What are ETFs and ETNs?
ETF stands for Exchange Traded Fund, while ETN stands for Exchange Traded Note. Both types try to follow the rate developments on a certain market - such as the dogecoin market.
When dogecoin goes up 33.233% in value , a successful ETF or ETN will also go up by 33,233%.
The difference between ETFs and ETNs
An ETF owns the stocks or assets it’s trying to follow. If you invest in a dogecoin ETF it would be in a fund, who also owns dogecoins. An ETN on the other hand doesn’t own the stocks or assets it’s trying to follow. An ETN works more like a bond of debt. If you purchase a dogecoin ETN, the issuer of the ETN will then be indebted to you. The debt is of the same value as the increase in value there’s been on the followed market.
You buy your way into an ETN, who follow dogecoin. Let’s say you invest 100 DKK.
Between April and November, dogecoin’s value increases by 80% - and thus the ETN owes you 80% of your investment, which is equivalent to 180 DKK.
But because these are bonds of debt, where there’s no real ownership over actual assets, you could risk losing your entire investment, if the ETN goes bankrupt.
With an ETF, it would rarely go this sideways. The ETF actually owns the assets - such as dogecoins - and can then choose to sell them in order to get capital to pay back you and the other investors.
On the other hand, one of the advantages with ETNs are, that they typically have a lower tracking error. Tracking error covers how well a fund manages to follow a certain index. If dogecoin increases by 85% and delivers the fund 85%, there’s a tracking error of 0%.
If dogecoin increases by 85% and delivers the fund 40%, there’s a tracking error of -45%.
A tracking error of -45% can happen because the fund chose to invest a little more or a little less in a certain asset in their index.
Let’s say you buy your way into an ETF, which tries to follow the overall rate development for the most popular cryptocurrencies . For the sake of simplicity, let’s say that the most popular cryptocurrencies are bitcoin , ethereum and dogecoin - making it the rate developments for these three cryptocurrencies, that the ETF must follow.
If we take a closer look at the distribution of the collective market value for the three cryptos, we see that bitcoin makes up the majority of the value, then ethereum, and lastly dogecoin.
For instance, a distribution could look like this:
Bitcoin: 100,000 DKK
Ethereum: 70,000 DKK
Dogecoin: 30,000 DKK
Collective value: 200,000 DKK.
This means that bitcoin makes up 50%, ethereum 35%, and dogecoin 15%. A tracking error could then arise, if the ETF has weighed it’s investments differently than the actual distribution.
For example, the ETF could choose to wager a bit more on bitcoin. Like that, the ETF’s distribution could then be 70% on bitcoin, 20% ethereum and 10% dogecoin, for instance.
If bitcoin is performing poorly through a period of time, while ethereum and dogecoin is performing relatively well, a difference between the exchange rate developments will arise on the actual market and for the ETF.
The opposite could also be the case, where the EFF manages to beat the market. Here, we see a positive tracking error.
With the ETN, tracking errors are a rare occurrence. This is because the ETN, as mentioned before, doesn’t invest in actual assets. It’s more like a promise that they will pay out the rate development seen in a certain index. The concrete promise will be described in more detail in the ETN’s prospect. Here, you need to remember the running costs and fees which are connected to both ETFs and ETNs.
There are pros and cons with both types of funds, which you need to be aware of before you invest.