Bitcoin and other cryptocurrencies have once again hit new all-time highs over the past few weeks; many believe this was largely due to the hype surrounding the inception of the first Bitcoin Exchange Traded Funds in the United States.
The hype around the Bitcoin ETFs, like the ProShares Bitcoin Strategy ETF (BITO), was largely due to the idea that now the average investor or fund manager can easily garner access to Bitcoin through their standard investment platforms. The ETF would allow them to invest in Bitcoin without relying on the Coinbase's of the world or setting up a digital wallet and transferring funds into those accounts. It may sound like a small thing, but most investors prefer all their investments in one clean place.
The Grayscale Bitcoin Trust (GBTC), which many considered the first fund that gave the average investor access to Bitcoin in an easily tradable way and is a fund that actually holds bitcoins. BITO and the other newer Bitcoin ETFs, hold ‘futures’ contracts on Bitcoin, not the actual asset itself and this causes some issues with these new ETFs accurately tracking the price movements of Bitcoin. That is not to say that BGTC tracks Bitcoin price movements perfectly either, but it doesn’t have to deal with the same issues the newer ETFs will be facing. *(see footnote)
This type of investing is different from actually holding the asset itself because, in order to gain exposure to the asset through futures contracts, you spend more money to gain that exposure. Plus, you spend it each and every month when you'll roll' from one month's futures contracts into the next.
This 'roll' cost is called contango, and a lot of different ETFs experience this, especially those that are heavily leveraged. In order for the ETF to gain that leveraged, they use futures contracts, and thus they pay a 'roll' cost or experience contango. As a result, these leveraged ETFs typically all have a warning to investors that those funds are not intended to be held for periods longer than 24 hours because of their contango or high roll cost.
For example, think of a 3X-short S&P 500 ETF. For that ETF to get three times short exposure, it has to buy futures contracts each, and every morning the market is open. Buying those contracts often pushes the funds expenses very high for two reasons. The first is because it will have a lot of trading fees. The second is the contango that it experiences because it is constantly buying and selling futures contracts which likely have premiums that are changing daily. This means that if the fund buys a contract and pays $1.00 for the contract on Monday morning, it may only be able to sell that contract for 0.98 cents Tuesday morning. And at that time, it will need to pay, say, $1.00 for the new contract that gives it three times short exposure on Tuesday, which it may only sell for $0.97 on Wednesday morning.
With leveraged ETFs, this happens every day, and those funds are trading many different contracts, not just one.
With the Bitcoin ETFs and funds, they are doing the same thing, but only on a monthly basis, not daily. However, because the contracts are being held for one month, the difference in what they paid for the contract, say $1.00, and what they sell the contract for will likely be a much larger difference than what the daily funds are experiencing. As a result, the Bitcoin $1.00 contract may drop down to $0.75 or even lower.
The Bitcoin futures-based ETFs are facing one more problem: with other leveraged ETFs or commodity-based funds, the commodity typically has a more liquid and fluid market. For example, in the oil markets, people buy oil futures, sell them, and even short them all the time. The oil market is healthy, as in it has a lot of different players involved, which provides liquidity for investors to get in a position and easily get out of that position with really no problems.
As for bitcoin, the futures market is not yet 'healthy,' meaning there are not many players who are constantly trading these contracts. That means liquidity is not great, and thus in order to get into a position or out of a position, which these Bitcoin ETFs are forced to do at the beginning and the end of each month, they may have to pay a higher premium to entice someone to sell them a contract. On the flip side, when they need to sell their contracts, they may have to drop the price to a level they wouldn't want to sell them at to persuade someone to buy them.
This 'overpaying' and 'selling at a discount' for the Bitcoin futures contracts takes the 'roll' cost or contango and exacerbates it to the point that the Bitcoin fund is no longer truly tracking the price of Bitcoin very accurately.
As an investor, the way to solve this is by following the advice of the highly leveraged ETFs and only investing in these types of products for short periods. While the leveraged products' roll' every day and thus advise only holding for 24 hours, perhaps Bitcoin ETF investors should hold for a few weeks, maybe two or three at the most, to avoid portfolio deterioration from the funds' contango.
*A previous version of this article stated that the Grayscale Bitcoin Trust (GBTC) did not own actual bitcoins, but that the fund was based on futures contracts. This was a mistake and we apologize if this caused confusion to any readers.
Disclosure: This contributor did not own shares of any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.