Bitcoin-linked ETFs attract record assets with strategy designed for traders

The race is on among futures-based Bitcoin ETFs with two funds launching this week and a third expected Monday, and at least a half-dozen more could launch by the end of the year.

If the Oct. 18 debut by ProShares Bitcoin Strategy ETF (BITO) is an indication, the U.S. market is hungry for easy access to anything providing exposure to cryptocurrencies.

The fund gathered more than $1 billion in its first two trading days, eclipsing a record set in 2004 when SPDR Gold Shares (GLD) reached the $1 billion mark in its first three days of trading.

“The ETF market was much smaller in 2004, but BITO’s demand is unprecedented,” said Todd Rosenbluth, director of mutual fund and ETF research at CRFA.

While ProShares is enjoying the classic first-mover advantage in the ETF space, Valkyrie Funds is putting a positive spin on its position as second in the field, launching the Bitcoin Strategy ETF (BTF) on Friday and seeing a third the trading volume of BITO in mid-day trading.

“The bad news is, we’re second and not first, and the good news is, we’re second and not first,” said Valkyrie Funds chief investment officer Steven McClurg.

While acknowledging the lack of the first-mover advantage, McClurg said BTF might also be avoiding some of the early challenges that might be facing BITO in the form of inflows forcing adjustments to the strategy, which invests exclusively in Bitcoin futures contracts.

Not only has BITO already bumped up against its futures contracts limit for October, forcing it to purchase November contracts, but it had to employ its ability to temporarily increase the share creation fee to 10 basis points from 1 basis point to help stem the pace of order flow on the second day of trading.

That creation fee has since been dropped back down to 1 basis point and the futures contracts limit will double for November, but the message is clear the first U.S. Bitcoin futures ETF is blazing a trail and taking its lumps.

The early rocky road might also help explain why Invesco pulled its filing at the last minute, even though was expected to receive approval for launch this week. Invesco did not respond to a request for comment.

“Competition should help draw some of the intensity away from BITO,” said Eric Balchunas, ETF analyst at Bloomberg Intelligence.

“If all the ETFs get their share, which rarely happens with ETFs, then they could all track closely to the Bitcoin spot price,” he added. “But BITO will be our guinea pig.”

With VanEck expected to join the party on Monday with its own futures-based Bitcoin ETF, the pressure on contract limits could lighten even more. But the ongoing question remains as to whether the strategy that allows ownership of futures contracts will be able to track the Bitcoin spot price in a way that will keep investors satisfied.

“The reason people are buying this isn’t because they understand the roll of futures contracts, it’s because they are excited to get exposure to Bitcoin,” Balchunas said. “I think these will mostly be used by traders. You can’t take away the value add for traders.”

EXTREME VOLATILITY

While ETFs investing in futures contracts might be ideal for traders, financial advisers might end up pulling their hair out trying to manage client expectations and reactions to what could be extreme volatility.

Nate Geraci, president of The ETF Store, sees the futures-based ETFs as a foot in the door of regulatory oversight for funds investing directly in cryptocurrencies, but in the meantime, “I use the word suboptimal to describe these (futures-based) strategies.”

“They will not perfectly track the spot price of Bitcoin,” he said, explaining that futures contracts are priced based on the anticipated price of Bitcoin, and that the ETFs are only permitted to own futures.

“If you have the futures curve in contango, with the out months at a higher price than near months, you get a negative roll yield, which is effectively selling low and buying high,” Geraci said. “As you roll when futures contracts are in contango that has a negative impact on the fund.”

Of the first three Bitcoin ETFs, ProShares is enjoying the first-mover advantage, Valkyrie stands out as having the most cryptocurrency chops, and VanEck is taking the lower-cost path, cutting 30 bps off the competitors’ 95 bps fund fee.

Steve Larsen, president of Columbia Advisory Partners and co-founder of cryptocurrency education community PlannerDAO, doesn’t believe the futures-based access is ideal but he does understand the appeal among financial advisers and investors.

“Everybody has been waiting for an easy way to access crypto using their existing brokerage account,” he said. “This may not be ideal, but it certainly checks the box on ease of use.”

Larsen, who invests his clients directly into cryptocurrencies, said financial advisers need to understand why they’re allocating to the futures-based ETFs.

“There are two very distinct ways to look at Bitcoin investments,” he said. “If you’re looking at it as a store of value as a last resort if there are serious monetary problems, the futures contracts will not help you. And then there’s the view that Bitcoin is an asset class, and if that is what you’re trying to accomplish, you can do that through the futures ETF.”

But if the Securities and Exchange Commission allows the futures-based ETFs pave the way for strategies investing directly in cryptocurrencies, these concerns over tracking error might all be for naught.

“I think the futures-based Bitcoin ETFs are living on borrowed time,” said Geraci. “As soon as the SEC approves a physical Bitcoin ETF, the flows from these futures funds will move to the spot product.”