Don’t Ignore Bitcoin Futures Roll Costs

John Hyland, CFA, is a retired ETF executive and longtime investment industry professional who has contributed articles to ETF.com. He currently sits as an independent director on the board of the Esoterica NextG Economy ETF (WUGI). Hyland also is a director of Matthews International, the investment advisor to the Matthews Asia family of mutual funds. We caught up with him to help us understand where the bitcoin ETF race stands following key comments from SEC Chair Gary Gensler in August.

ETF.com: SEC Chair Gary Gensler made waves early in August when he suggested the commission could consider a futures-based bitcoin ETF for approval. What are your thoughts on what he said?
John Hyland: Gary's argument to allow a bitcoin futures-based ETF, but not a physical one, is pretty much a total about-face of the SEC’s earlier stated concerns about the reliability of global bitcoin prices and trading.

A bitcoin ETF, whether futures owning or physical owning, each have the exact same problem. That is, all day long the bitcoin reported price—and thus the bitcoin futures trading price, and thus the ETF's indicative net asset value (INAV), and thus the end-of-the day NAV—are subject to the same uncertainty because of the largely unregulated nature of bitcoin trading. (Read: SEC Chair Hints Bitcoin ETF Possible)

ETF.com: Gensler also hinted that he prefers bitcoin ETFs that are registered under the Investment Company Act of 1940. 
Hyland: Gary Gensler's claim that '40 Act wrappers provide better investor protection than '33 Act versions is nonsense. Is Gary really saying that the SEC does a tremendous job protecting investors in '40 Act funds, but that the SEC does a poor job when it comes to '33 Act funds? After all, they regulate them both. I don't think so. 

In fact, it’s quite clear that a '33 Act futures-owning ETF, like the United States Oil Fund LP (USO), is far superior in many ways to a futures-owning '40 Act mutual fund like the Bitcoin Strategy ProFund (BTCFX) when it comes to dealing with investors.

For example, I don't think BTCFX is disclosing either their AUM [assets under management], or their holdings, or their flows, or their cash yield or their trading except with a long delay. USO does disclose that data daily. How is the '40 Act automatically "better"?

When you have futures-owning ETFs with identical strategies, I don't really see any advantage that a '40 Act version of a particular strategy— for example the Invesco Optimum Yield Diversified Commodity Strategy No K-1 ETF (PDBC)—offers investors over a '33 Act version with the exact same strategy—like the Invesco DB Commodity Index Tracking Fund (DBC)—in terms of "investor protection" (other than tax treatment).

ETF.com: In the commodity world, there’ve been instances where commodity ETPs faced troubles rolling their positions from month to month. USO faced a situation like that last year. Is that something that could happen in the case of a futures-based bitcoin ETF?
Hyland: The question is, is the bitcoin futures market—as measured by open interest and daily volume—really big enough to accommodate a large, bitcoin-futures-owning mutual fund or ETF that has to roll each month? Certainly not at present.

Right now, the September CME bitcoin futures contract has $1.24 billion in open interest. But the next contract they’ll need to roll to—October—right now only has $73 million in open interest.

To put that into perspective, USO is a $2.7 billion oil ETF. Sounds big, right? But the front-month contract in oil currently has $24 billion in open interest, while the next-month oil future has $16 billion.

Unlike oil or natural gas, I don't think there’s a large pool of natural shorts in the bitcoin futures market who need to maintain those short positions across rolls and need to do a "short roll.” In oil, you have holders of physical oil who hedge it by being short the futures.

When expiration comes, they need to buy back the front-month and sell the second-month to keep their hedge in place as long as they own the physical oil—unless they want to go unhedged. They become a natural counterparty to somebody like USO.

But that does not exist in bitcoin at present, so when a large ETF or mutual fund goes to roll bitcoin futures, whoever is willing to accommodate them can totally screw them over on a "calendar spread" once they get to be too big. 

If the mutual funds list themselves as "active" and not passive, they can take some steps to avoid getting killed in their trading, such as not rolling at all and just letting their contracts expire and settle for cash. Then they have to go buy the next month's contracts as a "one legged" trade.

The downside of this is they start to become an unreliable tracker of bitcoin prices, since you don't know where they’re going to end up every month. 

ETF.com: Are we going to see roll costs be an issue for futures-based bitcoin ETFs? 
Hyland: Bitcoin futures will likely always be in a mild contango, much like gold futures–a small, but not welcome, outcome. So even if a bitcoin futures fund is small and can easily trade their futures, they will still likely underperform the spot price every year if using futures.

ETF.com: It was recently reported that Valkyrie Investments got the first filing for a ’40 Act bitcoin futures ETF out the door two months ago. Do you think they are a front-runner?
Hyland: In my ETF.com article in April handicapping the race for the first bitcoin ETF, I named Valkyrie as one of my top bets. This most recent move of theirs to file their prospectus confidentially was clever, but I’m not sure it will actually help them that much, since they’re not the only issuer in the bitcoin futures pipeline (five others at a minimum).

And I’m guessing that shortly there will be a bunch more. So, it may help them be out of the gate when the SEC says OK, but there’s no guarantee they’ll be the first. In fact, the SEC may have two or three all go at the same time.

ETF.com: Regardless of who wins the race to be the first U.S.-listed bitcoin ETF, will it be as wildly successful as many believe?
Hyland: I’m not sure how much traction the three bitcoin-futures-owning mutual funds are getting—the Bitcoin Strategy ProFund (BTCFX), the Stone Ridge Bitcoin Strategy Fund (BTCIX) and the Cboe Vest Bitcoin Target Volatility Strategy Fund (BTCVX).

Have they brought in millions, tens of millions or hundreds of millions? My informed guess is ProFunds' BTCFX has $12 million so far, and the others no better, so maybe that suggests a bitcoin futures-based ETF may not exactly be the home run everybody thinks it will be. 

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