• Bitcoin Futures ETFs Have Arrived. Is a Physical ETF on the Way?

  • Allocating to bitcoin for their clients is a difficult task for many advisors. Advisors must choose between using something like the Grayscale Bitcoin Trust (GBTC) to gain exposure and assisting their clients in setting up a bitcoin/crypto account that is not managed by them.

    Aside from these two options, there aren’t many other solutions that advisors can easily access. This issue has sparked numerous debates in the advisory world – one that could be easily resolved if the United States Securities and Exchange Commission (SEC) approved a bitcoin exchange-traded fund (ETF).

    The first bitcoin ETF filing was made in 2013, and the SEC quickly denied it. The most recent formal bitcoin ETF denial occurred in 2018. The SEC now has a long list of bitcoin ETF applications awaiting approval or rejection. The majority of them are “physical” bitcoin ETFs, which are funds that will hold actual bitcoin.

    Interestingly, several bitcoin futures-based ETFs are awaiting approval, with the ProShares Bitcoin Futures fund (BITO) being the first-ever ETF approval, which began trading this week. Cathie Wood’s Ark Investments (ARKA) futures-based ETF is another notable application.

    Multiple bitcoin ETF filings have occurred since the first quarter of 2021, with Gary Gensler now serving as the SEC’s chairman. According to Nate Geraci, host of the “ETF Prime” podcast and president of the ETF Store, a registered investment advisor, this was due to Gensler’s reputation as a crypto enthusiast, having taught blockchain courses at MIT.

    ETFs based on futures versus ETFs based on physical assets

    The SEC approved a futures-based ETF on October 19, and the first fund (BITO, by ProShares) began trading the following day. On the first day of trading, the fund received nearly $1 billion in volume. To put this in context, this is the highest first-day organic volume in ETF history.

    However, Bitcoin futures held by a fund pose interesting challenges. If the bitcoin futures curve is in “contango” (the out-months are trading at a higher price than the front-months), this is equivalent to selling low and buying high. Futures that are held in an ETF must be rolled at the end of each month. This results in what is known as a negative roll yield – a decay in terms of return.

    What this really means is that a futures-based ETF will struggle to track the spot bitcoin price, and it will be an expensive way for advisors to allocate to bitcoin for their clients. However, for the time being, it may be the most convenient option.

    “One of the most significant advantages of a futures-based ETF is that the futures are cash settled.” There is no legal custody. According to Nate Geraci, “if the SEC has any issues with custody with bitcoin itself, that won’t be a concern with a futures-based bitcoin ETF.”

    A “physical” ETF, on the other hand, does not have the same issues as a futures-based solution. While the costs of crypto trading, custody, and reporting are higher than in traditional finance, a physical bitcoin ETF will not have the same drag as a futures-based ETF. A physical bitcoin ETF will almost certainly be more expensive than most other ETFs on the market, but it will almost certainly be less expensive than a futures-based ETF.

    A physical bitcoin ETF will also track the spot bitcoin price more accurately than a futures-based ETF. Grayscale, which currently offers the Grayscale Bitcoin Trust (GBTC), has applied to convert to the ETF structure. [Editor’s note: Grayscale is owned by Digital Currency Group, CoinDesk’s parent company.] GBTC is currently trading at a -20% discount to the spot bitcoin price, a phenomenon that many ETF experts believe will be reduced to 0% upon ETF conversion.

    Nate Geraci, for example, believes that a physical bitcoin ETF will not be approved until at least the second half of 2022 – and I agree with him. This is unfortunate because a physical bitcoin ETF is clearly in demand.

    Other methods of gaining crypto exposure

    Advisors may be wondering what other options exist for exposing their clients to bitcoin. There are a few companies that provide separately managed bitcoin and cryptocurrency accounts (SMAs), but implementing these strategies is not as simple or elegant as simply purchasing an ETF.

    SMAs have a significant advantage over ETFs in that they can trade actual bitcoin and potentially earn a yield on the position. They are also much more agile and will not be limited to a single cryptocurrency. As a bitcoin investor since 2012, I believe that direct ownership is the best way to buy bitcoin (although often not the most convenient).

    The bitcoin ETF market is rapidly evolving. Advisors will soon be able to allocate to bitcoin for their clients in a variety of ways, including assisting clients in setting up crypto accounts with crypto exchanges, a futures-based ETF, or even a SMA. Advisors are in charge of determining and researching the best way to accomplish this allocation. Fortunately, the number of opportunities to do so appears to be rapidly increasing.

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