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The SEC approved a bitcoin futures ETF that will allow retail investors to gain indirect exposure to the fastest-growing asset on the planet.
However, a bitcoin futures ETF won’t be perfect. Here’s what you need to know before buying it.
What Is A Bitcoin Futures ETF?
A bitcoin futures ETF tracks the price movements of bitcoin futures contracts, which are derivatives of the underlying asset.
Therefore, a bitcoin futures ETF mimics the price of bitcoin futures instead of the market price, or “spot price” of bitcoin.
A bitcoin futures ETF provides exposure to bitcoin without having to buy the cryptocurrency directly.
You can buy and sell a bitcoin futures ETF the same way you’d buy and sell a stock.
Understanding Bitcoin Futures ETFs
A bitcoin futures exchange-traded fund is a basket of contract derivatives, which are obligations to buy or sell bitcoin later at an agreed-upon price.
The seller of the futures contract agrees to “deliver” bitcoin to the buyer at a future date at a predetermined price.
This price is established on the day of the agreement instead of the future date. The agreed date is known as the contract settlement date or expiration date — at which point, each party must fulfill its obligation.
However, buyers of a bitcoin futures ETF will never take ownership of the underlying bitcoin because the fund is a derivative of these contracts.
The ETF issuer will purchase futures contracts and then offer a securitized version to investors.
The issuer won’t take ownership of the asset either — they’ll continue to trade the contracts to keep the ETF in operation.
If they didn’t roll over the futures contract and allowed it to expire, the issuer would take ownership of the BTC, and there wouldn’t be a securitized version of the contract for retail to buy.
The price of these contracts rises and falls depending on the market’s sentiment, which causes the market price and futures price to frequently diverge.
The value of futures increases when the market expects the price of bitcoin to rise, and the value of futures decreases when the market expects the price of bitcoin to fall.
The futures price and market price tend to converge as the expiration date of contracts nears.
Buyers and sellers tend to agree on price more than a month from now compared to three years from now.
Advantages of a Bitcoin Futures ETF
Public Market Bitcoin Exposure
While it’s not the optimal investment vehicle, a bitcoin futures ETF might be one of the better ways to achieve public market exposure to bitcoin.
Bitcoin Maximalists want exposure in tax-advantaged accounts, and everyday investors want exposure in the same account that holds Apple (AAPL).
More options have come to market in recent years, such as GBTC, mining stocks like Hut 8 (HUT) and Marathon (MARA), and bitcoin holding companies like MicroStrategy (MSTR), but a bitcoin-anything ETF is long overdue.
Increases Bitcoin Adoption
A bitcoin futures ETF will generally contribute to the asset’s broader adoption, likely driving up its price and bringing more wealth creation to the space.
Institutions can seamlessly purchase it and manage it through traditional methods without worrying about custody.
Investment advisors can buy it and manage it in their clients’ accounts.
The wave of institutional money will further feed the Bitcoin flywheel:
- Mining and other bitcoin businesses become better capitalized as more capital flows into the space
- These operations become more profitable
- They can use fiat to pay bills instead of selling their bitcoin block rewards, which further limits the circulating supply
- Bitcoin’s network becomes more secure
- Demand as a store of value rises
Obviously, a bitcoin futures ETF won’t singlehandedly drive this loop, but its mainstream progress towards other milestones will.
This “advantage” speaks more to the Bitcoin ecosystem than owners of the ETF.
Wall Street Arbitrage – BTC Perspective
Large inflows into bitcoin futures contracts, driven by people buying the ETF, will bid up the spread between the spot price and futures price.
This creates an arbitrage opportunity that will bring Wall Street into the space.
The spread incentivizes traders to do a “cash-and-carry” trade, where they’ll sell the futures contract, buy a spot, and capture the yield.
While the cash-and-carry arbitrage attracts more capital to the Bitcoin ecosystem, it’s not beneficial to the individual buying the bitcoin futures ETF (more on that later).
At the very least, it’s directionally bullish for Bitcoin’s narrative and legitimacy from the perspective of traditional finance.
Bitcoin Spot ETF Is Coming
The futures fund was the latest domino to fall — it’s now inevitable that a bitcoin spot ETF will eventually get approved.
It’ll be superior to the future product because it will be backed by real bitcoin, resulting in fewer tracking errors.
If you’re skeptical about the futures product, you can sit back and wait for the spot version.
However, you’ll probably be waiting until late 2022 or 2023 for the spot approval.
Disadvantages of a Bitcoin Futures ETF
There will be times when bitcoin futures ETFs will inaccurately price the underlying asset. These tracking errors come in two flavors:
- Contango: the future price is higher than the spot price
- Backwardation: futures price is lower than the spot price
Tracking errors are more common in these types of ETFs because of the time component of futures contracts. This can cause futures to dramatically underperform spot.
Bloomberg’s James Seyffart recently tweeted, “… rolling front-month Bitcoin futures has underperformed spot price by ~36%” This was over the last year and before fees.
When the future curve is in contango, and the ETF issuers are forced to roll over contracts, they’ll sell cheaper futures and purchase more expensive futures.
This difference is called “roll return” and is not good for the fund’s performance.
The frequency and magnitude of these divergences remain to be seen — the number of Wall Street firms that arbitrage it and the severity of roll returns will certainly play a factor.
Wall Street Arbitrage – Retail Perspective
Cash-and-carry traders are exploiting the mispricing of the underlying asset (spot price) and its corresponding derivative (futures price) at the cost of the retail investor.
According to Dylan LeClair, the retail buyer bleeds capital to Wall Street firms that are capturing the spread.
This is a disadvantage for bitcoin futures ETF holders because they’re throwing away capital that could have been used to buy more bitcoin.
High & Hidden Fees
Buying a bitcoin futures ETF will come with extraordinarily high fees relative to buying the asset outright.
You’ll have to pay a premium on whatever convenience that you’re optimizing.
According to Raoul Pal, retail will kick a portion of their gains to “the ETF provider, clearinghouse, futures broker, administrator, auditor, law firm, CME, and hedge fund arbitrageurs.”
The average bitcoin futures ETF will charge an explicit expense ratio of around 1.00%, but other fees will occur under the hood.
Inferior to a Bitcoin Spot ETF
As previously mentioned, the futures product will be inferior to the eventual spot product for most investors.
The futures market on CME is heavily regulated, so it makes sense why a bitcoin product would first have to pass through it.
Approval of a spot ETF will ultimately face more friction from regulators because the issuers are taking ownership of the underlying asset, which opens a whole new set of challenges for regulators to navigate.
Bottom Line: Bitcoin Futures ETF Definition
The launch of a bitcoin futures ETF brings unprecedented opportunities for retail investors andhedge fundsalike.
It will track the price of bitcoin much better in the short-term compared to the long-term.
Regardless of the arbs, tracking errors, and fees, we believe the SEC approval of a bitcoin product is a significant net positive for Bitcoin.
The second-order effects on Bitcoin will be something to watch as these products hit and mature the market.
This article is for informational purposes only, and it is not intended to be investment advice. Read our editorial guidelines and public equities research methodology to learn more about how we researched bitcoin futures ETFs.