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 of a certain market – such as the terra market.
So, when terra sees a 35% increase in value, a successful ETF or ETN will then also see a 35% increase in value.
The difference between ETFs and ETNs
An ETF owns the stocks it tries to follow. That means that when you invest in a terra ETF, you’re investing in a fund that also owns terra. An ETN doesn’t own the stocks it tries to follow. An ETN works similarly to a bond of debt. If you purchase a terra ETN, the issuer of the ETN will then be indebted to you. The debt is then of the same value as the rise in value there has been on the market the ETN follows.
You buy your way into an ETN who follows terra. Let’s say you invest 100 DKK.
Between March and September, the value of terra goes up 60% - that’s why the ETN now owes you 60% of your investment, equal to 160 DKK.
But since these are bonds of debt, where there’s no real ownership over actual assets, you could risk that the issuer goes bankrupt. This would mean that you could lose all the money you’ve invested.
With an ETF, the situation would rarely go this sideways. Because the ETF actually owns the assets - such as terra - the ETF can then choose to sell their terra coins, in order to raise capital to pay back their investors.
On the other hand, one of the big advantages of an ETN is that they typically have a lower tracking error.
Tracking error covers how well a fund manages to follow a certain index.
If terra increases by 60% and delivers 60% to the fund, there’s a 0% tracking error.
If terra increases by 70% and delivers 40% to the fund, there’s a -30% tracking error.
A -30% tracking error could happen because the fund chose to invest a little more or a little less in a certain asset in the index.
You’re investing money in an ETF who follows the index of cryptocurrencies. The index is made up of an array of different cryptocurrencies - but the ETF then chooses to bet a bit more on bitcoin, than what the index is actually made up of.
Let’s say that the crypto index consists of 60% bitcoin , 30% ethereum and 10% terra . That’s the actual diversification of assets across the index.
Your ETF chooses to go a different route when it comes to investment strategies. The board has their faith set on bitcoin, which is why they choose to weigh their inventory with 70% bitcoin, 20% ethereum and 10% terra.
If there then is a period, where bitcoin is doing badly compared to ethereum and terra, it would result in a tracking error.
On the other hand, bitcoin could turn out to do significantly better than the other coins, and then you’re benefiting from a positive tracking error through your ETF.
With ETNs there’s rarely any tracking errors. This is because the ETN doesn’t invest in actual assets. It’s more like a promise that they will pay out the rate developments in a certain index.
The concrete promise would be described in more detail in the ETN’s prospect. Here, you also need to remember the running costs and fees which are connected to both ETFs and ETNs.
There are pros and cons to both types of funds, which you need to consider before you invest.