update 26 October 2021

The First Bitcoin ETF Is Already in Danger. Here’s Why

The first US Bitcoin ETF – The ProShares Bitcoin Strategy ETF – may prove itself popular beyond sustainability. The fund is already approaching its limit on futures contracts holdings, as enforced by the Chicago Mercantile Exchange (CME).

Bitcoin ETF: Too Popular to Handle?

Last week, data from Bloomberg indicated that ProShares’ Bitcoin ETF was holding 1900 futures contracts dated for October. This was only 100 short of the 2000 futures contract limit that the CME imposed during an ETF’s first month.

Things don’t look much better going into the next month either. Bloomberg’s market data also showed 1400 November futures contracts held by ProShares. Monthly contract limits for November and beyond are as high as 5000, with additional agreements held under more significant trading limits. At the rate things are going, November is likely to approach its contract limit soon as well.

The ProShares Bitcoin Strategy ETF (ticker: BITO) was the first and long-awaited Bitcoin ETF in the United States. After launching last week, the fund saw the second most successful opening day in New York Stock Exchange (NYSE) history. It raked $500 million in trades within an hour of opening and over $850 million by the end of the day. This number was only rivaled by a BlackRock carbon fund with pre-seed investments that raised its first-day volume.

ProShares will have to restart purchasing contracts dated for later months if monthly futures contract limits continue to break.

Nate Geraci – president of an advisory firm called “The ETF store” – explained why this is bad news for the futures market.

“The end result is the ETF will start taking on potentially significant tracking error versus the spot price of Bitcoin. The ETF is forced to obtain Bitcoin price exposure at higher and higher prices as it goes further out on the futures curve.”

Drawbacks of a Bitcoin Futures ETF

The SEC’s approval of a Bitcoin ETF has been a long-awaited and broadly welcomed development for Bitcoin. However, it has also seen substantial critics, and rightfully so. Generally speaking, Futures ETFs come with several disadvantages compared to their spot-based equivalents.

Detached Futures Market Prices

As Geraci points out, the futures markets will diverge further from Bitcoin’s spot price the later the contracts are dated.

As Bitcoin’s value is expected to grow over time, its future curve is upward sloping. This means that ProShares will be forced to purchase contracts at ever-increasing and detached prices compared to Bitcoin’s spot value. Therefore, ProShares risks exposure to Bitcoin at heavily inflated valuations.

Detached futures prices give wealthy investors accessible opportunities to arbitrage trade Bitcoin between spot and futures markets. This may apply whether futures curves are downward sloping in bear markets or upward sloping in bull markets.

Exorbitant Fees

Besides price tracking errors associated with the product, Futures ETFs also come packaged with multiple added fees for investors. These fees cut from profits they otherwise would have kept by investing in a spot-based ETF or actual BTC.

Raoul Pal – CEO of Global Macro Investor – voiced this concern before the first ETF’s launch.

“This vehicle means that the arbitrageurs take their slice, the ETF provider takes their slice, the lawyer who set up the fund takes their slice… the administrator, the auditor, everybody is taking a slice out of your pie.”

Paul contrasts this with simply buying hard Bitcoin, in which case only the exchange takes a small transaction fee. He also criticizes the concept of trading the cryptocurrency using paper, as Bitcoin’s core philosophy rests on the self-custody of coins.

Grayscale CEO Michael Sonnenshein also criticized the SEC’s preference of a Bitcoin Futures ETF over a spot ETF. “There are high costs that will make their way to investors…including the need to roll the contracts from one expiry to the next,” he told Marketwatch.

Grayscale is currently attempting to convert its current Bitcoin fund – the largest in the world – into a spot-based ETF. So far, they’ve had no luck.

Complications

Futures ETFs are undoubtedly complicated products. However, since they involve the price detachments and fees mentioned above, many clients may deem purchasing real bitcoin a more accessible alternative.

Ben Cruikshank – head of the Flourish Investing platform – explained to Market Watch that few firms were interested in Bitcoin Futures as imagined.

“The feedback that I’m getting is that a derivative is a less efficient form of ownership… are we going to recommend a complicated futures product that is more complicated than…opening a Coinbase account in 5 minutes?”

Cruikshank mentioned that the firms he had spoken to were “extremely skeptical” of a future product.

The Bright Side

That said, ProShares’ opening day success would still signal tremendous interest in the Futures-based ETF, despite its drawbacks. Moreover, the ETF may see some of its demand pressure alleviated as similar products flood into the market regarding its contract limit. Last Friday, Valkyrie launched the United States’ second Bitcoin ETF. Furthermore, VanEck’s ETF will soon begin trading and offer significantly lower fees than its current competitors.

Bloomberg’s senior ETF analyst Eric Balchunas also predicts that any negative outcome with BITO may spur the approval of a Bitcoin spot ETF. Grayscale’s ETF filing would likely be the first in line for this, allowing it to add to its existing 3.5% of Bitcoin supply.

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In the end, the ETF’s approval contributed to BTC’s price breaking all-time highs shortly after that. As a result, the markets ahead look remarkably bullish.