Here’s the deal with Bitcoin ETFs.
What’s an ETF: An exchange-traded fund (ETF) is a type of investment-fund or exchange-traded product typically traded on stock-exchanges, similar to mutual-funds, except ETFs are bought and sold throughout the day while mutual-funds are bought and sold at day's end. An ETF can hold assets such as stocks, bonds, currencies, futures contracts, commodities like gold bars, and usually operates with an arbitrage-mechanism designed to keep it trading close to its net asset value.
Most ETFs are index-funds meaning they hold the same securities in the same proportions as a certain stock/bond market index. In other words, the fund portfolio is constructed to match/track components of a market index, such as the Standard & Poor's 500 Index (S&P 500) or the National Association of Securities Dealers Automated Quotations (NASDAQ) 100 index.
Besides non-transparently actively managed ETFs, the list of stocks each ETF owns and their weightings are usually posted daily on the issuer’s website. Big ETFs have annual fees of 0.03% on all money invested, some lower, specialty ETFs can have over 1% fees. Fees can be paid out of dividends received from underlying holdings or from other assets.
Futures vs Spot ETF: Future ETFs are derivative-trading instruments where parties agree to buy or sell BTC at a predetermined price and date. A spot-based Bitcoin ETF would tracks the price of actual ‘physical’ bitcoins. Before going on you might be able to simply see why us crypto lovers would prefer a spot ETF, backed by, you know, real bitcoin. With futures, one party agrees to buy/sell at specific time, the settlement date.
Once the future contract expires, or is 'settled', one party must buy/sell at agreed upon price. No on-chain activity; no actual product; synthetic price movement. They will get a discount or a pay a premium depending upon price movement. If people believe bitcoin price will rise, the value of futures contracts will be higher than current bitcoin market price. So instead of tracking Bitcoin price, it tracks Bitcoin’s future price.
Bitcoin Spot ETF investors receive exposure to Bitcoin via regulated financially-familiar methods without owning actual Bitcoin. Now why don’t you just own Bitcoin you ask, well yes that’s more secure but you have to understand the financial market aren't innovative and imaginative degens like us, they want to play it by the book or else they, you guessed it, lose money, be it thorough fines or just bad investment plays.
So you have a wall of institutional money that use these commodities-exchanges like the Chicago Mercantile Exchange (CME, largest financial derivatives exchange) and only use those platforms, who are unable to put their money into real Bitcoin due to the riskiness of the new emergent asset class space, so instead they use ETFs.
Future contracts expire at the end of each month, so if they want to attempt to track front-month bitcoin futures contracts, they must sell their position before expiration and then purchase other contracts for the next month. This is called position-rolling can come at a cost to investors if later-month futures contracts are higher than near-month futures, a phenomenon known as ‘contango’ (the futures price of a commodity is higher than the spot price).
But there is also ‘Backwardation’ when current price is higher than prices in the futures market. Another issue with futures are position-limits; the CME only allows an entity to hold 4,000 front-month futures contracts (20,000 BTC). BITO almost touched that constraint.
The ProShares Bitcoin Strategy ETF (BITO); ’provides exposure to bitcoin returns in an ETF-wrapper, and does not invest directly in Bitcoin. The value of bitcoin futures is determined by the CME Group and Crypto Facilities Bitcoin Reference Rate (CME CF BRR), aggregating trading activity across major global bitcoin spot trading venues, in a one-hour window, divided equally into twelve 5-minute segments, each having a volume-weighted median, expressed as the arithmetic mean of the 12 VWMs, London Time.
The fund gains exposure through a Cayman Island subsidiary.’ On October19th 2021 – BITO launched and $1.2 billion flowed in during the first 3 days and while only $285 million came in the three weeks following.
With a spot ETF, the value is directly tied to the value of Bitcoin, no need to roll positions. Although, relative to a heavily-regulated futures contract, Spot ETFs may be considered riskier as they are tied to an unregulated crypto-asset. Still, Grayscale plans to convert its Bitcoin Trust (GBTC) into an ETF when the SEC provides “formal indication”.
U.S. Securities and Exchange Commission remains reluctant to approve a spot ETF, even though some have existed in Europe for years and one just became available in Canada (Purpose Bitcoin ETF).
Gary said a few days ago “The markets for actual Bitcoin itself today are largely unregulated…..This lack of regulatory oversight and surveillance leads to concerns about the potential for fraud and manipulation….As fellow regulators, our staff seeks to learn from the experiences of others…..Actions in the other jurisdictions are not binding on U.S. regulators, and our staff continues to follow applicable legal standards and processes under the federal securities laws.” Last Wednesday, the SEC denied WisdomTree’s application for a spot bitcoin ETF saying “The Commission concludes that [WisdomTree-Cboe] BZX has not met its burden under the Exchange Act and the Commission’s Rules of Practice to demonstrate that its proposal is consistent with the requirement that the rules of a national securities exchange be ‘designed to prevent fraudulent and manipulative acts and practices’ and ‘to protect investors and the public interest.”
Craig Salm, Head of Legal at Grayscale has said: “Grayscale is strongly of the belief that if the SEC is ok with futures based Bitcoin ETFs, then logically, they have to also be okay with a Bitcoin ETF…..The reason being, the issue with an ETF, whether futures or spot, has always been what the SEC believes is the potential for fraud and manipulation in the underlying spot market. The futures market uses the same Bitcoin marketplaces for pricing the underlying assets. And so, to the extent you think there is any fraud and manipulation happening on the spot Bitcoin market that would impact the SEC’s approval for both futures and spot Bitcoin ETFs.”
“Approving the futures strategy funds is an endorsement of Crypto as an investable asset class.” -Dave Abner, Global Head of Business Development at Gemini
Some related thoughts:
Arbitrageurs who buy Bitcoin and sell premium-priced futures can keep the prices of the two close together bridging the gap between the crypto world and traditional finance where futures live.
Yahoo finance says ‘futures are protected from market volatility and negative price movements’ but only say ‘futures don’t offer the option to vote or stake coins like you would if you directly owned the currency’ which I feel is disingenuous.
Physical ETFs ruled via the 1933 Securities Act require Form 19b-4 to show the underlying market is not subject to manipulation. But futures-based ETFs ruled via the 1940 Investment Company act do not require that form.
The Treasury Department and other agencies specified the SEC has authority over stablecoins like Tether.
There is the Valkyrie Bitcoin Strategy ETF and I’m scared to research that.
Fidelity Investments (who report $4.2 trillion in discretionary assets) just became the largest asset manager to launch a cryptocurrency ETF (FBTC).
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