Earlier today the first bitcoin-linked exchange traded fund (ETF), ProShares Bitcoin Strategy (BITO), commenced trading on the New York Stock Exchange. I say “linked” as BITO doesn’t actually hold bitcoins. Rather, ProShares structured BITO as an investment vehicle in bitcoin futures, or contracts traded on the regulated Chicago Mercantile Exchange (CME) that track the future prices of bitcoins. I have no idea what ProShares’ “strategy” might be with respect to trading bitcoin futures other than simply being the first ETF to do so. While the first-mover advantage frequently represents a fine strategy, we’ll withhold judgment on this one for a while.
Investing in futures contracts likely represents one of the few ways that the Securities and Exchange Commission allows an ETF to offer exposure to bitcoin. Notably, the SEC chose not to disapprove or approve BITO. Rather, they simply chose not to act on ProShares’ offering of BITO. The SEC had a 75-day period over which they could comment on BITO, which expired yesterday (10/18/21). The fact that BITO invests in futures traded on a regulated exchange, much like similar ETFs tied to crude oil, gold, or other commodities, likely paved the way for inaction from the SEC. More futures-based cryptocurrency ETFs likely soon will follow BITO.
Before investors jump into BITO or their likely soon-to-be-launched look-alike ETFs, I recommend taking a moment to digest the differences between owning futures and owning the underlying assets. Most prominently, price relationships between futures and bitcoins infrequently will reflect 1:1 proportionality. In fact, based on the anticipated popularity of BITO CME’s bitcoin futures contracts recently reflects a 15% premium to the actual spot price of their underlying bitcoin. Second, this “contango” relationship, which describes the condition under which the prices for the underlying in the future trade higher than the current spot price, creates “roll risk.” As funds like BITO periodically must reinvest in new futures contracts to replace expiring contracts, the potential exists for these ETFs to buy high and selling low if bitcoin spot price dynamics change substantially between buy and sell dates. Additionally, BITO cannot participate in the spot market for bitcoins, which removes a key function many large futures traders employ to limit the potential negative impact of roll risk. While the bitcoin futures and spot markets appear large and liquid the potential for manipulation persists. Trading bitcoin futures is not a cost-less exercise either.
All of these potential risks, however, probably pale in comparison to the substantial risk of price volatility posed to bitcoin investors. Without the linkages to material uses offered by the more typical assets on which futures markets base values – currencies, lumber, interest rates and such – bitcoin prices reflect consumers’ views as a store of value. As such bitcoin price behavior likely will correlate better with art and collectibles than it does even with gold, the other historically popular store of value. All of this is not to say that investors owning bitcoin or other cryptocurrencies is necessarily bad or good, just that it likely will be quite different than their experiences owning other assets.