As you’ve likely seen from the headlines, Bitcoin (BTC) futures exchange-traded funds (ETFs) are now trading in the United States and have so far been met with tremendous enthusiasm.
The U.S. Securities and Exchange Commission (SEC) allowing these funds to trade is a major step in the broader acceptance of cryptocurrencies as an asset class, and as a means for institutions to pour money into the market. Yet, for a variety of reasons, these derivatives-based ETFs are really just the first step — the door-opener rather than the be-all and end-all vehicles for institutional inflows.
To put it simply, an ETF built around crypto futures isn’t the most efficient, economical or easiest route. Physically backed products are. They’re likely to attract more assets and open the crypto market to more investors. And they are much easier for investors to understand.
This is why fund issuers should and will continue to press the SEC for clarity on what’s needed to get the Bitcoin spot ETF approved instead of stopping with the more complex, more expensive futures-backed product. This is not the finish line for issuers and investors — it’s the starting block.
A complete framework — but with incomplete reasoning?
One of the reasons a crypto futures ETF was approved first is because, at this juncture, the regulatory framework for futures is clear-cut and well established, particularly compared with physical crypto assets.
Futures fall under the Commodity Futures Trading Commission’s purview. Contracts are standardized. In the case of Chicago Mercantile Exchange (CME) futures, there’s no need for digital wallets, and the absence of a physical asset means fewer questions surrounding the crypto custody puzzle. Know Your Customer, or KYC, is less of a concern because there is no decentralized asset that can be moved from one address to another. Generally, futures markets are more highly regulated and monitored than the spot markets currently are.
Related: The new episode of crypto regulation: The Empire Strikes Back
These futures-backed ETFs are also registered under the 1940 Investment Company Act. “‘40 Act funds,” as they are called, fall under the jurisdiction of the SEC and provide much more robust investor protections, which makes this type of product more appealing to regulators and, not surprisingly, the first type of product out the door. Mutual funds, including those with hedge fund-like strategies, are registered as ’40 Act funds.
What’s the benefit of Bitcoin futures ETFs registering as ’40 Act funds? They avoid many regulatory hurdles, in part because of their mandate of investing primarily in futures listed on a regulated U.S. exchange such as the CME.
More complexity with futures
Simplicity is good, especially when the objective is to attract new money that has been waiting patiently on the sidelines. But futures introduce more complexity by nature, which goes against the spirit of ETFs.
ETFs were designed to be a lower-cost, highly liquid alternative to actively managed funds. Futures, however, aren’t particularly cost-efficient. They require margin as collateral, at disproportionately higher rates compared to other asset classes.
Additionally, trade volumes at U.S.-regulated exchanges are comparatively low, but are expanding, in comparison with offshore exchanges. This prompts the question: Will there be enough liquidity on SEC-approved exchanges such as the CME to meet demand? Early results have raised flags. As investors flocked to the first Bitcoin futures ETF, ProShares Bitcoin Strategy ETF, in just the first two days of trading, the fund started to approach CME’s position accountability limits on how many futures contracts a single entity can hold in a given time frame — in this case, one month. That prompted concern that the issuer would have to look to longer horizons, which could increase costs.
In practice, this first generation of futures ETFs will likely be composed of a basket of different assets in addition to the Bitcoin futures contracts. And due to tax and asset diversification complexities, to hold these investments a subsidiary also needs to be set up, typically in a low-tax jurisdiction like the Cayman Islands. Complexity, of course, means higher costs for investors.
There’s also the issue of discrepancies between futures prices and spot prices. Futures contracts don’t track the underlying assets perfectly. With Bitcoin specifically, there can be a big delta between the projected price of Bitcoin in 30 days (what a futures contract signifies) and the actual price when that date hits. For the year ending September 2, 2021, a rolling position in Bitcoin futures trailed the price of Bitcoin itself by 38 percentage points (295% to 333%, respectively).
Related: Mass appeal: Could a Bitcoin futures EFT electrify US investors?
A reasonable step in the right direction
But does that mean a Bitcoin futures ETF does more harm than good?
Absolutely not. Though it is not necessarily as simple or inexpensive as a spot ETF, a Bitcoin futures ETF still marks a step in the right direction to provide prospective investors access to crypto.
These funds will attract new assets. The ETF structure will make it much easier for financial advisers and others to integrate Bitcoin into their portfolios and standard processes. They will also carry all of the investor protections of the 1940 Act. The rigorous SEC oversight that applies to ‘40 Act funds will allay many investors’ concerns and impose governance checks on fund management. All of this will foster trust and more investment.
Related: Ethereum ETFs are here, building case for US approval of BTC and ETH funds
Considering the sharp rhetoric and critical stance the SEC has adopted in crypto discussions in recent months, the approval of a Bitcoin futures ETF is a significant step forward. It shows the SEC’s willingness to allow crypto asset products to enter the marketplace more fully with a regulatory oversight wrapper and potentially alleviate recent concerns of government overreach.
Yet, the existence of, and success of, these futures funds shouldn’t take issuers’ focus away from the primary goal: working with the SEC and other regulators to establish the clarity needed to get a spot Bitcoin ETF approved.
That process may be lengthy, but the outcome would most certainly be worthwhile. It would finally give investors the low-cost, highly liquid vehicle to track Bitcoin with precision — and thereby align their crypto investments better with their overall portfolio. This, we believe, will ultimately bring in a new, substantial wave of assets that has been long-awaited by industry proponents, investors and issuers alike.
The article has been updated to reflect the recent announcements of Bitcoin futures exchange-traded fund approvals.
This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.