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Bitcoin ETN– the latest “long-form”money-making initiative, but you had better understand what’s a Bitcoin Exchange-Traded Note and be wide awake when you take this one on.

There are numerous methods of “passive income earning.” Contrary to belief, this does not mean letting the machine do the work, while you take a back seat.  It does require you to take an active role in getting the best product and method.

What is an ETN and how is it different to ETF?

You can be excused for not knowing the difference: the SEC recently had an issue with this.

Both ETFs and ETNs are traded securities. This means that they can be bought and sold on the market trading platforms. An ETF (exchange-traded fund) is a registered investment “FUND.” This means that an investor has ownership of part of a more extensive portfolio of assets. The investor receives a published asset value or intraday indicative at 15-second intervals throughout the daily trading period. The ETF redeems, or issues share units at their net asset value in real time daily trading. This ownership is the fundamental difference between ETNs and ETFs.

Given that ETNs issued, based on long trade or buying with the expectation that the price will go higher and profit forecast (realized) over a specified time, the risk involved gets taken up by the investor and faith in the product.

This places ETN holders at risk because their value is subject to the “creditworthiness” of the investment vehicle. What this means is that ETNs (Exchange Traded Notes) differ in that they are underlying monetary mechanisms or derivative contracts, issued against a direct investment by the issuer.

ETN Rule of Thumb

ETNs linked to the price of something (Bitcoin cryptocurrency). The issuer makes available Bitcoin ETN based on a particular formula over a specified period, during which, the value of the investment is predicted to increase as the Bitcoin price rises. However, the reverse is also true, and there is no option to pull the stake while the price is in crash mode.

The dissimilarity between ETN and ETF in the underlying: ETF track (underlying) commodities indices and ETN’s track non-commodity underlying. ETNs are therefore securities without maturity. The vehicle trader, generally with high international financial standing will issue investment trades in underlying derivative contracts in both primary and secondary markets.

The price of the ETN linked to the performance of an underlying index, where it passively tracks the movement of the underlying. What this means is that an ETN is a financial securities derivative issued by a company with the intention of mirroring currency, equity, and rate indices.

Primary Market: daily buy and sale of securities are approved ETN value.

Secondary Market: the (Stock) Exchange “Trading Book” determines price according to best ask and bid orders.

Are ETN’s derivatives?

The uninterrupted trading on the ETFPLUS Market, which is showing record levels of liquidity, makes it easier and more transparent for investors to access untracked indices and underlying.

Direct access by the issuing company to the underlying market enables the ETNs to track various indices, such as currency, bonds, equity, in their “real-time” performance(with leverage). This means that investors have immediate awareness of the underlying derivatives and their exposure to a “long” position.

Volatility Risk

The Volatility Index (VIX) shows market sentiment: Fear or Optimism reverses the course of the indicators.

VIX has not worked well in ETNs. Financial commentators have likened the market blow out experiences to being like a casino on steroids, where volatility linked ETN derivatives have lost over 90% of their value since they launched.  This is one area where investors have to stay “on point,” especially if they invested in ETNs that have a volatility link. Earlier this year, Credit Suisse shut down and pulled out of a volatility-linked ETN offering when things became too dynamic to pick up the pieces.

Does ETN Pay Interest?

Short answer; NO!

Investopedia: “ETNs are structured products that are issued as senior debt notes, while ETFs represent a stake in an underlying commodity. ETNs are more like bonds in that they are unsecured. ETFs provide investments into a fund that holds the assets it tracks, like stocks, bonds or gold.”

Given that ETNs are unsecured debt obligations, they are very different from corporate securities (commodities). Traditionally, institutions pay a stated interest rate on any financial returns. However, the way ETNs are structured, their financial gain (or loss!) is based on performance. This means that a benchmark or reference index quoted for the investment period, where the profit basis is on the expected gain – minus any investment fees (in the region of 2.50%).

ETN holders generally get no interest on their investment. The money made is in the expected financial gain of the market; payments on ETNs offer leveraged exposure to multiple underlying, in the emerging market of cryptocurrencies, linked to the benchmark based indexes tied in with other industrial or financial sectors. Traditionally, ETNs are issued with 20 to 30-year maturities, which is a long way off for cryptos who are considered an emerging market.

Bitcoin ETNs

The fact that there growing interest in Bitcoin ETNs is another proof that BTC will not be dying soon.

XBT Provider Bitcoin ETN received the go-ahead from the SEC. The regulator’s approval allows investors in the United States access to the ETN tracker, which was until recently, only available to European investors. Bloomberg and Bitcoin XBT show the NASDAQ listing under the CXBTF: US market ticker.

What this means is that XBT Provider CXBTF:US buys and holds Bitcoin and investors can then purchase Bitcoin ETN as shares, giving an “indirect investment” in BTC.

What are the risks?

Digital asset trading has shown that there are inherent risks and the Bitcoin ETNs will be no less volatile.

ETNs, unsubordinated debt

Ref. NASDAQ: “Unsecured, unsubordinated debt securities that are traded on an exchange and offer returns based on the performance of a market index upon maturity. As they are issued by an underwriting bank, their value also depends on the credit rating of the issuer.”

In the case of bankruptcy or insolvency, unsubordinated debt is prioritized as the senior debt. This means that as highest-ranking debt, it would be paid out in full, before junior debt defenders. Usually, ETN issuers are large financial corporates with high credit ratings giving some financial stability comfort to investors. However, who had a crystal ball in 2008? Lehman Brothers fell with all the other banking cards, and their line of Opta ETNs went down in the blaze.

Although this 2008 collapse was a worst-case scenario, cryptocurrencies are not flameproof either as there is little in the way of physical assets to sell off if the project goes belly-up.

In closing, understand the mechanics of Exchange-traded Notes (ETNs), it will go a long way to prevent an unpleasant financial surprise.