Bitcoin FOMO Fuels ETF Frenzy. Retail May Still Miss Out
Traders who piled in to the first U.S. Bitcoin exchange-traded fund in the hopes of reaping big gains may risk missing out on even greater rewards.
It all boils down to the shape of the Bitcoin futures curve. Longer-dated contracts typically trade at a premium to the spot price -- a structure known as contango -- because the cryptocurrency is inherently scarce and theoretically should rise, building in bullishness to the futures market. Funds that invest in futures must continually roll forward the exposure as the contracts expire, paying a fee to do so along the way. That process eats into returns, causing the ETF’s performance to become unmoored from the asset it tracks.
Case in point: The Horizon Bitcoin Front Month Rolling Futures Index -- which factors in the cost of rolling forward the contracts -- has returned roughly 530% during the past two years. By comparison, the world’s largest cryptocurrency has gained about 678% over that period. It’s this dynamic that had cryptocurrency and fund experts alike sounding a warning ahead of Tuesday’s launch of the first U.S. Bitcoin futures ETF. It may turn out to be a slow bleed for investors.
“You’re moving away from what people want, which is exposure to Bitcoin,” said Will Hershey, chief executive officer of ETF issuer Roundhill Investments. “If you want to take a short-term view on Bitcoin, this is probably not the worst product, but if you want to buy Bitcoin and hold it for five years, this isn’t the optimal structure.”
Bloomberg Intelligence estimates that maintaining exposure to the front-month contract will cost investors 10 to 20 percentage points of performance per year. As a result, financial advisers -- who are well-acquainted with the roll costs of derivatives-based commodity funds -- likely won’t be clamoring to buy funds like the new ProShares Bitcoin Strategy ETF (ticker BITO).
Even so, BITO boomed in its trading debut Tuesday. More than 18 million shares worth roughly $740 million changed hands by around 1:24 p.m, according to data compiled by Bloomberg. While comparisons are difficult because some funds are pre-funded, that volume makes it easily one of the busiest ETF debuts ever seen.
Invesco Ltd. took a different tack from ProShares, dropping its pursuit of a Bitcoin futures ETF on the eve of its rival’s debut and just days before its filing’s deadline with U.S. regulators. The issuer said in a statement that it’ll continue to work toward a “physically backed, digital asset ETF.”
Within the $6.8 trillion ETF arena, the most successful commodity ETFs are physically backed. State Street’s SPDR Gold Shares (ticker GLD), the world’s largest commodities fund, stores $56 billion worth of bullion in an underground London vault. The $28 billion iShares Gold Trust (ticker IAU) and the $13 billion iShares Silver Trust (ticker SLV) -- the second- and third-biggest such funds -- are also physically backed.
Contrast that to the trials of the $3 billion United States Oil Fund LP (ticker USO), a derivatives-based ETF, which for years tracked the front-month crude oil contracts. The fund was forced to repeatedly roll forward its holdings to longer-dated futures after the price of oil plunged into negative territory in April 2020, and warned it may see “significant tracking deviations” to its benchmark.
To be sure, while Bitcoin can be volatile, it doesn’t share some of the idiosyncrasies of the oil market. For example, cryptocurrency is far less onerous to store than barrels of oil, so the contango in the futures curve shouldn’t be as dramatic, according to Three Arrows Capital’s Su Zhu.
“A futures ETF is not ideal, but that said, I think it’s actually an okay product because people are making oil comparisons and oil has to be stored,” said Zhu, the firm’s co-founder. Traders will likely step in to arbitrage away the steepness in the curve, which “will probably converge to a pretty reasonable rate, I think. People are talking about 10-12% now. There’s a lot of ways people can capture that yield.”
And while a physical fund would be ideal, the emergence of futures-backed ETFs is still a good development for the industry because it will extend access to new types of participants, Zhu said. For example, BITO would be a fit for institutions that can’t access the Grayscale Bitcoin Trust (ticker GBTC) because it trades on an over-the-counter exchange, as well as investors whose mandates prevent them from trading futures.
Genesis Trading’s Noelle Acheson says Bitcoin bulls are overestimating the potential demand for futures-based ETFs, given that they will be subject to relatively high roll costs and fees. For example, BITO carries an expense ratio of 0.95%, whereas the average fee on an actively managed equity ETF clocks in at 0.71%.
“The futures-based ETF will have higher carry and rollover costs and it will also have higher fees, most likely, because it has to be actively managed,” Acheson, head of market insights at Genesis, said on Bloomberg’s “QuickTake Stock” streaming program. Genesis is affiliated with Grayscale Investments, which filed Tuesday to convert its Bitcoin trust to an ETF. “It can’t be a passive fund like a spot ETF.”
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