Bitcoin exchange-traded funds (ETFs) have been a hot topic in the crypto industry for the past few months. Several fund providers have applied to launch bitcoin ETFs in the US, hoping to attract more investors to the nascent asset class.
However, not all bitcoin ETFs are created equal, and some have faced more challenges than others in gaining regulatory approval and market share. Here’s a brief overview of the current state of play for bitcoin ETFs in the US and abroad.
A bitcoin ETF is a type of investment fund that tracks the price of bitcoin, the leading cryptocurrency by market capitalization. Unlike buying bitcoin directly from an exchange or a wallet, investing in a bitcoin ETF allows investors to gain exposure to the crypto market without having to deal with the technical and security issues of storing and transferring digital assets. A bitcoin ETF also offers more liquidity, transparency and tax efficiency than other forms of crypto investing.
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There are two main types of bitcoin ETFs: physical and futures. A physical bitcoin ETF holds actual bitcoins in custody, while a futures bitcoin ETF uses derivatives contracts to track the price of bitcoin. Both types of bitcoin ETFs have their pros and cons, depending on the investor’s risk appetite, cost sensitivity and regulatory preference.
Physical vs. futures bitcoin ETFs
A physical bitcoin ETF is considered to be more faithful to the underlying asset, as it reflects the actual supply and demand of bitcoins in the market. A physical bitcoin ETF also avoids the risks and costs associated with futures contracts, such as rollover, contango and margin requirements.
However, a physical bitcoin ETF also faces more regulatory hurdles, as it requires the approval of the Securities and Exchange Commission (SEC), which has been reluctant to authorize such products due to concerns over market manipulation, fraud and custody.
A futures bitcoin ETF, on the other hand, is easier to launch, as it only needs the approval of the Commodity Futures Trading Commission (CFTC), which oversees the derivatives market. A futures bitcoin ETF also offers more flexibility and diversity for investors, as it can track different futures contracts with different maturities and prices.
However, a futures bitcoin ETF also introduces more complexity and volatility to the investment, as it depends on the performance of the futures market, which can deviate significantly from the spot market.
So far, no physical bitcoin ETF has been approved in the US, despite several attempts by various fund providers. The SEC has repeatedly delayed or rejected applications for physical bitcoin ETFs, citing unresolved issues regarding market surveillance, investor protection and custody standards.
The most recent example is the VanEck Bitcoin Trust, which was filed in December 2020 and has been postponed several times by the SEC. The latest deadline for a decision is February 14, 2022.
However, in October 2021, the SEC approved the first two futures bitcoin ETFs in the US: the ProShares Bitcoin Strategy ETF (BITO) and the Valkyrie Bitcoin Strategy ETF (BTF). These funds track the price of bitcoin futures contracts traded on the Chicago Mercantile Exchange (CME), which is one of the largest and most regulated futures exchanges in the world.
Since then, several other futures bitcoin ETFs have been launched or are in the pipeline, such as the Invesco Bitcoin Strategy ETF (BTCF), the VanEck Bitcoin Strategy ETF (XBTF) and the WisdomTree Bitcoin Strategy ETF (BTCW).
The performance of these futures’ bitcoin ETFs has been mixed so far. BITO, which was the first to launch on October 19, 2021, has seen strong inflows and trading volumes, reaching over $1 billion in assets under management (AUM) and over $500 million in average daily volume (ADV) in its first month.
BTF, which launched a day later, has also attracted significant interest, with over $200 million in AUM and over $100 million in ADV. However, BTCF, which launched on October 25, 2021, has lagged behind its peers, with only $50 million in AUM and $20 million in ADV.
The main reason for this discrepancy is likely due to the different fee structures and tracking errors of these funds. BITO charges an annual expense ratio of 0.95%, while BTF charges 0.8% and BTCF charges 0.65%.
However, BITO also has a lower tracking error than BTF and BTCF, meaning that it closely follows its benchmark index without deviating too much. According to Bloomberg data, BITO had a tracking error of 0.06% as of November 19, 2021, while BTF had 0.13% and BTCF had 0.23%.
This means that investors who buy BITO are getting a more accurate exposure to the price of bitcoin futures than those who buy BTF or BTCF.
Another factor that may influence the performance of these futures’ bitcoin ETFs is the shape of the futures curve. The futures curve shows the relationship between the prices of futures contracts with different maturities.
When the futures curve is upward sloping, meaning that longer-dated contracts are more expensive than shorter-dated ones, it is said to be in contango. When the futures curve is downward sloping, meaning that longer-dated contracts are cheaper than shorter-dated ones, it is said to be in backwardation.
The shape of the futures curve affects the returns of futures bitcoin ETFs, as they have to roll over their contracts periodically to maintain their exposure. When the futures curve is in contango, futures bitcoin ETFs have to sell their expiring contracts at a lower price and buy new ones at a higher price, resulting in a negative roll yield.
When the futures curve is in backwardation, futures bitcoin ETFs have to sell their expiring contracts at a higher price and buy new ones at a lower price, resulting in a positive roll yield.
The CME bitcoin futures curve has been mostly in contango since the launch of the futures bitcoin ETFs, meaning that these funds have suffered from a negative roll yield.
The outlook for bitcoin ETFs
Despite these challenges, the outlook for bitcoin ETFs remains positive, as more investors seek to gain exposure to the crypto market through regulated and liquid vehicles. The demand for bitcoin ETFs is evident from the inflows and volumes that these funds have attracted in their short lifespan, as well as from the number of applications that are still pending or being prepared by various fund providers.
However, the ultimate prize for the crypto industry is still a physical bitcoin ETF, which would offer a more direct and simple way to invest in bitcoin without the complications and costs of futures contracts.
Many analysts and experts believe that a physical bitcoin ETF is inevitable in the US, as it is only a matter of time before the SEC addresses its concerns and follows the example of other jurisdictions that have already approved such products, such as Canada, Europe and Brazil.
Until then, investors who want to access the crypto market through an ETF have to weigh the trade-offs between physical and futures bitcoin ETFs and choose the one that best suits their risk profile, cost sensitivity and regulatory preference. As always, investors should also do their own research and due diligence before investing in any product or asset class.