Should You Buy the New Bitcoin ETF?

Tomorrow morning, the first Bitcoin ETF (Ticker BITO) is expected to start trading. The ETF will track the price of Bitcoin by using well-established Bitcoin futures contracts listed on CME Group to do so, much in the same way that ETFs track the price of Gold, Oil, and other commodities. Not only are the contracts well regulated, but the issuer, ProShares, is one of the largest ETF providers, with assets under management in excess of $62 billion.

With these established names and practices behind it, the Securities and Exchange Commission approved the application.

So does that make it right for you?

The basics: Futures explained

The ProShares Bitcoin ETF will use futures contracts to mimic the price of Bitcoin.

So what’s a futures contract? It’s a legal contract that provides someone with the claim on a certain quantity of a financial instrument or commodity at a given date—much like an options contract. Futures have been used for 100s of years to hedge or speculate on everything from corn and wheat to the EUR/USD exchange rate.

CME Group is the home of many of these futures contracts and is where the main Bitcoin futures contract is listed (another contract is housed at cboe). Each contract represents five Bitcoin and is associated with a specific date. For instance, there are contracts listed from October-December at present.

One thing to know: futures prices mimic the price of the underlying asset but aren’t exactly equal to it since they represent a price in the future. At writing, the October Bitcoin future price is $62,285, while the November price is $62,320 and the December price is $62,815. The variance in price primarily relates to the cost of holding Bitcoin between now and the delivery date.

When looking at these prices, you should view all the prices as equivalent. The futures curve does not suggest that the price in December will be $62,815. Instead, it says if you bought a Bitcoin today and the price did not move, the expected price (due primarily to interest rates) in December is $62,815.

A risk: Futures drag

The concept of BITO being a futures ETF is what leads us to one of the main drags of this as a product.

In order to track Bitcoin prices, BITO will have to buy Bitcoin futures contracts and then, before they expire, will sell those contracts it owns and buy the contracts in a later month. It will do this over and over again. This creates a natural drag on the portfolio.

For instance, using the example above, let’s say that the BITO ETF had enough assets to buy 10 October Bitcoin contracts ($622,850 in AUM). Assuming the price does not change, at some point between now and when the October contract expires, it will have to roll its trades to November in order to maintain the Bitcoin exposure. At that point, it will only have enough to buy 9.9156 Bitcoin—in effect giving up 0.0844 Bitcoin just to roll to the next month (a “fee” of 0.844% per roll). Then, you can assume that the next month it will “lose”another 0.0844 Bitcoin in the roll. Compound this month after month, and there’s a reason that the main Oil ETF (USO) is down 38% over the past five years while the price of Oil has increased by almost 50%.

This makes it very hard to buy and hold futures ETFs for long periods of time.

A benefit: Listed ETF exposure

While there are definitive downsides, the upside to a Bitcoin ETF is that it allows traders to get Bitcoin exposure in their stock trading accounts, including retirement accounts like IRAs. For now, the only way that you can gain exposure to Bitcoin or other cryptocurrencies is to do it at a crypto broker or through futures at the CME Group. That changes with the launch of BITO.

In stock trading accounts, the stock exposure is in a tertiary way with those stocks that hold Bitcoin—the Grayscale Bitcoin Trust (GBTC), Microstrategy (MSTR)—or those stocks that mine or otherwise deal in Bitcoin—Riot Blockchain (RIOT), Hut 8 Mining Corp (HUT), or Silvergate Capital Corp (SI).

While those can be good stocks, they are not purely a play on the price of Bitcoin. For instance, while the Grayscale Bitcoin Trust owns Bitcoin, its price trades with a number of factors. In fact, right now, it is trading at a discount to its net asset value by roughly 15%. This means that if the assets of the Grayscale Bitcoin Trust are $1,000,000, then the market capitalization of GBTC would be $850,000. The discount to NAV can vary on a day-to-day or week-to-week basis and is in and of itself a risk to owning GBTC.

On the company side, the risk is in the business performance. You would be essentially owning the equivalent of a gold miner or services company vs. the precious metal itself. Yeah, the stock price should track the performance of the metal, but it won’t do so perfectly.

If you want to own gold, the best way is to buy gold. And if you want to own Bitcoin, the best way is to buy Bitcoin. With BITO, you will be able to do that in your stock and equities portfolio.

Is BITO right for you?

Only you can properly answer this question. However, you should never invest without knowing the risks and benefits, including those above.