With the mainstream appeal of cryptocurrencies surging in the last few years, many investors are looking to add this alternative asset class to their portfolios. 

Those looking to gain exposure have two options – own the underlying asset or invest in financial products whose value is closely related to the performance of the underlying asset. A crypto ETF is one such product. Much like any traditional ETF, a crypto ETF can be bought or sold on an exchange and tracks the performance of the underlying asset(s). The push to list more mainstream standardised financial products tied to cryptocurrencies is not new. The first attempt to create a Bitcoin ETF was in 2013, but these products have generally struggled to gain traction because of regulatory roadblocks. 

There are a few benefits to owning an ETF share versus the underlying Bitcoin: 

• Investors avoid having to deal with some of the pitfalls of Bitcoin ownership like the storage costs and security concerns (i.e., no need to deal with an unregulated cryptocurrency exchange or wallet). 
• Exchange traded products are simple to trade. 
• There is greater regulatory protection for investors (brokerage accounts are protected by the Securities Investor Protection Corporation in the US). 
• For investors with a bearish view on Bitcoin, ETFs can be constructed to provide short exposure to the asset.  

The SEC has yet to approve an ETF tracking the spot price of Bitcoin in the US, citing the potential for fraud and manipulation in the market. However, ProShares launched their Bitcoin Strategy ETF (with the BITO ticker) in October last year, which was the first of its kind in the US. The fund tracks the futures price of Bitcoin rather than the spot price, based on futures contracts traded at the CME. It proved to be one of the most-traded ETFs on record on its trading debut, with approximately $1B worth of shares changing hands. 

As in more traditional futures markets, the Bitcoin futures contracts underlying the ProShares ETF are subject to margining and collateral requirements. In addition, to maintain a consistent futures position, these contracts need to be periodically “rolled” (i.e., bought and sold) as they have set expiry dates.  

This introduces a particularly punitive cost for the fund if the market is in contango (i.e., the futures price is higher than the current spot price), since it costs more to exit the expiring contract and enter the new one. Clearly, this can hinder the fund’s ability to achieve its investment objectives. 

A recent Risk.net article these concerns, noting that investors in the ProShares fund will pay an average of 8% a year to roll the underlying futures from one month to the next. In addition, the fund has a 0.95% annual management fee. These costs have contributed to the fund’s poor performance – down 42% since inception. 

Despite this poor performance, this is still a space that is ripe for innovation and development. Many investors and fund managers believe it is only a matter of time before an ETF tracking Bitcoin’s spot price is approved in the US. There are already spot cryptocurrency products listed on exchanges in Germany, France and Switzerland. As regulation evolves, it is inevitable that more products will be developed to track the movements of a wider range of digital assets in future. 

Author: Nicholas Petersen

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