May 14, 2023

Bitcoin EFTs: a bad idea whose time has come You can now buy a bitcoin exchange traded fund. Or rather, a Bitcoin derivatives ETF: , which tries to capture returns from the cryptocurrency using futures contracts, started trading yesterday. I’m sure this is good news for someone, but on the face of it, it is hard to imagine a less appealing financial product.

The original idea of an ETF was that it provided a cheap way to receive the beta available in a given market, beta that would be hard to efficiently capture otherwise. Reproducing the return of the Russell 3000 would be a pain in the ass for me to do at home, but Vanguard’s ETF does an almost perfect job of it for me, for all of 10 basis points.

Bitcoin Strategy provides an expensive way to capture some of the beta in a market, which it would be easy to capture, more efficiently, another way. The annual fee is 1 per cent. It draws its exposure to changes in bitcoin’s price from short-term bitcoin futures contracts, meaning that it has to regularly sell expiring contracts and buy new ones.

Because the longer-term contracts are usually more expensive than the shorter ones, rolling the contracts over creates a drag on performance that, it has been estimated, could run to 5-10 per cent annually. The chances that the ETF will perform nearly as well as bitcoin are very low.

This is not very attractive, given than I can jump on to a crypto exchange and buy bitcoins directly, get all of the digital asset’s performance, and pay a lower fee. Other bitcoin funds might be even worse. The great big Grayscale Bitcoin Trust owns bitcoin directly, but it charges 2 per cent. It is a closed-end fund, meaning new shares are not created when assets flow into it.

The trust units therefore trade according to supply and demand, rather than maintaining a link to the value of the underlying assets, as would be the case with an ETF. This year the value of the units have fallen to a 25 per cent discount to the underlying bitcoins (perhaps because investors saw an ETF coming), meaning its relative performance has been awful.

But at least a discount to net asset value does not recur year after year, like the costs of rolling futures contracts. This is the heart of the matter. People want access to crypto returns, but they want the process to work like a standard financial product, and they want bitcoin to sit right alongside the other products in their portfolio.

This is the reason products such as ProShares’s exist. But it is a bad reason. Bitcoin is not at all like standard financial products. It is supported by highly complex technology, the source of its value is fundamentally open for debate, and by far its most common current use is as a vehicle for the purest speculation.

If you can’t be bothered to learn the unique subtleties involved in owning this stuff, you can’t possibly understand the risks, and so you should not own it at all. Bitcoin EFTs should not exist. 

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