Original article by Javier Paz, Forbes staff

Original compilation: Luffy, Foresight News

Michael Sapir, CEO of ProShares. Photo: AP

In the 20 months before January 2024, investors who wanted to put money into Bitcoin funds traded on U.S. exchanges had only the option of entering the futures market. The U.S. Securities and Exchange Commission (SEC) has rejected more than 30 cryptocurrency fund applications on the grounds that crypto asset markets are vulnerable to manipulation. These funds simply buy top cryptocurrencies and package their holdings into shares that trade on major stock exchanges.

The SEC ultimately approved a Bitcoin futures ETF because it was considered arbitrary and capricious because its price is determined by regulated commodity exchanges. It doesnt matter, futures prices are based on the Bitcoin spot market. Therefore, starting with the ProShares Bitcoin Strategy ETF (BITO) in October 2021, 13 futures-based Bitcoin ETFs have been launched. Bethesda, Maryland-based ProShares was the first to launch a Bitcoin ETF, which raised more than $1 billion on the day of its launch, making it the most successful ETF in history. Since then, the company has amassed approximately $2.5 billion in assets as of January 10 this year, when the U.S. Securities and Exchange Commission allowed 10 spot ETFs to begin trading.

Since the Bitcoin spot ETF was launched in January this year, it has accumulated US$34 billion in assets in just one month (including more than US$28 billion in Bitcoin converted from the closed-end fund GBTC). The prospects of the Bitcoin futures ETF It suddenly became less clear. “Investor interest will shift from products that provide Bitcoin futures exposure to products that provide direct Bitcoin spot exposure,” said Kyle DaCruz, director of digital asset products at VanEck. “Spot products can more closely track the price of Bitcoin,” VanEck isn’t waiting for futures Bitcoin funds to fizzle out. The company closed the $43 million Bitcoin Strategy Fund (XBTF) futures ETF last month in favor of the new spot fund VanEck Bitcoin Trust (HODL), which currently holds $176 million in assets.

ProShares, by contrast, is doubling down on futures ETFs. It has no plans to exit its $2 billion Bitcoin Strategy ETF (BITO) or convert it into a spot fund. Instead, it recently filed to offer a complementary series of futures ETFs that add leverage to the fund’s indirect Bitcoin investments. ProShares BITO expense ratio is equivalent to 0.95% of fund assets, about three times that of new spot ETF competitors.

Bitcoin Futures ETF, source: Forbes, data as of February 14, 2024

background

BITO and similar futures Bitcoin ETFs purchase cash-settled futures contracts on regulated exchanges such as the Chicago Mercantile Exchange (CME) and package them into shares that trade freely on the stock market. These products differ from new spot ETFs, in which issuers buy physical Bitcoin and then offer shares that represent partial interests in a Bitcoin portfolio. Futures ETFs can be more complex and expensive because issuers need to keep buying new contracts at each expiration (usually at the end of the month), and if Bitcoin prices start to climb, hidden rollover costs can eat into profits.

As shown in the chart below, BITO has lagged its benchmark, the Bloomberg Galaxy Bitcoin Index, by 8 percentage points since its inception through January 30 this year. Note that there is a difference between cumulative return and spot price return because cumulative return includes other factors such as dividend payments and interest on the funds cash. Cash-only ETFs havent paid dividends yet.

The performance of BITO relative to the BTC index benchmark since its inception. Dark green represents BITO price return (excluding dividend reinvestment), light green represents BITO cumulative total return (including dividend reinvestment), and yellow represents BTC index return %; data source :Bloomberg

Given these additional mechanisms and increased costs, it may come as a surprise to some that the SEC approved futures ETFs in the first place. However, SEC Chairman Gary Gensler, who previously ran the futures market regulator the Commodity Futures Trading Commission, feels more comfortable with ETFs tracking products that trade on regulated exchanges, rather than those that trade on largely unregulated cryptocurrency exchanges. off-the-shelf products.

The strongly launched ProShares BITO accounts for 90% of the market share among Bitcoin futures funds. BITOs assets under management fell by $126 million between January 10 and February 16, but its total assets were still $1.3 billion higher than in mid-October 2023, when institutional investors were bullish in anticipation of SEC approval of spot ETFs Bitcoin, start buying futures ETFs.

The exact reason for the massive outflow of BITO since January 11 is difficult to determine, and a large part may be due to profit-taking by short-term buyers. Cathie Woods Ark Invest converted its BITO shares into her companys spot ETF, the Ark 21 Shares Bitcoin ETF, and gained approximately $93 million.

