ProShares is set to launch the first U.S. exchange-traded fund on Tuesday to track the price of Bitcoin, the culmination of eight years of failed attempts to wrap the volatile digital asset in Wall Street’s favorite package.
An ETF structure opens Bitcoin up to people who have been nervous about buying Bitcoin directly, and want to hold it next to their stocks and bonds using similar safeguards to their S&P 500 index funds. Even those who are skeptical about the products that are about to launch expect them to draw billions of dollars in assets.
It’s important for investors to understand exactly what they are buying, however. The Bitcoin Strategy ETF (ticker: BITO) sponsored by ProShares will invest in futures contracts that allow people to bet on the price of Bitcoin at a later date. Futures track the price of Bitcoin relatively closely, but they are by no means the same as the real thing.
“It’s a very different beast,” says Ben Johnson, director of global ETF research at Morningstar.
The latest prospectus from ProShares makes this clear. “The performance of Bitcoin futures contracts and therefore the performance of the Fund may differ significantly from the performance of Bitcoin,” it says. It expects to buy Bitcoin futures through a subsidiary organized under the laws of the Cayman Islands that will hold about 25% of the fund’s assets. And it will hold money market instruments like U.S. Treasuries, too. Funds like this need to hold cash because futures have inherent leverage, Johnson says.
CME Bitcoin Futures, the futures product that it will trade, has strong liquidity and has followed the price gyrations of Bitcoin, but it doesn’t do so at a perfect one-to-one match. In recent days, as the likelihood of approval has risen, the price of CME Bitcoin futures has exceeded the cash price of Bitcoin on spot exchanges. The annualized premium for futures versus spot has risen to 15% from 7.7%, according to The Wall Street Journal. The ETF will fluctuate with changes in the level of that premium or discount, which could blunt or accentuate the way that the ETF tracks the price of Bitcoin.
ProShares had previously said the fund might also invest in Canadian Bitcoin ETFs and a closed-end fund called the Grayscale Bitcoin Trust (GBTC) that holds Bitcoin, but its latest prospectus doesn’t mention those options. A spokesman for ProShares had no comment on whether the change was a result of pressure from the Securities and Exchange Commission.
Gary Gensler, the SEC chairman, has previously said that he is more comfortable with Bitcoin futures—which are already directly regulated by the Commodity Futures Trading Commission—than with the direct Bitcoin markets.
Yet the green light being given to ProShares for its fund that invests in Bitcoin futures may not offer many clues about the SEC’s broader views on crypto regulation. The agency does not need to formally approve the ETF for it to begin trading. The fund will start trading if the SEC simply does not object to it.
More Bitcoin futures ETFs from providers including Invesco, VanEck, and Valkyrie could begin trading in the next two weeks as the deadline for the SEC to object to those products passes. Invesco’s could launch as soon as Wednesday.
The SEC did not respond to questions on whether it plans to approve those, and an Invesco spokesperson had no comment on the company’s timeline.
These products are so new that analysts who track and compare ETFs said in interviews that they were not ready to weigh in on which might be best for investors. But one thing is likely—fees to invest in them are likely to keep falling. ProShares will charge 0.95%, which is better than some other ways of buying Bitcoin for an investment account. GBTC has a 2% fee, for instance.
“I would expect that the second product and the third product will be cheaper than the first one, because they’re largely going to be offering the same exposure to Bitcoin, and they’re going to have a liquidity disadvantage being available second,” says Todd Rosenbluth, CFRA’s head of ETF and mutual fund analysis. “It is reasonable to think that we see this as a next wave of the ongoing fee war that we have in the ETF market.”
The biggest problem with futures-based funds is that they invest in contracts that expire, and then have to buy new contracts to replace them. Depending on investor expectations and dynamics within the asset market itself, contracts expiring in later months often trade at discounts or premiums to the most recent contract. With Bitcoin, longer-dated futures currently trade at a premium, a dynamic known as contango. If current trends hold, ProShares will end up selling lower-priced futures contracts at expiration and replacing them with higher-priced contracts—selling low and buying high.
That “roll” effect can hurt the performance of an ETF that tracks futures. Gold ETFs offer a cautionary tale—and a particularly fitting one given that Bitcoin has been likened to digital gold. The SPDR Gold Trust (GLD) holds gold itself, while the Invesco DB Gold Fund (DGL) holds gold futures. On a five-year timeline, the SPDR fund has risen 37%, while the Invesco fund is up 24%.
“That has a lot to do just with the roll cost, just maintaining that futures exposure systematically, selling low and buying high each month.” Johnson says.
And the roll cost is much more severe in other markets.
“It’s not nearly as pernicious in the gold futures market, because the shape of the futures curve tends to be fairly flat over time,” Johnson said. “It can get really nasty in other markets” such as “oil markets where contango can really eat into longer term returns.”
In addition, futures contracts can sometimes trade with high volatility at expiration, as traders holding them may want to get rid of them instead of paying cash for the Bitcoin. Oil futures contracts went negative last year when some traders could not get rid of expiring contracts. The most popular fund tracking those contracts, the U.S. Oil Fund (USO), began investing some of its money in longer-dated contracts because of that dynamic. ProShares says in its prospectus that it will be investing in front-month contracts, those with the shortest time to maturity, so it may not be protected from the volatility.
For now, the models for how Bitcoin futures will trade in an ETF are just theoretical. That could all change on Tuesday.
Write to Avi Salzman at avi.salzmanbarrons.com
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