Blog Podcast The ‘future’ is here: What you need to know about bitcoin futures ETF

The ‘future’ is here: What you need to know about bitcoin futures ETF

date October 27, 2021 time 8 min read 631 views

In the past twelve years, bitcoin moved from the obscure corners of the internet to the mainstream. Last week marked a milestone for cryptocurrency as investors started trading the first US bitcoin futures exchange-traded fund (ETF). 

These funds invest in bitcoin futures contracts, or agreements to buy or sell the asset later for an agreed-upon price, rather than bitcoin directly. On this podcast, find out what ETFs are, the obstacles bitcoin overcame, and the benefits of investing in bitcoin ETFs.

You can also listen to Apple Podcast, Deezer, Spreaker and Podcast Addict. 

Remember: All investing involves risk. The content of the podcast is for informational purposes only and is not investment advice. Please always use caution and diversify.

TREVOR:

Hello and welcome to the 24th episode of Alternative Investing. I’m your host, Trevor Kraus, Communications Manager at MyConstant. 

If you recall, in early September when I started the podcast on the History of Investing, I said something to the effect of not wanting to only discuss cryptocurrency on this podcast in terms of an alternative investment. 

What’s hard though, is that crypto is constantly in the news, and it seems like every few months bitcoin, in particular, makes headlines. And if you follow crypto news, last week was no different.  

Last Tuesday, October 19th, a provider of specialized exchange-traded products based in Bethesda, Maryland—began trading of the Bitcoin Strategy Fund. This marked the first Bitcoin ETF to trade in the nation. Trading under the ticker, BITO. 

A lot of people predicted that ETFs and Bitcoin would converge sooner than later. The possibility of an ETF that tracks bitcoin is the best opportunity for this type of connection. However, there have been growing pains and problems in trying to launch the first bitcoin ETFs.

The primary reason is that bitcoin—the largest cryptocurrency in the world—remains largely unregulated. On top of that, the Securities and Exchange Commission (SEC) is hesitant to allow an ETF focused on the new and mostly untested cryptocurrency market to make its way to the public.

But before I get into the bitcoin aspect of this, it’s important to define EFTs and why they’re so popular. 

So, an ETF stands for exchange traded fund and it’s a type of security that tracks an index, sector, commodity, or other asset, but can be purchased or sold on a stock exchange the same way a regular stock can. 

An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities. ETFs can even be structured to track specific investment strategies.

A well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index. If you’re unfamiliar, The S&P 500 Index stands for Standard & Poor’s 500 Index, and it’s a market-capitalization-weighted index of 500 leading publicly traded companies in the United States. But you should note that it’s not an exact list of the top 500 US companies by market cap because there are other criteria to be included in the index.

ETFs can contain many types of investments, including stocks, commodities, bonds, or a mixture of investment types. An exchange traded fund is a marketable security, meaning it has an associated price that allows it to be easily bought and sold.

An ETF is called an exchange traded fund because it’s traded on an exchange the same way stocks are. The price of an ETF’s shares will change throughout the trading day as the shares are bought and sold on the market. This is unlike mutual funds, which are not traded on an exchange, and trade only once per day after the markets close. Additionally, ETFs tend to be more cost-effective and more liquid when compared to mutual funds.

I don’t want to get too sidetracked, but many people do wonder about the difference between mutual funds and ETFs. Mutual funds and ETFs hold portfolios of stocks and/or bonds and occasionally something more exotic, such as precious metals or commodities. 

They both adhere to the same regulations concerning what they can own, how much can be concentrated in one or a few holdings, how much money they can borrow in relation to the portfolio size, and more.

Beyond those elements, they go in different directions. Some of the differences may seem obscure, but they can make one type of fund or the other a better fit for your needs. 

When you put money into a mutual fund, the transaction is with the company that manages it—the Vanguards, T. Rowe Prices, and BlackRocks of the world—either directly or through a brokerage firm. The purchase of a mutual fund is executed at the net asset value of the fund based on its price when the market closes that day or the next if you place your order after the close of the markets.

When you sell your shares, the same process occurs, but in reverse. However, don’t be in a hurry. Some mutual funds assess a penalty, sometimes at 1% of the shares’ value for selling early (typically sooner than 90-days after you bought in). 

In contrast, with an ETF, because buyers and sellers are doing business with one another, the managers have far less to do. The ETF providers, however, want the price of the ETF to align as closely as possible to the net asset value of the index. To do this, they adjust the supply of shares by creating new shares or redeeming old shares. 

Price too high? ETF providers will create more supply to bring it back down. All of this can be executed with a computer program, untouched by human hands.

Okay, I really went off topic, but I was enjoying myself and I think that was some valuable info. So why has it taken so long for bitcoin to enter ETFs? Firms looking to launch bitcoin ETFs have run into a laundry list of problems with regulatory agencies. 

