The US finally got a bitcoin ETF, but one that provides exposure via the inefficient futures market. This ETF is an expensive solution due to the cost of rolling future each month. We are talking 5-15% annualized cost. This is what counts as “investor protection” in today’s regulatory world. Yes, bitcoin futures trade on the regulated Chicago Mercantile Exchange. However, any problems in the spot market will surely filter into futures prices. So, where’s the investor protection in futures?
Despite the high cost, the ProShares bitcoin ETF traded $981m on day one, the second most active ETF launch ever and gathered a record $1bn in two days. There’s clearly appetite for digital assets despite the cost of using futures contracts.
The Proshares bitcoin ETF approval is an important marker. The SEC has provided another positive nod to the largest digital asset following positive nods to software company Microstrategy investing heavily in bitcoin and Coinbase IPO approval. If you still worry about bitcoin or crypto being banned by the US, please reassess the fear.
The full list of discussion subjects of The Dispatch #34 follows. Note this week’s edition was completed on Thursday October 21, 2021, instead of the usual Friday.
- The US finally gets a bitcoin ETF, one based on futures
- Futures roll cost could be a double-digit performance headwind
- Most successful ETF launch could breach CME position limits
- Futures-based oil ETF returns have been poor
- Grayscale files to convert GBTC to an ETF
- NY Attorney General goes after crypto yield products
- White House executive action on crypto coming
Bitcoin futures ETF is inefficient, but available
ProShares Bitcoin Strategy ETF (Ticker: BITO) started trading on Tuesday, October 19th. As mentioned above, it was a highly successful launch despite the inefficiency of using futures contracts. The inefficiency is due to Contango, which is just a fancy word to say that futures prices is at a premium to today’s spot price. The reverse can happen when future monthly prices are lower than the current month, which is called backwardation. Bitcoin CME futures were in backwardation briefly during the May 2021 bear market.
Future roll may add double digit percentage costs to the ETF
The table below shows the CME futures contract prices at 12:20pm on Wednesday, October 20th. The difference between the October futures contract price and the November futures contract price in the table below is 1.54%.
If that relationship holds between each future month for the next twelve months, then the annualized cost of rolling each future will be over 18%! In this scenario, the ETF will underperform the spot bitcoin price by 18% over that period.
ProShares has already started their marketing spin on the roll costs. In this wealth management industry publication, RIAIntel article, a company representative is quoted saying roll cost from September to October was just 0.2%. As the picture above illustrates, past roll costs are no guarantee of future costs!
The roll-cost could worsen due the success of the BITO ETF and as similar ETFs proliferate in the coming weeks. Here’s Bloomberg’s ETF analyst Eric Balchunas on the historic launch.
BITO could breach position limits due to high money inflows
Given the heavy flow of money into BITO, the ETF is hitting position limits on the CME futures contracts.
Yes, the CME sets limits on how many contracts a single entity can hold. As a result, BITO has purchased not just October futures contract, but also November contracts, which traded at a higher premium to spot. The table below shows that at the end of day-2 of trading, 43.6% of the funds were invested in the November contract.
BITO ETF’s CME future contract position as the end of October 20th
With many other ETF providers scheduled to launch their own bitcoin futures ETFs in the coming days and weeks, we could see the Contango expand further.
List of forthcoming bitcoin futures ETFs
Bitcoin futures ETF inefficiency translates into more profits for professional traders
As the SEC channels all capital seeking bitcoin exposure to the futures market, Real Vision’s Raoul Pal says that hedge fund and other sophisticated investors will enjoy higher near risk-less arbitrage profits. If you buy bitcoin in the spot market, then short the November future contract, that was ~1.5% more expensive. When the November contract matures, this trade would have yielded the starting price gap with no exposure to the bitcoin price. Investors who buy the futures contract, which now includes these ETFs, will underperforming spot prices by a similar margin.
For further reading on the subject of future roll costs, this CME Group webpage has more details. This Reuters article also looks at the futures roll headwinds. The Investopedia futures roll page is also a resource for the very keen.
Could rising capital inflows lower futures spreads?
