The Bitcoin Futures ETF
A crypto-exchange traded fund, the ProShares Bitcoin Strategy ETF (BITO) was launched in 2022. Another bitcoin ETF, the Valkyrie Bitcoin Strategy ETF (BTF) was also launched in the same year.
The bitcoin futures ETF, such as the one that has started trading in 2022 tracks the price of CME’s bitcoin futures rather than the price of bitcoin directly. The ProShares ETF as such buys bitcoin futures contracts rather than the cryptocurrency itself. A physical bitcoin ETF would track the underlying cryptocurrency’s price. ProShares claims its fund offers speculators and investors a way to gain exposure to bitcoin. To achieve and retain that exposure, ProShares utilises investors’ cash from ETF purchases and uses some of it to buy bitcoin futures, mainly the closest month’s futures contract, as that normally gives the closest correlation to the cryptocurrency’s spot price.
This is when it gets tricky since when a contract expires the exchange traded fund has to roll its current contracts into next month’s Other market speculators are aware of this so they buy the next month’s futures ahead of this which puts upward pressure to the price and permits traders to profit by selling into into the demand created when the fund rolls. The higher price that the fund pays comes out of investors’ pockets.
It can cost you a lot of money to roll your bitcoin futures. There’s an element of traders taking advantage of it, and an investor potentially losing out.
The ProShares Bitcoin Strategy ETF has a 0.95% annual fee, but the main cost comes from the futures being more expensive than bitcoin. The ETF buys them a month ahead, but they fall in price as they approach maturity, so it makes a loss, known as the roll cost. While there may not be a huge difference in returns in the short term, the returns might diverge by a few percentage points over the course of a year. Still bitcoin futures ETFs are likely the only crypto ETF products to launch in the U.S. at the moment. Securities and Exchange Commission Chair Gary Gensler has expressed a preference for futures ETFs due to the investor protections outlined by the law that governs these ETFs.
There are structural problems with a Bitcoin futures ETF. They may purchase futures contracts trading at a premium to cash Bitcoin. If Bitcoin is trading at $60K the ETF might purchase one month futures trading at $61K. If Bitcoin rose to $70K at the end of one month and the futures settle at $70K at maturity, Bitcoin cash would have gained 16.7% versus 14.8% for the futures. While cash outgaining futures by 1.9% does not seem like much, the underperformance would annualize at about 23%. This was observed with USO (the oil ETF) which buys futures contracts. USO underperformed Crude Light (Cash) by just 6% over 1 year, by 86% over 2 years and 100% over 5 years.
Bitcoin futures open positions total about $22 billion. If the new ETFs were to buy $5 billion of futures, the 22% increase in open interest could result in elevated premiums of futures over cash. The result might be that the ETFs fail to deliver anywhere near the returns on a Bitcoin investment that investors hope for.
This sort of longer term performance can’t be avoided in a futures based ETF. The Achilles’ heel of a futures-based ETF is that the fund needs to take large positions in near-term futures and frequently “roll” them into the following month, rather than taking cash at expiration. In the past year, the annualized roll yield on bitcoin futures—highlighting the gap between the front-month futures and bitcoin’s price—has averaged 8.4%. What this means in real terms is that an investor in a futures ETF would net $91.60 annually before fees for every $100 in gains made by bitcoin. This has discouraged other ETF issuers from issuing more bitcoin futures funds due to capacity issues.
Unlike USO, the funds run by ProShares and Valkyrie are both actively managed, giving fund managers greater latitude and potentially limiting the impact of the front-running trades. Still, both ETFs publish their daily holdings, just like USO and most other ETFs, allowing traders a clear line of sight into how they are positioned. “It’s like poker,” said Mr. Koutoulas of Typhon Capital Management. “You lose an edge when the whole market knows your position.”
I guess some people want to gamble on very shorter term bitcoin moves, and hope they guess right on the volatility. I know I sure can’t.
But if one wants to buy and hold, maybe dollar cost average into (and maybe trim some profits from time to time in a nontaxable IRA) they should run from this new ETF and go with GBTC (Grayscale Bitcoin Trust established by Digital Currency Group Inc) until an ETF is approved that holds the actual commodity. GBTC is trading at a big discount (36% discount currently) relative to the price of the bitcoins it held on Friday, according to YCharts. The trust charges a 2% annual fee and pocketed investor fees of $615 million in 2021. Assets it manages have dropped to $12.3 billion from over $40 billion in 2021, reducing the fees it can collect.
There is no question, especially at the ridiculous 15-20% discount presently, that GBTC is a far better alternative for anyone wanting to hold some bitcoin in a traditional brokerage account. The 2% expense ratio compared to basically 1% for the futures ETF is meaningless if one is bullish.
- USO is a great example of the disaster that these futures-based ETFs are for the longer term. Look at the 5-year performance.
- USO down 37.82%
- Oil up 61%
This has happened before with other futures markets. One very popular exchange traded fund trading in the USA is USO which follows the oil market. The ETF is so big that it controls a sizable portion of the most active oil futures contracts. Even if that market is a lot more liquid than the futures market for bitcoin, oil speculators regularly queued to buy the next-month futures contract before USO could and this increased the costs that the oil ETF fund paid for its futures and reduced returns for the fund’s investors. This practice is referred to as front-running. Over the last 10 years, USO has almost lost 80% of its value, while crude-oil prices have whipsawed up and down but ended essentially where they started.
Bitcoin is a cryptocurrency; it’s easy to buy and, for individuals who want to speculate on its future value, easy to hold. All you have to do is download some software, choose a good password, sign up to a crypto broker, transfer the bitcoin into your blockchain wallet and you’re done. If you wanted a traditional currency you wouldn’t pay a 0.95% annual fee, plus sizable futures costs, to get something that roughly tracks the value of a dollar—you’d just hold some dollars. The only problem with this is that unless you store the Bitcoin in a cold wallet, you’ll have the risk of the Bitcoin balance resting with an unregulated exchange. The new ETFs sidestep the trust problem by buying bitcoin futures instead of bitcoin, introducing a new layer of gambling and arbitrage.
