This is a departure from my usual blog, focusing on the newly launched ProShares Bitcoin Strategy ETF (BITO). Most ETFs analyzed in my blog articles are covered by ValuEngine with a handful of exceptions. ValuEngine does not cover any ETFs that do not hold stocks. Moreover being newly launched, our price-based models cannot yet be applied. Therefore, viewpoints expressed here about BITO are entirely my own and do not necessarily represent the opinion of ValuEngine,Inc. or any of its owners.
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Let’s start with some very basic facts:
- BITO holds futures on Bitcoin listed on the Chicago Mercantile Exchange (CME). It does not hold Bitcoin. Accordingly, it irritates me that many in the investment media are calling it a Bitcoin ETF. My fervent hope is that any client-facing investment professional reading this will make clear to clients that this is a Bitcoin Futures ETF, not a Bitcoin ETF.
- Futures are derivative securities that by their nature bear many risks not inherent in stocks. These include contango, backwardation, roll risk and more.
- Returns on gold futures vary significantly from “paper returns” on the spot price of gold. Thus far in its history, Bitcoin has incurred a daily volatility higher than the very high volatility associated with gold. My expectation is that the mismatch risk between futures and “spot” will be even higher with Bitcoin than it is with gold.
- There are risks associated with Bitcoin by its very nature that is not true about futures on commodities, securities indices and almost anything else on which futures are traded. Bitcoin is not tangible. It has no intrinsic usage value. It has no government nor deep pockets standing up to insure it during potential crashes or wipeouts. Presently, it is believed to be non-hackable and non-stealable, but no one knows whether that will always be the case. Analysts believe part of its value is from the fact that the distributed ledger technologies that keep it safe also keep it untraceable. It is also possible for that to change in the future.
- BITO is expensive relative to other ETFs with an expense ratio of 0.95%.
Therefore, I recommend even more strongly something I always preach. Download the BITO prospectus and read it carefully before attempting to buy it or use it in a trading strategy. Here is the link to the prospectus from the ProShares website:
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Between pages 3 and 7 you will find 21 risks spelled out in detail. All are important and many may not be intuitive. Beyond massive volatility and negative compounding, they include; negative yield roll risk; contango; backwardation; counterparty risk; liquidity risk; market capacity risk; risk related to potential scarcity of authorized participants; risks of potential increased collateral requirements; increased expense ratio risk, etc. None of these things should necessarily scare you away from considering the product. However, make certain you understand them and their implications for your potential strategies before you start trading BITO.
Bethesda-based ProShares is a terrific ETF provider that has existed for nearly 20 years. They have a well-deserved strong reputation as a high-quality sponsor. most of their products are derivatives-based. Many are leveraged or inversely weighted. Futures and similar derivatives are governed by the CFTC which requires investors that trade on the CME and other futures exchanges to submit documents showing that they understand the risks and are qualified to take those risks. The CFTC expressed many concerns about ETFs holding futures specifically because there are no such qualifications required to buy and sell ETFs. Therefore, the name ProShares is very apt. To me, it infers that they are designed to be used by market professionals, not novices.
Indeed, I have personally had to explain to a colleague how he lost about 7.5% per year holding ProShares UltraBull S&P 500 ETF (UPRO), a three-times leveraged product, during a three-year period from 2010-2012 in which the S&P 500 gained nearly 9% per year. The answer is daily compounding. Derivatives-based ProShares are designed for short term trading, the majority of it intraday. The fund tracks the index on a daily basis – NOT on an annual basis. Another example of a ProShares futures product that gave many holders and unpleasant surprise was the ProShares Short-Term Inverse VIX ETF (SVXY) that provided very good returns when stock market volatility was low but lost 96% of its value in two days when an unexpectedly sharp market downturn spiked volatility tremendously in a short period of time. To be clear, BITO is neither leveraged nor inverse-leveraged, so these specific unpleasant surprises are unlikely to apply. The lessons to be learned from these cautionary tales is that it is important to understand how futures products work before trading them. ProShares’ material explicitly state that the futures-based products are designed for daily tracking and trading.
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A Twitter tweet that received a lot of attention on the day BITO commenced trading stated, “Friends don’t let friends buy and hold futures-based ETFs.” I agree with this statement even though it cannot be considered impartial. It was made by Barry Silbert, Founder of the Greyscale Bitcoin Trust (GBTC). GBTC which buys and holds bitcoin at spot on coin exchanges is a closed-end trust holding bitcoin. It has an embedded expense ratio of more than 2%. Consequently, GBTC generally trades at a significant discount to Bitcoin spot. As Bloomberg ETF expert Eric Balchanus pointed out in reply to Barry’s tweet, “I don’t disagree but in all fairness, GBTC is lagging bitcoin spot by 160 percentage points in the past 12 months. That’s equivalent of 10 years of roll costs.”
BITO is fine for short-duration institutional traders used to trading futures and futures-based ETFs. I consider it a short-term tactical tool that should be used only by professionals. GBTC is high-cost and has structural design and trading platform issues that I believe most investors should avoid. Longtime colleague Matt Hougan, CEO of Bitwise Asset Management and an expert in ETFs and Bitcoin, believes that both products are too expensive relative to the cost of opening a cryptocurrency trading account at a secure trading platform such as Robin Hood or Coinbase. This advice makes sense to me for investors wishing to buy and hold Bitcoin.
Senior Quantitative Analyst