Do the names Cameron and Tyler Winklevoss sound familiar? They were closely involved in the founding of Facebook, and more recently, for their Gemini digital currency exchange. Back in 2017, they had a petition to launch a bitcoin ETF called the Winklevoss Bitcoin Trust but it was turned down by the SEC. 

The reason for the rejection was that bitcoin is traded on largely unregulated exchanges, leaving it susceptible to fraud and manipulation. However, the Winklevoss brothers didn’t give up on their efforts. On June 19, 2018, the US Patent and Trademark Office awarded them a patent for a firm called Winklevoss IP for exchange-traded products.

The Winklevosses were not the only cryptocurrency enthusiasts looking to be the first to successfully launch a bitcoin ETF. CBOE Global Markets (CBOE), the exchange responsible for bringing about bitcoin futures, hoped that the SEC would permit digital currency-related ETFs, too. CBOE also acquired Bats Global Markets, the exchange on which the Winklevoss ETF would have been offered.

So what does Bitcoin’s integration into EFTs mean for you—the investor? Well, for starters, it helps reduce the fears that many crypto newcomers have, including concerns about navigating exchanges and using wallets and private keys.

I think I mentioned on the podcast before, that the first time that bitcoin came on my radar was in 2017 and at that time 1 Bitcoin was worth around $8,000. And a very nerdy friend of mine was imploring me to buy one. I thought about it for a while but I had no idea how to do it. When I read about Binance and other exchanges, it just sounded so obscure to me. And I think it still does for many people.  

Again it’s this idea that investing is for a select group of people either very wealthy or “in the know.” Having bitcoin in an EFT demystifies some of this. 

The ETF allows you to invest in bitcoin without dealing with any of the unfamiliar aspects of the cryptocurrency ownership experience. By letting you indirectly invest in bitcoin without actually holding the digital asset itself, Bitcoin ETFs eliminate many of the entry barriers surrounding traditional cryptocurrency trading.

The new bitcoin-linked ETF, which gains exposure to bitcoin via future contracts, became the second-highest traded fund on its debut. According to data compiled by Bloomberg, 24 million shares of the Bitcoin ETF changed hands during its first day of trading.

When the ETF launched on the NYSE (under the ticker BITO) it started with $20 million of seed capital. Meanwhile, the price of the cryptocurrency rose as much as 3.8% to a record high of around $66,000 following the Bitcoin ETF launch (today it’s closer to $62,000). 

It’s important to understand that investing in a futures-based bitcoin ETF is not a direct investment in bitcoin. Since the fund tracks bitcoin futures, which are contracts speculating on the future price of the cryptocurrency,

rather than the bitcoin itself, investors should note that the price of the ETF may deviate from the price of the cryptocurrency.

The introduction of a new bitcoin-linked ETF does seem to have added more legitimacy to bitcoin. Yet, trading in futures contracts and speculating where the price will go next may be even more expensive than trading right now in cryptocurrency on an exchange. 

In a way, futures-based bitcoin ETF could potentially be more expensive than investing in bitcoin directly since there are a number of additional costs attached to the futures contracts that can impact the price you, the investor, end up paying. The price of a futures contract will be equal to the spot price (SP) plus the net cost incurred in carrying the asset till the maturity date of the futures contract.

Before I wrap up, I want to give you the 3 key benefits of these bitcoin ETFs. So if you’re out with a group of friends, and the topic comes up you can recall these points.  

The first benefit is the Institutionalization of Bitcoin  

One of the biggest advantages of the futures market is that it removes the cost and hassle of storing whatever commodity it is you have, which in turn makes that commodity much 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 or Binance account in seconds and start trading bitcoin — or any number of other cryptocurrencies, for that matter.

The second benefit is an easier path to 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. 

On top of that, 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 for things to go sideways. 

Something many don’t realize is that bitcoin futures contracts, the ones that underpin most of the current ETF filings, are index-based, tracking the 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 benefit of this consolidated tape approach is that it reduces the risk of market stress events or failure from any one exchange. It also deters price collusion by forcing would-be bad 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.

The final and third benefit is that futures regulation is incredibly clear.

Cryptocurrency markets are largely unregulated—in fact, to some people, 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 futures contract, including surveillance requirements, position limits, risk disclosures, and more. 

On top of that, the CME—oh, CME by the way stands for Chicago Mercantile Exchange—they’re a global derivatives marketplace based in Chicago.They have their own reporting requirements and surveillance activity surrounding futures as a condition of the contracts continuing to list on the exchange. Now, we even have clarity on how bitcoin futures should be taxed.

As I wrap up today’s podcast, I’m curious to hear from listeners out there, does bitcoins ETF make you more interested in investing in bitcoin? Does it give you a border sense of security when it comes to the asset? If you have a moment, drop me an email or send a message on Live Chat and let me know what you think. 

Thank you for listening this week. If you have any other comments relating to today’s podcast, drop me an email at [email protected].

You’ll hear from me again in 2 weeks. Good bye everyone!

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Trevor Kraus

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