24th October 2021 > > Futures based BTC ETFs.

tl;dr

Futures based BTC ETFs (exchange traded funds) are not what they are cracked up to be.

Market Snap

Market Wrap

All quiet.

Occasional Series – Watford F.C.

A rare subject, but Everton 2 Watford FIVE needs to be acknowledged.

Norwich, Newcastle, and Burnley for the drop. Sorry for Norwich, but apart from that all good.

Especially Newcastle, as they embark on their journey of racism, misogyny, and homophobia.

And don’t even start talking to the Saudis about trans rights. That is the quickest route to losing ownership of whatever genitalia you currently possess.

Occasional Series – Centralised exchange security

Always, always use TFA (two-factor authentication) for every single centralised exchange you use.

Google Authenticator is my go-to recommendation.

If you need help, let me know.

Curious Cryptos’ Commentary – Those two new US BTC exchange traded funds (ETFs)

I do hope you don’t think I am banging about any one of my special interests (remember the CCC, - though sceptical in outlook - is vehemently non-partisan and aims to inform, and perhaps occasionally educate, across a broad spectrum of topics).

But one just cannot avoid ETFs right now, after this last week.

I frequently commented that for me, the approval and launch of futures based BTC ETFs would be a disappointment. I thought perhaps that the launch might even, counter-intuitively, lead to a sell-off in the price of BTC.

Fortunately, on this occasion (and frankly it just doesn’t happen that often) I have been proved mightily wrong, with BTC up from $44k on the 1st of October 2021, a 67% increase to the recent all-time high (ATH) at $67k.

Supporters of the futures route to BTC ETFs will point to that fact and say, “I told you so”.

And, for now at least, they are right.

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But this discussion is far from over.

On the 21st of October 2021, we explored the twin concepts of contango and backwardation (past copies available on request). In essence, these are a function of the fact that traditional futures (not perpetual futures swaps) have monthly fixed expiry dates, and that futures contracts of different dates therefore have different prices.

These different prices can be theoretically justified by looking at carry costs, storage costs, and dividend streams. In the case of BTC, carry costs are really the only material factor so far.

The rise of BTC De-Fi (see yesterday’s CCC) brings with it the tantalising and complicating potential for yield farming to affect futures prices, but that will not be particularly relevant for a few months or so.

One might also claim that staking now impacts the futures price and therefore the arbitrage potential between spot and futures. One can certainly argue that point, though some of the data is hard to source and very volatile.

All of this means that futures prices contracts for BTC are (usually) in contango – later dated contracts are priced higher than earlier ones.

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An investor in a BTC futures-based ETF must pay annual fees, which seem to have settled at 0.95%.

This seems a reasonable charge to me for the ease of execution, the liquidity, and the lack of responsibility the buyer takes for storage issues.

So, that’s all good.

Contango however, has a dark side.

Contango means that every month the contracts are rolled at a real cost to the investor. These costs cannot be avoided and will eat into the returns to the investor.

In the commodities world, one can find facts and figures that suggest this underperformance is of the order of 2-5% per annum, which is not insignificant, but manageable.

An analysis of the cost of the monthly roll for BTC for the last few years, has been 2.29% per MONTH.

Over the last year, a theoretical BTC futures fund would have paid away a whopping 28% of the return relative to the spot market.

If that relative underperformance is seen in practise, futures based BTC ETFs will become a lot less attractive, particularly to institutions.

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A fair criticism of this analysis is that as liquidity is drawn to the futures market simply because of the existence of these ETFs, then the contango bleed will reduce. This is possibly true.

But there are two off-setting market push factors that might overwhelm this positive aspect.

Firstly, as the BTC ETF market grows, every month there will be a natural offer in the current contract, and a natural bid in the next dated contract as the expiry draws near. This can only increase the contango.

Secondly, the ProShares ETF launched on Wednesday has already nearly filled its regulatory mandated limit of 2,000 front dated contracts. Much more demand for this product, it will have to start buying longer dated contracts which are less liquid and prone to even greater price discrepancies.

At 5,000 contracts, no BTC futures-based ETF can expand any more, producing further upward price pressure on that ETF and further reducing returns relative to spot.

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I suspect most retail investors are unaware of these wrinkles, but I might be wrong.

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I retain my right to remain sceptical about these products.