to tracks the performance of underlying assets.

Nevertheless, this is merely the tip of the iceberg!

The distinctions between ETFs and ETNs are what fundamentally set these two concepts apart from each other

Let’s understand!

·       Fundamentals: ETNs are unsecured debt instruments that can track indexes or assets through forward contracts. It doesn’t own the underlying assets. ETFs own the securities that comprise the index they track.

·       Taxability: ETN investors are subjected to capital gains tax when selling shares at a profit. However, unlike ETFs, ETN holders do not need to pay interest or dividends, thus avoiding the generation of taxable income.

·       Market Risks: ETFs do not involve credit risks, thereby making them safe from market risks. However, ETFs are debt securities issued by underwriters, which makes them vulnerable to credit risks. Additionally, ETNs also carry liquidity risks, causing a wide gap between the bid and ask prices. 

·       Benchmark Performance Tracking: Unlike, ETFs there is no tracking error with ETNs. ETN issuers use options, futures, and other instruments or tools to achieve returns. The issuers promise to pay the full value of its benchmark index. 

What drives investor interest in ETNs?

Given that ETNs carry credit risks, you might wonder what makes them alluring to investors. Let’s answer your doubts!

·       Less chance for tracking errors: The issuers of ETNs promise to pay the return on an index, which implies that the ETNs should be expected to match closely with the performance of the index. Thus, this stands as a clear benefit!

·       Uniqueness: If you wonder what makes ETNs more unique, then let me give you another interesting piece of information. Some ETNs promise to deliver the returns of a particular index that are not available on an ETF framework. Therefore, investors looking for nice investments find ETNs beneficial.

·       Tax-friendly: ETNs do not distribute dividends or interest income like stock or bond funds do; therefore, most taxes are deferred and taxed as capital gains. However, the gains from foreign ETNs are taxed like ordinary income.

Why You Should Exercise Caution Dealing with ETNs?

Just like every story has two sides of narration, investment in ETNs also comes with its benefits and risks. 

·       Credit Risk: ETNs, like unsecured bonds, are based on the creditworthiness of their issuers. If the issuer defaults, ETN investors may receive a few cents or nothing at all!

·       Liquidity Risk: The trading activity for ETNs fluctuates greatly. Bid-ask spreads on ETNs with relatively limited trading volume can be extremely wide. 

Wrapping it Up!

LSE’s upcoming market for Bitcoin and Ethereum ETNs marks a significant leap towards an official endorsement of cryptocurrencies. The gradual adoption may result in the mainstream acceptance of cryptocurrencies. Hence, the announcement by LSE also mirrors the UK government’s gradual effort to position itself as a crypto-friendly hub.

You need to login in order to Like