In what was a watershed moment for both cryptocurrency and U.S. financial markets, the Securities and Exchange Commission (SEC) greenlit Bitcoin exchange traded funds on October 15, 2021. The only catch – these products are required to invest in futures contracts rather than actual Bitcoin or Canadian Bitcoin ETFs that invest in physical Bitcoin on investors’ behalf. While this past week marks a major step in democratizing safe access to a novel asset class, there are some key differences to keep in mind as an investor.
Futures Primer: What Are Futures Contracts?
Futures contracts provide investors with the ability to purchase (or sell) an asset at a fixed price on a defined date in the future. In essence, this allows an investor to lock in a price today for a planned transaction. In the case of Bitcoin, purchasing future contracts gives instant exposure to a future purchase of Bitcoin. These futures contracts are cash settled, meaning that the contract holder receives a cash settlement equal to what a Bitcoin is worth as of the defined date.
Futures contracts for a commodity are generally available to trade for many different delivery dates, and prices can differ along the futures curve. Many of these prices are different than what the commodity cost today. The reason for this is simple – sometimes these commodities provide benefits when holding or cost money to store, making the future price higher or lower than what it is today. When the futures prices for a commodity are higher than they are today, and increase as time goes on, the market is said to be in “contango.” Bitcoin is currently in a contango market, as transaction prices in the future are more expensive than the commodity cost today.
The Pricing of Bitcoin Futures
Data as at October 18, 2021.
Looking at the futures curve, as depicted in the chart above, one can visualize how much is being paid versus the current market price. The major issue with using futures contracts to provide long-term exposure to a commodity is that once the future date arrives, the fund needs to sell the existing futures contract to buy a new one, with a date further in the future; this is known as “rolling the futures.” The process needs to be repeated regularly to maintain exposure to crypto assets rather than settling the exposure in cash terms. In a contango market, such as Bitcoin, this results in losses over time.
Data as at October 18, 2021.
If the futures curve remains the way it is today, this imposes a cost on the fund’s total net assets. Each time the more expensive, longer-dated futures contract is purchased, the fund can afford less Bitcoin than it had exposure to with the sold contract.
Note that this chart is not depicting hypothetical performance data – instead, it demonstrates how costs of “rolling” futures may occur. These costs are not derived from the performance of the fund, they are a result of the inherent structure of a futures-based investment strategy.
Future-based ETFs are hardly new – for decades, investors have been able to purchase ETFs that provide exposure to various commodities. The graph below depicts what happens to the exposure over time.
Data for 2006 to 2019 as sourced on October 21, 2021.
At Purpose, our Bitcoin and Ether ETFs invest in actual Bitcoin and Ether – not futures contracts. We believe that providing access to actual cryptocurrency provides a better experience for investors, and results in better exposure to one of the fastest-growing asset classes of our time.
It is extremely important for investors to understand the implications of investing in a futures-based product. For most, the term “decentralized finance” invokes thoughts of transparency, democratization, and innovation. Some could say that investing in the ecosystem using complex, centralized financial instruments plagued by decay is counterintuitive. Feel free to reach out to firstname.lastname@example.org to learn more.
All data sourced to Bloomberg unless otherwise noted.
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