Oct 21 | 4 min read
While Canadians claim the title of first Bitcoin ETF globally, and similar products have come online in countries like Brazil and Dubai, the approval in the U.S. market has long been sought-after and is a major milestone. In this article, we’ll dig into the details of this now-famous Bitcoin ETF and weigh the pros vs cons.
While the ProShares Bitcoin ETF was first to market, it’s worth mentioning there are going to be many ETFs launching over the coming days, weeks, and months from a variety of financial institutions. This wave of ETFs will all have one thing in common: they’ll be structured as futures-based ETFs. That means instead of owning shares backed by Bitcoin, which is how a spot-based ETF would work, the shares will represent a bundle of contracts to buy Bitcoin in the future. The futures ETF will continuously trade futures contracts to keep them rolling month to month.
Futures ETFs give investors access to certain assets without the hassle of rollovers, expirations, multiple fees, basket-pricing, and headaches related to contract trading. But due to their structure, they often have tracking errors compared to the price of the underlying asset. There are two types of tracking errors:
Contango: when the futures price is higher than the spot price (the current market price)
Backwardation: when the futures price is lower than the spot price
The net result is that futures ETFs are very likely to underperform their underlying asset over the long term. In a case study, we can compare the commodity price of gold in orange to the most popular gold future ETF ($GLD) in blue, over the past 10 years.
Gold commodity ($GOLD) in orange; Gold futures ETF ($GLD) in blue
While the performance deviation starts small, mathematically it’s likely to widen over time. A roughly 5% difference might not seem significant, but that is nearly one-third of the total return being lost due to tracking error. This illustrates the importance of understanding the product structure for any financial product that attempts to track the price of an underlying asset.
At a conference in late September, Gary Gensler, chairman of the U.S. Securities and Exchange Commission (SEC), stated his support for bitcoin futures. He noted that a handful of mutual funds already invest in bitcoin futures and cited a 1940 law that provides “significant investor protection” for mutual funds and ETFs. His belief is that spot markets are more susceptible to manipulation.
It’s worth noting that the futures market itself is regulated by the Commodities Futures Trading Commission (CFTC), not the SEC. But because the ETF is a wrapper vehicle for those futures contracts, it’s deemed a security and under the purview of the SEC.
The ProShares ETF charges 0.95% in annual fees. So if you buy $1,000 in shares, $9.50 a year will go to fees. While that’s higher than what most regular ETFs charge, this is largely due to being a futures-based ETF, which incurs higher operating costs.
Given the tracking error, long-term investors should most likely look for other options such as purchasing Bitcoin directly or consider on-chain crypto indexes such as $BED from Index Coop (shameless plug). But for short-term investors and traders, the new Bitcoin ETF will be a suitable product. It’s expected to be one of the most liquid crypto vehicles, given it’s trading on a major U.S. stock exchange, and that was demonstrated on its first day of trading with $BITO doing over $1 billion in total volume.
While the futures-based ETF may not be the ETF product the broader crypto industry was hoping for, it’s still a significant step forward. And some will view it as a stepping stone to the elusive spot-based ETF. Just don’t hold your breath as it’s been 8 years and counting thus far. It also seemingly opens the door for other cryptocurrencies, such as Ether, which already have futures markets to get their shot at a futures-based ETF.
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