Eight years after the first application for a Bitcoin exchange-traded fund (ETF) was filed by the Winklevoss brothers, the first Bitcoin ETF in the United States will begin trading at the New York Stock Exchange (NYSE). ProShares—a provider of specialized exchange-traded products based in Bethesda, Maryland—filed an application Friday to begin trading of the Bitcoin Strategy Fund Oct. 19, 2021. The fund, which will trade under the ticker BITO, will track Bitcoin (BTCUSD) prices through futures contracts traded at the Chicago Mercantile Exchange (CME).
Michael Sapir, CEO of ProShares, emphasized that the launch of the ETF constitutes a milestone. “1993 is remembered for the first equity ETF, 2002 for the first bond ETF, and 2004 for the first gold ETF. 2021 will be remembered for the first cryptocurrency-linked ETF,” he stated.1
Douglas Yones, head of exchange-traded products at NYSE, also spoke about the momentous occasion but suggested that more progress remains to be made on crytpo investment products. “This is an exciting step but not the last,” he told The New York Times.2
Sapir said that the ProShares fund will provide exposure in the cryptocurrency to investors who have a brokerage account “but do not desire to go through the hassle and learning curve of establishing another account with a cryptocurrency provider … or are concerned that these providers may be unregulated and subject to security risks.”
Launch of trading in the ProShares fund’s shares is the result of inaction by the Securities and Exchange Commission (SEC). The agency has a 75-day period to provide comments on an ETF proposal. Funds are allowed to begin trading if the SEC allows the deadline to lapse. The deadline for ProShares’ funds expired on the morning of Oct. 18.
Other Bitcoin ETF applications that have an SEC commentary due this month include those from investment firms Invesco Ltd., Valkyrie Investments, and VanEck Associates Corp. According to reports, the agency is expected to follow a similar course of action for their applications and pave the way for listing of more futures-based bitcoin ETFs in public markets.
A Rocky Path to Approval
The path to approval for Bitcoin ETFs has been a rocky one. A Bitcoin ETF is considered the holy grail by some because it could open the floodgates to the injection of massive investment in the asset class by institutional investors. But the SEC has played spoilsport to this dream by rejecting numerous applications for funds that track the spot prices of bitcoin. The agency outlined its concerns with the Bitcoin ecosystem in a January 2018 letter published after the 2017 run-up in bitcoin prices.3
In the main, it is concerned with volatility of cryptocurrency prices and the potential for price manipulation in Bitcoin’s largely unregulated ecosystem. Major cryptocurrency exchanges, which are used to set spot prices for bitcoin exchange-traded products, are not registered with the SEC, making it difficult for the agency to verify their trade flow.
The current SEC Chairman Gary Gensler has repeatedly referred to the crypto ecosystem as a “Wild West” and asked Congress to bring cryptocurrency exchanges under his supervision. But he has said that the agency remains open to ETFs based on bitcoin futures traded at the CME.
Futures prices are based on bets made by trades on an assets price in the future. They do not involve ownership of actual bitcoin or trading on spot prices. Instead, the CME calculates a Bitcoin Reference Rate (BRR) during a one-hour window based on trade flow from major spot exchanges.4
A Bitcoin ETF based on futures prices at the CME will also not present a regulatory problem because the Commodity Futures Trading Corporation (CFTC) oversees CME. Since their introduction in December 2017, CME’s bitcoin futures have witnessed a steady increase in prices and trading volumes. The contracts are popular with institutional investors who use them to hedge risk while minting quick profits from a volatile asset class.
Caveats of Investing in Futures-Based Bitcoin ETFs
While they provide exposure to a rapidly growing asset class, ETFs based on bitcoin futures prices come with several caveats. For one, they may trade at a significant premium or discount to bitcoin’s spot price. For example, the annualized premium for CME bitcoin futures increased by 15% as compared to bitcoin’s spot price in recent days due to investor expectations for the approval of a Bitcoin ETF.5
A situation in which longer-dated futures contracts have higher prices as compared to short-term contracts, known as contango, could lead to losses for funds that track the prices of volatile assets like bitcoin.6 Karan Sood, chief executive officer at Cboe Vest, told The Wall Street Journal that the actual returns from funds based on crypto futures contracts can be “quite different” from bitcoin’s spot price.7
Bitcoin ETFs based on CME futures contracts could also be more expensive than other, similar products. Bloomberg Intelligence estimates that fees for a Bitcoin ETF are expected to be 1% for every $1,000 invested. According to the firm, the average active equity ETF charges 0.71% in fees.
The costs for Bitcoin ETFs will be further magnified during expiration of the underlying futures, when long-term investors roll over contracts to a new period. “Traders may use the new Bitcoin ETFs, but we expect their appeal to longer-term investors and advisers to be more muted because of the costs to roll futures,” Eric Balchunas and James Seyffart, analysts at Bloomberg Intelligence, wrote in a note.8
Still, the debut of a futures-based Bitcoin ETF is cause for celebration. It represents a significant evolution in the advance toward a fund based on bitcoin spot prices.
Matt Hougan, chief investment officer at asset management firm Bitwise Investments, told CNBC that the “homework” shows that the crypto market has changed. “The bitcoin market has matured to the point where the CME bitcoin futures market is actually the leading source of price discovery in the entire world,” he said. “Prices move on the CME market before they move on Coinbase, Kraken, FTX … and, as a result, it satisfies the SEC hurdle for the potential approval of a spot-based ETF.”9
Bitcoin price set a new record on Sunday, Oct. 17, charging beyond $63,000, after news broke about the imminent listing of the first Bitcoin ETF in U.S. markets.