Bitcoin Spot Vs Futures ETF Debate

[Check out our recent webinar, "Unpacking The Crypto ETF Dilemma"]

The first bitcoin futures ETF in the U.S. started off with a bang, accumulating $1 billion in assets faster than any ETF before it. But after those gangbuster first few days, asset growth for the ProShares Bitcoin Strategy ETF (BITO) has slowed significantly.

About $1.2 billion flowed into BITO during its first three days on the market, while it HAs pulled in a more modest $285 million in the three weeks since then.

The second and third bitcoin futures ETFs to launch in the U.S., the Valkyrie Bitcoin Strategy ETF (BTF) and the VanEck Bitcoin Strategy ETF (XBTF), are growing at an even slower pace, with inflows of $60 million between them.

But despite the slower growth recently, what these funds have accomplished so far is impressive. BITO’s launch was monumental, shattering a 17-year record. And as latecomers, although BTF and XBTF were at a disadvantage, they’ve still managed to attract a decent amount of investor interest.

Moreover, as Matt Hougan, chief investment officer at Bitwise, points out, a fast start followed by a pause isn’t unusual for new ETFs.

“I think it’s too soon to count the futures-based ETFs out,” Hougan said on the “Unpacking the Crypto ETF Dilemma” webinar. “The best analogy for ETF experts is [the SPDR Gold Trust (GLD)]. GLD came to market and gathered $1 billion in three days, one day slower than BITO.”

“In the next 12 months, it only gathered another $2 billion. It was only really after eight years that it fully matured and became a $75 billion ETF,” he added. “So, it’s not unusual for ETFs to spring out of the gate with huge asset gathering, take a breather as they get approved on various platforms, and then have a second leg up.”

Different Animals

The story is still being written about bitcoin futures ETFs and how popular they end up being with investors. While they may still become a multibillion-dollar category, one thing holding them back from reaching even greater levels of popularity may be the obvious fact that they hold futures, not the underlying bitcoin asset.

An ETF that owns bitcoin directly—the same way that GLD owns actual gold bars—is something that the U.S. Securities and Exchange Commission remains reluctant to approve. But that type of spot bitcoin ETF has existed in Europe for years, and earlier this year, became available in Canada.

In each instance, the funds have acted as promised, giving U.S. investors hope that, at some point, these ETFs will be available to trade in their country as well.

In any case, a spot bitcoin ETF is a different animal than a bitcoin futures ETF, and many would argue, a better product for long-term investors. The biggest difference between the two is a spot ETF can maintain its position indefinitely, while a futures ETF must roll its position forward over time.

That’s because futures contracts expire at the end of each month. A futures ETF like BITO, which attempts to track front-month bitcoin futures contracts, must sell its position before expiration and then purchase contracts for the next month.

This rolling of positions can incur a cost to investors if later-month futures contracts are more expensive than near-month futures contracts, a phenomenon known as contango.

For instance, currently, the November 2021 futures contracts that BITO holds are trading for $55,815, while the December 2021 futures contracts that the ETF will roll into are trading for $56,330. If the roll took place today, the ETF would have to sell at a lower price and buy at a higher price, leaving it with about 0.91% fewer contracts than it had before.

These roll costs can add up significantly. At the same monthly roll cost, an ETF would end up with more than 10% fewer contracts over the course of a year.

Varying Roll Costs

Roll costs can be higher or lower, depending on market forces. Arbitrageurs who buy underlying bitcoin while selling premium-priced futures contracts help keep prices for the two relatively close together. These traders help bridge the gap between the blockchain world in which bitcoin lives and the traditional financial system where futures contracts and ETFs live.

Their price for providing this service is the roll cost.

Theoretically, it is possible for the bitcoin futures curve to flip into backwardation, a phenomenon often seen in commodity futures markets. In that case, an ETF would actually gain from rolling higher-priced near-month futures contracts into lower-priced later-month futures contracts.

Because of the structure of the bitcoin market, that hasn’t happened, and it’s unlikely to happen on a sustained basis. That means investors buying into bitcoin futures ETFs will have to contend with roll costs for the foreseeable future.

With futures ETFs, there is another issue to contend with, which is position limits. The CME currently only allows a single entity to hold 4,000 front-month futures contracts—the equivalent of 20,000 bitcoins.

BITO has already knocked up against that constraint, so it’s had to move into holding second-month contracts as well. The greater its position in futures contracts outside of the front month, the more the performance of the ETF will deviate from spot bitcoin prices.

The Spot Solution

Understandably, all this makes many investors eager to see the launch of the next iteration of the bitcoin ETF—one that holds actual bitcoin. So far, the SEC has been reluctant to approve such an ETF, but if it occurs, it would almost certainly end up being a much better product for investors.

Such an ETF, like the Purpose Bitcoin ETF, which is currently trading in Canada, or the Bitwise Bitcoin ETP Trust, which is attempting to come to market in the U.S., holds bitcoin directly. Through a custodian, the ETF controls the private keys that are associated with actual bitcoin on the blockchain.

Thus, the value of the ETF is directly tied to the value of bitcoin. Under this arrangement, bitcoin can be held indefinitely; there is no need to roll positions forward over time.

As one might expect, it turns out that spot bitcoin ETFs track underlying bitcoin prices very closely and end up being much cheaper than bitcoin futures ETFs, which face a steady performance drag over time.

However, spot bitcoin ETFs may be considered riskier in one regard—that they own an unregulated cryptoasset, which, relative to a heavily regulated futures contract, is higher risk. Crypto assets can be safely secured through various means, but their short history has been riddled with instances of custodians getting hacked and having their assets stolen.

The ecosystem has evolved such that this isn’t so much of a problem, and many reputable custodians with pristine track records exist. Nevertheless, this is still a risk worth mentioning for anyone investing in spot bitcoin ETFs.

ETF.com recently held a webinar, "Unpacking the Crypto ETF Dilemma." You can watch it here. 

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2