Blockchain Exchange Traded Funds

A look at the ground-breaking technology blockchain and a popular way to gain exposure to it, namely, blockchain Exchange Traded Funds.

Whilst bitcoin may be the buzzword of the past 6-12 months, it is the technology behind the controversial cryptocurrency that is beginning to shape discussions. Now, the masses are seeing that the most interesting opportunity is not in the token of exchange, but in the underlying technology that facilitates the exchange.

Blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions, but virtually everything of value. In layman’s terms, it allows digital information to be distributed but not copied. And it is this technology that forms the backbone for a new type of Internet.

With the use of blockchain no longer being seen as simply the mechanism to allow the functioning of cryptocurrencies, large firms are investing big to find other potential uses for the technology. Amongst its growing fanbase are Microsoft and IBM as well a number of other blue chip companies. In 2017, total investment in blockchain technology stood around $945 million, and is likely to continue growing.With the continued development of blockchain, firms in various sectors are finding uses for it. With banks in particular expected to realise a saving in the range of $15 billion, as the technology improves efficiency of current operating systems.

With R&D in the technology increasing, so too is the demand from investors who are looking to gain blockchain exposure. Investors in this position are not blessed with a wealth of options. An investor could directly purchase stock in a company with a blockchain arm, use an active manager investing broadly into technology or alternatively, buy a blockchain ETF. In the blockchain ETF universe there is still limited options, however, this is sure to change as more investor demand sees the potential in blockchain.

The first two, and most popular blockchain ETF’s, BLCN and BLOK managed to collect $240 million collectively in the first week of their launch in January 2017. Comparing this to $51 million, the size of the average fund launched since 2017, it is clear to see that the appetite for blockchain based investments is large.

Other blockchain ETFs include the Innovation Shares NextGen Protocol ETF (KOIN) and First Trust Indxx Innovative Transaction & Process ETF (LEGR). KOIN was launched in January 2018 and principally gives investors exposure to cryptocurrency, mining enablers, solution providers and adopters of blockchain. The fund is the first artificial intelligence driven ETF.

LEGR on the other hand is passively managed and tracks an index of global equities selected based on their exposure to the development or usage of blockchain technology.

For this article however, we shall discuss BLCN and BLOK, which were the first two ETF’s formed, and collectively hold roughly over 90% of the AUM in blockchain ETF’s.

The Reality Shares Nasdaq NexGen Economy ETF (BLCN) is a passively managed fund that tracks the performance of the Reality Shares Nasdaq Blockchain Economy Index, which is an index comprising of companies which are involved in research, development or utilisation of the blockchain technology. The index assigns a ‘blockchain score’ to each potential company stock that may be eligible. Some 50 to 100 companies with top blockchain scores subsequently qualify for the index. The BLCN ETF then replicates these stocks.

Top 10 holdings for BLCN. Source: realityshares

The Amplify Transformational Data Sharing ETF (BLOK) is an actively managed fund which aims to invest in global companies that are deriving income from data sharing related business, or are engaged in the research and development of similar technology. The fund is a actively managed fund, and has been known to hold 47% and more of its assets in its top 10 holdings which is real conviction investing.

Top 10 holdings for BLOK. Source: AmplifyETFs

What is clear is that investing in blockchain isn’t straightforward and we’ve seen it called a ‘Wild West industry’ so it’s certainly not for the faint hearted.

Nevertheless investing in blockchain via an active fund or ETF enables investors to access this fast growing segment of technology in a liquid and diversified manner.

However, there are also downsides specific to blockchain ETF’s. With the first two funds, most of their holdings are large organisations that have only a small amount of exposure to blockchain. Hence, strong performance may not necessarily be related to the performance of actual blockchain arm.

Microsoft is a good example of a company with multiple revenue streams, one of which is blockchain. This is a problem common with most blockchain ETF’s, but one, which may be amplified for these ETF’s due to the fact that the technology is so new. Nevertheless, the industry has seen an explosion in smart beta and factor ETFs in recent years and no doubt blockchain ETFs will catch up in providing investors genuine exposure to fast growing blockchain companies.

It is also interesting to note that a large amount of BLCN’s holdings can be found in State Street Corp’s Technology Select Fund, with performance between the two funds being very similar. Management fees for the State Street Corps Fund, however, are significantly lower. So one could question whether the extra fee is worth paying and are investors simply paying for the fund name?

Whilst there are drawbacks to investing in blockchain ETF’s, the growth of blockchain will continue and these funds offers investors one option to invest in this fast growing industry, whilst not requiring them to pick their own blockchain related stocks. The issue is picking the right fund and whether to select an active fund or passive strategy.

Blockchain ETF’s comply with the EU rules for investment funds, known as the UCITS Directive.

They are not covered by the Financial Services Compensation Scheme.

They are seen as a high risk investment due to their lack of diversity.

Laurence Harper