A futures-based Bitcoin ETF is coming — and not in a theoretical sense, either. This morning, Bloomberg’s James Seyffart revealed that the ProShares Bitcoin Strategy ETF (BITO) was already being added to the Terminal’s data feed as we speak.
I’ll put my cards on the table here: I used to be a bitcoin ETF skeptic (probably like many of you), but I’ve since come around. Conversations with very smart people who are bullish on crypto and a vast ocean of research have convinced me that a bitcoin ETF offers more pros than cons.
See also: New Bitwise Bitcoin Filing Drops A Research Bomb
But a bitcoin futures ETF is not synonymous with a physical bitcoin ETF. Futures-based products can and do provide a different risk-return profile than physical ones because fundamentally, futures contracts are not the same as physical assets — a truth any commodities investor already knows. Futures contracts expire. Roll costs matter. Contango and backwardation matter. Position limits apply. The list goes on.
As a result, there are also pros and cons to using futures for bitcoin exposure, and that goes for any underlying asset, whether it’s crude oil, Treasuries, or anything else.
Earlier this week, Dave laid out many of the cons. However, I think it’s worth taking a big step back and outlining some of the benefits of a bitcoin futures ETF, as well.
Benefit #1: The Institutionalization of Bitcoin
One of the biggest advantages of the futures market is that it removes the cost and hassle of storing the underlying commodity, which in turn makes that commodity significantly easier to buy and trade, particularly by speculators (an important part of any market!). Of course, bitcoin’s already pretty easy to buy and trade. Anybody can open up a Coinbase account in seconds and start trading bitcoin — or any number of other cryptocurrencies, for that matter.
What you can’t do, however, is hold bitcoin in your Schwab account. You can’t trade it on your big platforms. Moreover, you can’t incorporate a bitcoin allocation into most model portfolio software, or run a rigorous risk analysis on it, or even paste it into the monthly portfolio reports you send to your clients. There’s a lot of fintech start-ups attempting to solve this problem, yes, but for the vast majority of financial advisors, cryptocurrency exists almost completely outside of their practice management infrastructure.
That’s a big problem because the reality is, clients want cryptocurrency, but they also want help managing it. They’re not financial experts. That’s why they hired a financial advisor in the first place. Financial advisors offer a much-needed steady hand; they act as that expert guide with the facts and numbers that clients can trust to make the smartest decisions on their behalf. But how can you be clients’ expert guide through the Wild West of cryptocurrency if you can’t actually rely on any of your usual tools or resources to do so?
So in my mind, the biggest advantage of a bitcoin futures ETF has nothing to do with futures at all — and honestly, it’s an advantage that a physical product would have, too: A bitcoin ETF institutionalizes bitcoin. It unlocks all the tools and resources that financial advisors have at their disposal and allows them to be put to much-needed use.
Benefit #2: A Smoother Path Towards Price Discovery
As it stands, cryptocurrency exchanges are… an “adventure,” let’s call it. Functionally, crypto is an over-the-counter market, where a coin’s best pricing can and does vary from exchange to exchange. There isn’t any kind of national best bid/best offer system in play. What’s more, when you invest directly in bitcoin on a crypto exchange, you’re at higher risk of bad actors manipulating the price of bitcoin to your detriment. There are some investor protections, but they vary from exchange to exchange, and between placing your trade and getting your coin, there’s plenty of chances to for something to go hinky.
Bitcoin futures attempt to mitigate those chances — and quite cleverly, I might add.
Something most folks don’t realize is that CME bitcoin futures contracts, the ones that underpin most of the current ETF filings, are index-based, tracking the CME CF Bitcoin Reference Rate. Essentially, that benchmark establishes a form of consolidated tape for bitcoin, much in the same way that major exchanges create a “ticker tape” for stock prices, to accommodate trading not just on a primary listing exchange, but on other trading venues as well.
The CME CF Bitcoin Reference Rate is a volume-weighted average of bitcoin prices across five of the biggest crypto exchanges, as determined by trading volume. (At the moment, that’s Bitstamp, Coinbase, Gemini, itBit, and Kraken, though the available universe extends to 165 crypto exchanges worldwide.)
The benchmark takes an hour’s worth of bitcoin prices across each of those five exchanges, as broken into 12 five-minute chunks, then weights those prices by volume. Median prices are used, which helps to exclude outliers (a deterrent for price manipulation). The index rate is then published once an hour throughout the trading day.
The benefit of this consolidated tape approach is that it reduces the idiosyncratic risk of market stress events or failure from any one exchange. It also deters price collusion by forcing would-be malicious actors — or even the exchanges themselves — to succeed in their manipulative efforts across not just one exchange, but five simultaneously, and to do so over an extended period of time long enough that it would surely attract the notice of security experts and regulators.
Personally, I think that’s a lower-risk approach than just buying coins directly on an exchange, and it’s clear that the SEC thinks so, too.
Speaking of which…
Benefit #3: Futures Regulation Is Crystal Clear
Spot cryptocurrency markets are largely unregulated — in fact, to some folks, that’s one of their big selling points. Coins exist in a decentralized marketplace that no one government or regulatory regime can control.
But when you engage in a market that’s unregulated, that comes with higher risk, not just that bad actors could act badly, or that market stress events could spiral out of control, but that at any moment, new regulation could be imposed that might completely upend how you interact with that market.
In the case of bitcoin futures contracts, however, the Commodity Futures Trading Commission has already set the rules. Trading in these contracts follows the same rules as trading in any other other futures contract, including surveillance requirements, position limits, risk disclosures, and more. On top of that, the CME also has its own reporting requirements and surveillance activity surrounding futures as a condition of the contracts continuing to list on the exchange. We even have clarity on how bitcoin futures should be taxed.
With bitcoin futures, we know what the rules of the game are, and the consequences of breaking those rules are telegraphed well in advance. And in places where the consequences may yet be murky — such as in the case of bitcoin futures ETFs bumping up against accountability limits — we at least have precedent, such as what went down with the U.S. Oil Fund (USO) in the spring of 2020.
Knowing the possibilities and being able to plan for them is preferable, in my opinion, to venturing into a market where the regulatory picture is still one big question mark.
The Bottom Line
We’re getting a bitcoin futures ETF soon. While that structure isn’t necessarily what many issuers or investors were hoping for, I think that there’s still a lot to like about the concept. As long as you make your trades with eyes wide open about the potential risks, the pros of a bitcoin futures ETF might be more than enough to outweigh the cons.
In any case, we’re about to find out.
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