Why the ProFunds Bitcoin Futures Mutual Fund Matters for a Bitcoin ETF

ProFunds launched the Bitcoin Strategy ProFund (BTCFX) at the end of July, the first of its kind publicly available mutual funds or ETFs in the U.S. to give investment results that correspond to bitcoin’s performance. The fund allows the incorporation of bitcoin exposure into a portfolio and eliminates the need for exchanges and crypto wallets by investing in bitcoin futures.

BTCFX should be the guidepost for the rash of bitcoin futures ETFs currently being filed with the SEC, as SEC Chair Gensler has indicated that a 1940 Act ETF investing in bitcoin futures would be looked upon favorably by the committee.

Before Gensler’s comments, almost every filing for cryptocurrency before the SEC was filed under the Securities Act of 1933, meaning they were being filed as commodities pools. All such filings fall under commodities pools with the ’33 Act, and not as an actual fund, and have fewer investor protections built-in. Filings under the Investment Company Act of 1940 are filed as funds, whether they are mutual funds, ETFs, closed-end funds, unit investment trusts, etc., with fairly rigorous investor protections. These protections include auditing requirements, financial disclosures, protections in case of fraud, and others.

One of the primary reasons for filing a ’33 Act is to avoid the tax headache of the K-1, particularly when futures contracts are involved. With a K-1, any gains from a futures contract present to the investor as if they were being sold to them, with the investor paying a 60/40 long/short capital gains tax on the amount. Issuers were bypassing all of that when filing their crypto-asset ETFs by filing them under the ’33 Act, but in doing so, they were leaving investors with a lot fewer protections in other areas. Given the volatility of the crypto markets, this was of great concern to the SEC.

Mutual funds have found a workaround to the tax problem when filing under the ’40 Act by pushing a percentage of assets (usually 25%) through Cayman Island subsidiaries. The subsidiaries then purchase all of the futures contracts and under-collateralize them in a way that brings the notional exposure back to 100%. The remaining 75% of assets not being sent through the Cayman Islands are kept as cash equivalents.

It’s a complicated way to bypass having to file a K-1, but it’s what has worked for the industry and a method that the SEC is happy with because ’40 Act funds still maintain investor protections. It’s also what ETF issuers should take a hard look at as they continue to file bitcoin futures ETFs because it’s one that the already approved ProFunds bitcoin futures mutual fund utilizes.

How BTCFX Works

BTCFX does not invest directly in bitcoin but instead in bitcoin futures which are currently only traded on the Chicago Mercantile Exchange. The fund only invests in bitcoin futures traded on exchanges registered with the Commodity Futures Trading Commission (CTFC). The value of bitcoin futures at any given point in time is determined using the CME CF Bitcoin Reference Rate, which indicates bitcoin across specific exchanges.

The bitcoin futures invested in by the fund are cash-settled, front-month futures, the bitcoin futures with the shortest length to maturity. The fund also can invest in short-term cash instruments with a maturity of 397 days or less, such as U.S. Treasury Bills or repurchase agreements. The fund also seeks to participate in reverse repurchase agreements, using the proceeds earned for investing purposes.

BTCFX seeks to invest roughly 25% of its total assets in a wholly-owned subsidiary of the fund organized under the laws of the Cayman Islands and advised by ProFund advisors. This percentage can be increased to meet tax efficiency if necessary, but doing so could potentially carry tax consequences.

In times of market instability, meeting increased margin requirements, or regulating inflows and outflows, BTCFX may invest in securities of ETFs listed and traded in Canada that reflect a portfolio seeking bitcoin exposure.

BTCFX has a 1.15% operating expense and $10 wire fees.

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