BITO ETF assets under management as of October 2021, source: Ycharts

key statistics

BITO Bitcoin equivalent holdings, data source: Forbes, ProShares

Bitcoin inflows (losses) from January 11, 2024 to February 14, 2024, source: Forbes

Transaction volume comparison. Green represents the average trading volume over the past 24 trading days, in millions of dollars; yellow represents the activity of the last day, in millions of dollars. Source: Forbes, ProShares, CME Group

Outlook and Impact

Proshares BITO has a stable revenue stream with an asset expense ratio of 0.95% and approximately $2 billion in assets, or approximately $19 million per year. If ProShares were to convert to spot ETFs, it would likely have to cut its expense ratio by two-thirds (although its costs would also fall) to match its competitors. BITO is just one of more than 40 exchange-traded products offered by ProShares, which has $64 billion in total assets under management. The company appears to be taking a similar approach to Bitcoin Trust (GBTC), which had an expense ratio of 2% when it was a closed-end fund, only to drop to 1.5% when it converted to an ETF. By comparison, most new spot ETF competitors have expense ratios of about 0.26%. ProShares public statements mirror those of Grayscale CEO Michael Sonnenshein, who sought to justify the high cost of GBTC by focusing on experience, operational efficiency, liquidity and lower bid-ask spreads.

Michael, CEO of ProShares, said: “We believe BITO’s continued success is driven by the desire of many investors to gain access to funds by investing in an orderly, efficient and highly regulated market and hosted by one of the largest banks in the world (JP Morgan). Bitcoin exposure.”

BITOs higher expense ratio will likely never trigger significant redemptions compared to spot ETF competitors. Inertia has long been a powerful force in investment management. Hector McNeil, founder of hanETF, said, About 75% to 80% of assets under management are invested in exchange-traded funds that have been established for more than 15 years. Theyre so deeply integrated into financial platforms and systems, theyre just reaping the money.

Another factor keeping investors in ProShares higher-cost funds may be taxes, especially compared to the capital gains taxes levied on some BITO holders with large paper profits.

But what about new funding? Are there reasons for investors to allocate to futures ETFs rather than spot Bitcoin ETFs? This is a more difficult argument. It turns out that futures-based commodity ETFs make more sense for some assets than others. For example, crude oil is difficult to store. The problem is, when you have it in stock, you need to store it in big tanks, McNeil said. There is a certain cost involved when storing physical products. However, he pointed out that spot gold ETFs do not present such challenges. Gold is easy to obtain because it is very valuable, small and suitable for storage in vaults... and there is a liquid spot market. Since Bitcoin is marketed as a form of digital gold, it is also easier to store , so the gold example makes more sense.

Futures-based funds could outperform Bitcoin amid falling cryptocurrency markets. While BITO may struggle to keep up with spot prices during periods of contango, when futures prices for longer-dated contracts are highest, the opposite may work in BITOs favor during bear market periods as rollover costs become increasingly cheaper. “Futures ETFs are a more complex product and therefore less suitable for most people,” said Ophelia Snyder, co-founder and president of 21.co. “It is a tactical strategic product rather than a buy and hold product. .”

What’s ahead for ProShares?

While the ProShares Bitcoin Strategy ETF remains the firms flagship cryptocurrency fund, the asset manager recently filed to launch five additional ETFs that would trade swaps, a new type of Bitcoin exposure. The funds will also use North American spot ETFs but will not hold cryptocurrency positions directly and seek to provide leveraged daily returns based on the Bloomberg Galaxy Bitcoin Index:

Source: SEC, ProShares filings

ProShares targets traders seeking financial leverage, which distinguishes it from spot ETFs, which cannot use leverage to amplify returns. These riskier funds have not yet been approved to begin trading, but given that the SEC has approved other products that offer multi-way bets and leverage on Bitcoin prices, they likely will.

ProShares second-largest cryptocurrency futures ETF, the ProShares Short Bitcoin Strategy ETF (BITI) (~$58 million in assets) also targets 1.0x inverse returns on the price of Bitcoin, but is different in that it primarily sells Bitcoin currency futures contracts to achieve their investment objectives.

Despite higher product costs, ProShares BITOs dominance among Bitcoin futures ETFs has given it a strong foothold among established cryptocurrency traders. ProShares is creating an ecosystem of leveraged products that should appeal to institutional investors looking to amplify returns or hedge risk. ProShares faces competition from similar products offered by other issuers, including Hashdex, GlobalX and Ark 21 Shares (assuming they are still operating).