Bitcoin futures exchange-traded funds (ETFs) have arrived, with the Securities and Exchange Commission (SEC) giving the green light for the ProShares’ Bitcoin Strategy ETF (BITO), and several others expected to follow suit.
Should you buy these?
The short answer is no because there are superior alternatives.
There are several ways to get exposure to bitcoin, and we’ll look at the drawbacks of a futures ETF as compared to a spot ETF.
The difference between the two is that the spot ETF holds the underlying asset in a treasury, while the futures contract adds another intermediary. Owning shares of an asset is essentially a claim on the asset in cutody, whether it’s bitcoin, ethereum, litecoin or commodities. With Spot ETFs you can redeem these shares for the asset they represent – this is typically the case with most assets traditional or otherwise.
Compared with futures ETFs – some of which could be settled in the commodity or underlying (highly unlikely) – bitcoin futures ETFs are cash settled. This means that no matter what happens, investors are not able to redeem the underlying asset – i.e. you have no claim on the actual bitcoin.
By buying a BTC futures ETF, you are a party to a contract settled in cash at a future date.
This runs contrary to the main attraction of hard assets like bitcoin, litecoin and gold – the absence of counterparty risk. You can face custodial risk, which is almost inevitable at some point, but in terms of counterparties, owning hard assets means your capital is not at risk from how others are affected by price fluctuations.
Here are four reasons why you should avoid these futures ETFs, and what you should buy instead.
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1. Counterparty risk
In the film “The Big Short”, there is a scene where the protagonists (who had been anticipating that the mortgage-backed securities market would blow up) faced a moment of sheer terror because the bank from which they shorted the market was exposed to derivatives and was insolvent. This surreal position is one instance of counterparty risk and is ultimately a testament to the downfalls of cash-settled futures ETFs.
2. Diluted Exposure
SEC regulations demand that consumer protection protocols be in place, but these have the effect of including multiple intermediaries that also need to get paid. These include the ETF provider, clearing house, futures broker, administrator, auditor, law firms, the CME and hedge funds that would take advantage of the arbitrage opportunities. On top of that, futures ETFs can only mimic exposure to bitcoin of up to 85% of their net asset value (NAV). The rest must be placed in “safer” instruments such as Treasury bills or bonds and the investor has no say in the matter.
As the settlement date approaches, contracts must be passed over to the next period, which involves closing out and opening new positions.
As those who trade perpetuals are firmly aware of, funding fees are a very real cost that you must be aware of too. The BITO ETF fund fees are 0.95%, which are added the longer a futures contract is open.
On the other hand, owning bitcoin directly, or having exposure to a spot ETF mitigates such costs entirely.
Touching on an earlier point, intermediaries and counterparty risks means that futures markets can sometimes be detached from the actual spot price. For decades, goldbugs have been shouting from the rooftops that futures do not reflect gold prices. This can become very conspicous during times of high volatility, like during the ‘#silversqueeze’ earlier this year, where silver traded at premiums north of 30% on futures markets.
But this volatility is not limited to silver. On April 20, 2020, oil futures traded in negative territory for a full day. The same is true of bitcoin perpetuals trading on semi-liquid exchanges like Bitstamp earlier this year.
This means that while futures are typically aligned with the spot market, premiums and high volatility events make it certain that this alignment is subject to major fluctuations.
What should you do instead?
Instead of bothering with futures ETFs, consider taking the plunge into crypto and setting up an account with some of the leading exchanges in the industry. Consider the relatively small learning curve as an investment into the future of finance, where you’ll be able to get exposure to both bitcoin and a growing basket of traditional assets. Some exchanges only require a simple email sign up before you can purchase bitcoin. Otherwise, wait for the Grayscale Spot-based Bitcoin ETF, which should be coming out in the next few months.
As a sophisticated investor, you can let the Bitcoin futures ETFs provide a gateway for previously inaccessible capital like pension funds, but there’s no reason for you to use the same instruments.
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