Who will win the Bitcoin ETF race in the US?

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Asset managers are scrambling to create America’s first bitcoin exchange-traded fund after a leading securities regulator signaled the way forward.

Over the past two weeks, ProShares, Invesco, VanEck, Valkyrie Digital Assets, and Galaxy Digital have all filed plans for bitcoin futures ETFs. If approved, the funds would make trade bets on the future value of bitcoin akin to buying a stock.

Earlier in August, Securities and Exchange Commission Chairman Gary Gensler indicated that he would be receptive to ETFs that trade bitcoin futures rather than the cryptocurrency itself as long as they follow stricter rules generally reserved for mutual funds. The SEC has already approved the first U.S. bitcoin-based futures mutual fund, which began trading last month.

Futures contracts allow traders to bet on the rise or fall of an underlying market such as oil, gold, or in this case bitcoin. Futures contracts trade separately from the underlying asset from which they are derived; the values ​​between the two can deviate, sometimes widely.

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Asset managers have been trying to persuade regulators to green light bitcoin ETFs for almost 10 years. So far, the SEC has rejected or delayed a decision on the funds. The regulator has taken a cautious approach to regulate the volatile crypto market. Digital assets have gained popularity with amateur traders and a growing number of professional fund managers.

Speaking at the Aspen Security Forum, Gensler said that issuers that structure ETFs under the Investment Companies Act of 1940 would help protect investors from illicit activity. The decades-old law is a more stringent set of guidelines that generally apply to mutual funds. For example, this requires an independent board of directors and gives a fund the ability to stop accepting fresh money, which most ETFs cannot do.

I look forward to the staff review of these deposits, especially if they are limited to those bitcoin futures contracts traded by CME, Gensler added. CME Group’s bitcoin futures began trading in late 2017.

Unlike crypto exchanges, trading platforms such as CME have agreements with the SEC, giving the regulator greater oversight.

Despite the additional safeguards, investors in such funds are likely to face the challenges of trading futures contracts, as well as the risks associated with cryptocurrencies.

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Todd Rosenbluth, head of ETF and mutual fund research at CFRA, warned that futures ETFs rarely replicate the performance of the underlying market they are tracking. The reason for this is the price fluctuations between futures and the spot market, especially if the demand for the asset or commodity is likely to change significantly in the future. There are also costs associated with renewing contracts when they expire.

It is likely that some of the investors who gravitate towards these products will either be disappointed with the performance or oblivious to the risks they are taking, Rosenbluth said.

Funds that trade in futures tend to buy contracts for the nearest month, known in the market as first month contracts. Before contracts expire, funds roll over their assets into the next month. If the futures contracts trade higher than the real-time price of bitcoin, funds would be forced to pay a premium to roll them.

Bloomberg ETF analyst Eric Balchunas estimated that this rolling process would cost investors up to 10 percentage points in annual returns on top of the expense ratios which are expected to be around 1% per year.

Funds that trade in futures are definitely more suitable for institutional investors, said Steven McClurg, chief investment officer at Valkyrie, whose proposed ETF will exclusively trade first month futures. But when no spot product is available, like oil or natural gas, retail investors turn to futures.

The worst-case scenario for investors would be a repeat of the US Oil Fund debacle. This fund often turned expiring contracts into more expensive contracts, causing it to lose twice as much over the past decade as the oil prices it tracked.

In 2020, when oil collapsed, the USO suffered huge losses. Fund managers have been forced to stop creating new stocks and reorganizing its holdings on several occasions, ultimately diversifying its mix of contract expiries into the future.

Some companies trying to launch a Bitcoin futures fund have detailed plans to diversify their asset mix. Invesco, for example, said in a regulatory filing that its fund may also invest in other bitcoin-related assets, such as ETFs listed outside of the United States. Invesco also said it will not renew contracts on a predetermined schedule in an effort to generate the best working performance.

Valkyries’ proposal, meanwhile, is an outright bitcoin futures ETF, which is more in line with Gensler’s thinking, analysts said. McClurg of the company downplayed the potential for a repeat of the USO featuring bitcoin futures funds, saying the USO situation was a unique confluence of events, including Covid-19, an overproduction of oil and oversupply.

I can’t imagine a world where this would happen, he said.

Write to Michael Wursthorn at [email protected]

This article was published by Dow Jones Newswires

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