Let’s end with the opposite view that bitcoin futures ETFs will increase efficiency and lower contango. Bloomberg’s commodity strategist Mike McGlone thinks we’ll see spread narrow as more capital participates in bitcoin. This is not how The Dispatch sees things, but we always look for the opposite point of view as well.
Experience with futures-based oil fund has been poor
This is not the first time that the SEC has approved futures-based ETFs. The United States Oil Fund (Ticker USO) provides exposure to crude oil price via futures contracts. While there are significant differences between the cash settled CME bitcoin futures and the physically settled NYMEX WTI futures, it’s worth considering the returns of the USO ETF vs. WTI oil price. The oil market is rather unique and mature, but the return gap still illustrates some of the risks of using futures contracts to track the underlying asset value. A physical oil ETF doesn’t exist due to storage challenges, which is not an issue with bitcoin.
10-year chart of WTI crude front month contract (blue) vs. USO ETF (Orange)
Despite these clear inefficiencies of futures-based ETFs for consumers, the SEC has repeatedly delayed approving spot bitcoin ETFs. The SEC claims the bitcoin spot markets don’t offer investor protection. As we said above, spot price moves impact futures market, so this assertion rings hollow.
Grayscale files to convert GBTC to an ETF
The SEC’s resolve on spot bitcoin ETFs will be challenged by Grayscale filing to convert GBTC into a spot bitcoin ETF. Grayscale argues along the same lines as The Dispatch when they highlight the linkage between futures and spot market to back their filing.
Source: Newswire. Highlights by The Dispatch
Since crypto spot markets are not currently regulated, multiple regulators appear to be jockeying for regulatory right over crypto assets. Congress could specify a regulator to oversee crypto assets or White House Executive Action could provide a stop gap measure. Until that happens, we’ll continue see decision that are not always in the consumers’ best interests.
If you are still unconvinced by The Dispatch’s cost argument, have a think about why there is no S&P 500 futures ETF. The S&P 500 futures is one of the most liquid markets globally, yet ETFs that follow the index invest in the underlying stocks, not the futures contracts. Nor do retail investors gain meaningful exposure via futures contracts. Futures are mostly used by institutional investors and trading firms for short term exposure with leverage.
NY Attorney General files cease and desist
Staying on the theme of regulatory action under the shield of consumer protection, the NY AG filed action against crypto yield platforms to stop activity in NY State. This Blockworks article provides more depth and context to the action.
As the Dispatch has voiced previously, this is simply regulation for the sake of regulation. These actions are preventing NY State residents from accessing crypto savings products that provide a return in excess of inflation, which is not offered by the banking system. Yes, the risks of crypto yield solutions are far different from FDIC insured bank deposits, but so are the 7-12% returns. Perhaps the better lens to evaluate crypto yield products are junk bond yields of 3.5%-4.5%. Again, this is not investment advice, but a review of the frequent conflict between regulators interpreting ancient laws unsuited for a software asset class. Consumer choice and returns suffer.
More than anything, this action highlights the urgent need for new regulatory clarity for digital assets. Consumers do need protection from the burgeoning ecosystem that’s growing with little oversight. Instead, what they get is barriers to access a high return on their savings as regulators go after the largest, best managed and capitalized entities. The risks at the small end of the crypto asset economy are higher, but the regulatory baton amplifies far better when the highest profile firms are targeted.
White House crypto executive order coming says Bloomberg
Let’s end with a discussion of potential Executive Orders on crypto. If you read this article in Pymnts the White House plan appear to be encouraging a deeper investigation of the asset class before developing oversight rules. The Dispatch spent much of this week watching the DC Fintech Week panels, which were stacked with regulatory heavy hitters. The Dispatch was encouraged to hear a balanced view on the risks and benefits of crypto from the acting head of FinCEN. SEC Chair Gensler, speaking in a personal capacity, was quite balanced on the benefits and risks. The Dispatch remains hopeful that we will get better digital asset regulations over the long term. It just won’t come quickly or comprehensively when a government shutdown and debt ceiling loom in early December. Stay patient.
Stay well, enjoy fall and do reach out if you have any questions or comments about the material in this Dispatch. I appreciate any and all feedback as that allows me to fine tune the material.
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