The future of Bitcoin futures is uncertain with the arrival of spot bitcoin ETFs. These ETFs allow investors to buy shares of Bitcoin directly, challenging the existing futures-based funds. However, ProShares, a company based in Bethesda, MD, is not backing down.
The future of Bitcoin futures
For nearly two years leading up to January 2024, investors who wanted to invest in U.S. exchange-traded Bitcoin funds had to use the futures market. The Securities and Exchange Commission (SEC) rejected over 30 applications for funds that aimed to simply buy Bitcoin and trade shares on major stock exchanges. They cited concerns about the potential manipulation in the digital-assets market. However, the SEC approved futures-based Bitcoin funds, as they were based on prices verified by regulated commodity exchanges, even though these futures prices are derived from the spot-market for Bitcoin. ProShares was the first to launch a futures-based Bitcoin ETF, called the ProShares Bitcoin Strategy ETF (BITO), in October 2021. It raised over $1 billion on its first day, becoming the most successful ETF launch ever. Since then, it has accumulated about $2.5 billion in assets. However, with the introduction of spot Bitcoin ETFs, which have amassed around $34 billion in assets, including conversions from the closed-end fund GBTC, the future of futures-based crypto funds is unclear. Some experts believe that investor interest will shift from futures-based products to those offering direct exposure to Bitcoin. VanEck, for example, closed its $43 million Bitcoin Strategy Fund (XBTF) futures ETF and introduced a new spot offering, the VanEck Bitcoin Trust (HODL), which currently holds $176 million. In contrast, ProShares is sticking to its strategy. It has no plans to retire its Bitcoin Strategy ETF (BITO) or convert it to a spot offering. Instead, it recently filed to offer a suite of complementary futures-based ETFs that provide leverage to indirect Bitcoin investments. ProShares’ BITO has a higher expense ratio compared to the new spot offerings, but the company is confident in its approach.
Background:
BITO and similar ETFs buy futures contracts settled in cash at regulated exchanges like the Chicago Mercantile Exchange (CME). They then turn these contracts into shares that people can trade on the stock market. These are different from the new spot ETFs. Spot ETFs get actual bitcoins and offer shares representing a part of those bitcoins. Futures ETFs can be more complex and costly because the issuers have to keep buying new contracts each month. These hidden costs can eat into profits if the price of bitcoin goes up. As shown in the chart below, BITO has not performed as well as its benchmark, the Bloomberg Galaxy Bitcoin Index, since it started. This difference in performance is because the cumulative return includes things like dividends and interest on the fund’s cash. Spot ETFs don’t pay dividends yet. Some people might be surprised that the SEC approved futures products first, given these extra complications and costs. But Chairman Gary Gensler, who used to oversee the Commodity Futures Trading Commission, felt more comfortable with ETFs that track products traded on regulated exchanges, rather than in the largely unregulated world of cryptocurrency trading.ProShares’ BITO had a strong start, capturing 90% of the market share among bitcoin futures funds. Although BITO's assets decreased between January 10 and February 16, they are still higher than they were in mid-October 2023. This increase came as institutional investors bought into the ETF, betting positively on bitcoin in anticipation of the SEC approving spot ETFs. It’s hard to pinpoint exactly why there have been significant outflows from BITO since January 11, but some of it may be due to short-term buyers taking profits. About $93 million of the outflows can be attributed to Cathie Wood’s Ark Invest moving holdings from BITO to her firm’s spot ETF, Ark 21Shares Bitcoin ETF.
Outlook And Implications:
ProShares’ BITO has a steady income source with its 0.95% expense ratio on around $2 billion in assets, making roughly $19 million a year. If ProShares were to switch to a spot ETF, it would likely have to reduce the expense ratio significantly to match its competitors, although its costs would also decrease. BITO is just one of more than 40 exchange-traded products offered by ProShares, which has a total AUM of $64 billion. The company seems to be following a similar strategy to Bitcoin Trust (GBTC), which had a 2% expense ratio as a closed-end fund and only lowered it to 1.5% when it became an ETF. This compares with expense ratios of about 0.26% for most of the new spot ETF competitors. ProShares’ statements align with those of Grayscale CEO Michael Sonnenshein, who has defended GBTC’s higher costs by emphasizing experience, operational efficiency, liquidity, and tight bid-ask spreads. ProShares CEO Michael Sapir believes that BITO's continued success is because many investors want to gain bitcoin exposure through a fund that invests in a regulated marketplace and custodies with a large bank like JPMorgan. Despite BITO’s higher expense ratio compared to its spot ETF rivals, it might not see a significant number of redemptions due to investor inertia, which has a strong influence in investment management.Additionally, taxes could also play a role in investors sticking with ProShares’ higher-cost fund, especially considering capital-gains taxes for BITO holders with significant paper profits. However, when it comes to attracting new investors, the argument for allocating into futures ETFs instead of spot bitcoin funds becomes more challenging. Futures-based commodity ETFs may be more suitable for certain assets than others. For instance, crude oil is difficult to store, requiring large tanks and incurring storage costs. However, spot gold ETFs don’t face the same challenges because gold is valuable, small, and easily stored in a vault, with a liquid spot market. Since bitcoin is often compared to digital gold and is even easier to store, the gold example is relevant. A futures-based fund could potentially outperform bitcoin in a declining cryptocurrency market. While BITO might struggle to keep up with spot prices during periods of contango, when futures prices are highest for long-term contracts, it could perform better during bearish times when rollover costs decrease, known as backwardation. Overall, a futures ETF is considered a more sophisticated product, suitable for tactical strategic investing rather than a simple buy-and-hold approach, according to Ophelia Snyder, co-founder and president of 21.co
What's Ahead for ProShares:
Even though ProShares Bitcoin Strategy ETF remains the main crypto fund for the company, they've recently filed to introduce five other ETFs. These new funds would use swap agreements, a different way to get exposure to bitcoin. They wouldn't directly buy cryptocurrencies but would aim to give investors daily returns based on the Bloomberg Galaxy Bitcoin Index. ProShares is focusing on traders who want more financial leverage, unlike spot ETFs that don't use leverage to boost returns. These riskier funds haven't been approved for trading yet, but they're likely to be allowed since the SEC has approved other similar products that offer different bets and leverage on bitcoin's price.ProShares also has another significant crypto futures ETF, ProShares Short Bitcoin Strategy ETF (BITI), which targets an inverse return on bitcoin's price. Unlike BITO, it mainly sells bitcoin futures contracts to achieve its investment goal. Despite the higher costs of its products, ProShares BITO's strong position among bitcoin futures ETFs gives it a solid place among experienced crypto traders. ProShares is working on creating a range of leveraged products that could attract institutional investors looking to increase gains or manage risk.Nevertheless, it contends with rival offerings from companies such as Hashdex, GlobalX, and Ark21 Shares, provided they remain in operation.
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