Who Will Prevail in the Bitcoin-ETF Race?

After a major securities regulator suggested a road to approval, asset managers are racing to launch the first bitcoin exchange-traded fund in the United States.

ProShares, Invesco, VanEck, Valkyrie Digital Assets, and Galaxy Digital have all submitted proposals for bitcoin futures ETFs in the last two weeks. If allowed, the funds would be able to trade bitcoin future value bets in the same way that stocks are traded.

Chairman of the Securities and Exchange Commission Gary Gensler said earlier this month that he would be open to ETFs that trade bitcoin futures rather than the cryptocurrency itself, as long as they adhere to tougher standards than mutual funds. The Securities and Exchange Commission (SEC) has already authorized the first bitcoin-futures-based mutual fund in the United States, which began trading last month.

Futures allow traders to wager on the growth or collapse of an underlying market such as oil, gold, or, in this case, bitcoin. Futures are traded separately from the underlying asset from which they are generated, and the prices of the two might differ significantly.

For over a decade, asset managers have been attempting to persuade authorities to approve bitcoin ETFs. The SEC has so far rejected or postponed a decision on the funds. The government is treading carefully when it comes to regulating the volatile cryptocurrency industry. Amateur traders and a rising number of professional money managers have been more interested in digital assets.

Issuers who build ETFs under the Investment Company Act of 1940, Gensler stated at the Aspen Security Forum, will assist safeguard investors from illegal activity. The regulation, which dates back decades, establishes a stricter set of rules that generally apply to mutual funds. For example, it necessitates the formation of an independent board and grants a fund the power to cease taking new money, something most ETFs lack.

“I eagerly await the staff's assessment of such submissions, especially if they are restricted to these CME-traded bitcoin futures,” Gensler added. Bitcoin futures contracts from CME Group began trading in late 2017.

Trading venues like the CME, unlike crypto exchanges, have agreements with the SEC that provide the agency more supervision.

Despite the extra precautions, investors in such funds would have to cope with concerns like trading futures and the dangers connected with cryptocurrency.

Futures-based ETFs seldom mirror the performance of the underlying market they follow, according to Todd Rosenbluth, head of ETF and mutual-fund analysis at CFRA. Pricing differences between futures contracts and the spot market are the cause, particularly if demand for the asset or commodity is projected to vary considerably in the future. Rolling over contracts when they expire comes with its own set of fees. “Some of the investors who gravitate toward these products are likely to be disappointed in the performance or uninformed of the dangers they are taking,” Rosenbluth added.

Futures-trading funds typically purchase front-month contracts, which are contracts for the following month. Funds roll their assets into the next month before the contracts expire. If the price of futures contracts rises above the price of bitcoin in real time, funds will be compelled to pay a premium to roll them.

This rolling process, according to Bloomberg ETF analyst Eric Balchunas, may cost investors up to ten percentage points in yearly returns, on top of expense ratios that are projected to be about 1% every year.

Futures-trading funds are “really more suited for institutional investors,” according to Steven McClurg, chief investment officer at Valkyrie, whose planned ETF will trade just front-month futures contracts. “However, when a spot commodity is unavailable, such as in the case of oil or natural gas, ordinary investors turn to futures products.”

A recurrence of the United States Oil Fund disaster would be the worst-case situation for investors. This fund frequently rolled expired contracts into more costly ones, causing it to lose twice as much as the oil prices it monitored over the last decade.

When oil prices plummeted in 2020, USO incurred massive losses. The fund's management were obliged to cease issuing new shares and restructure its holdings numerous times, resulting in a more diverse mix of contract expirations in the future.

Some companies attempting to create a bitcoin futures fund provided comprehensive strategies for diversifying their asset mix. Invesco, for example, stated in a regulatory filing that its fund may invest in other bitcoin-related assets, such as ETFs traded outside of the United States. Invesco has stated that it will not roll contracts on a fixed schedule in order to maximize roll yield.

Valkyrie's plan, on the other hand, is a pure-play bitcoin futures ETF, which experts believe is more in line with Gensler's views. The firm's McClurg downplayed the possibility of a replay of the USO involving bitcoin futures funds, claiming that the USO was a unique convergence of circumstances including Covid-19, overproduction of oil, and too much supply.

He remarked, "I can't see a world where it would happen."