The journey to a Bitcoin ETF started with the first application in 2013.

Now – eight years later – the first Bitcoin Futures ETF if finally launched. The pent-up demand of a Bitcoin ETF was displayed when ProShares Bitcoin Strategy ETF (BITO) became the second-most traded ETF in its trading debut, with a trading volume of US$ 1.01 Billion.

Interestingly, the fund does not directly invest in Bitcoin. Instead, it maintains exposure primarily to Bitcoin Futures Contracts. And the end result is the same…

Rather than investing in Bitcoin through cryptocurrency exchanges, investors can now get exposure to Bitcoin’s price movement through their conventional investment accounts.

What are Exchange Traded Funds (ETFs)?

Exchange-Traded Fund (ETF) is an investment entity that utilizes funds invested by investors to track an index, a commodity, or a wide portfolio of assets.

For example, Vanguard S&P 500 ETF (VOO) invests in stocks in the S&P 500 Index, representing 500 of the largest U.S. companies. ETF is like a mutual fund as they both offer a system for investors to diversify into various assets without owning the assets themselves.

However, unlike a mutual fund, the units of the ETF are listed on a stock exchange and can be traded like any other stock. Furthermore, their price changes continuously to reflect changes in their holdings. Whereas Mutual Funds can be purchased only at the end of each trading day based on a calculated Net Asset Value (NAV).

How does ProShares Bitcoin Strategy ETF (BITO) work?

As mentioned earlier, ProShares Bitcoin Strategy ETF (BITO) does not directly invest in Bitcoin.

The U.S. Securities and Exchange Commission (SEC) has earlier rejected applications for “Spot” Bitcoin ETFs stating that Bitcoin was traded in highly unregulated exchanges, making them vulnerable to fraud and manipulation.

BITO tracks the price of Bitcoin by entering Bitcoin Futures Contracts that are traded on Chicago Mercantile Exchange and regulated by the SEC. Since, the futures price and spot prices are highly correlated the ETF accurately tracks the price of Bitcoin (however, situations like contango or backwardation may occur where there might be a mismatch of prices).

Investment Rationale

• Diversification: The new Bitcoin Futures ETF provides a new avenue for retail and institutional investors to obtain exposure to Bitcoin and diversify their holdings
  
• Regulated: Unlike “Spot” Bitcoin that is unregulated, Bitcoin Futures Contracts are traded in U.S. Securities Exchanges, that are regulated by SEC and give protection from Counterparty Risk.
  
• Straightforward: Unlike “Spot” Bitcoin, this ETF presents an easier path to invest in the asset through regular investment accounts
  
• Active Management: The ETF is actively managed, and the management can utilize their expertise to reduce the volatility of Bitcoin and utilize cash efficiently at good investment opportunities.
  
• Shorting Opportunity: ETFs are traded in stock exchanges and therefore, provide an opportunity to short them and gain profit when Bitcoin drops in value.

But, should you invest in ProShares Strategy Bitcoin ETF now?

Short Answer – Bitcoin prices are highly volatile and only for investors with a high-risk tolerance. On top of that, the ETF itself is new to the market so it may be wise to take a “wait and see approach”.

Long Answer - Remember that the fund doesn’t directly invest in Bitcoin, but rather Bitcoin futures?This makes a big difference!

Bitcoin (and crypto in general) is an asset class, whereas Bitcoin futures are a contract that uses Bitcoin as a reference asset. Like all other contracts, Bitcoin Futures expire too! As these contracts expire, the fund will regularly need to sell the contracts they own and buy new ones.

Earlier we mentioned a situation called contango or backwardation thatmay occur. While it may sound exotic, as an investor contango is not the kind of dance you want to be doing.

Contango is when the subsequent months’ contracts are trading at the price higher than the current months’ contract. In this situation, the fund will incur losses (because it is a sell-low, buy-high kind of transaction). 

These losses are borne by investors in the form of costs.

Thus, you won’t ever match the true return of a Bitcoin by investing in Bitcoin Futures ETF. On the other hand, Backwardation is the exact opposite of Contango.

The other reason to be careful of investing in these futures now is to avoid getting trapped in a stampede. The BITO ETF is trading at very high volumes since its debut. The BITO ETF used up 2/3rds of its cap (trading limit), and if it hits the cap, the exchange may halt new contract creations.

This could adversely affect the existing investors.

So, before flocking to invest in Bitcoin (futures) ETFs, it could be better to wait until these ETFs are stabilized.

Other Generic Risks

• Systemic Risk: Bitcoin prices have been highly volatile. The value of the fund’s assets may suddenly decline in value due to various events. Investors must be prepared to withstand situations when the market price of the ETF declines considerably.
  
• Liquidity Risk: Bitcoin Futures Contracts are at a very nascent stage, and it may be possible that there is an unavailability of buyer or seller of a position at the desired price. This can cause a divergence between the price of the derivative and the underlying asset.

Conclusion

The approval of Bitcoin Futures ETF will create a trend of more investment companies launching new ETFs that track Bitcoin and other crypto prices.

In fact, already other Bitcoin Futures ETFs are popping up like Valkyrie Bitcoin Strategy ETF (BTF) and soon to launch Vaneck Bitcoin Strategy ETF (XBTF).

Investors have been demanding an ETF for Bitcoin for a long time. New products related to it will provide solutions for different people based on their needs and risk profile. But, before jumping on the bandwagon, it is better to wait until the market for these new ETFs stabilizes.