Russian doll of Cryptocurrency

Bitcoin-Flavoured Funds

Hi Everyone đź‘‹,

If you’re reading this but haven’t subscribed, join our community of +49k smart, fun & edgy investors 👇

EXPOSURE TO EXPLOSIVE MARKETS. Blockchain Foundry is at the forefront of innovation in the blockchain and NFT markets. From helping enterprises with opportunity audits, consulting, DeFi, token service to a custom-built NFTGen pipeline that will enable much more than what is offered with your typical NFTs, Blockchain Foundry is the gateway to the decentralized universe*.
*This is sponsored advertising content.

So Bitcoin has been around for a while, and it looks like it's here to stay for a while longer. More people around the world are giving into their FOMO and deciding to invest in BTC.

However, with Bitcoin's abstract nature, it's not evidently clear as to what one needs to do to purchase the cryptocurrency. Even for technically-minded people, Bitcoin has not been a straightforward investment to make.

And it’s not getting any easier, as new Bitcoin-based products become available - each with its own specifics and complexities.

At the moment, you can trade Bitcoin spot, futures, options, ETFs and options on those ETFs.

So what do you do when you just want to get some BTC exposure?

Bitcoin-Flavoured Funds

The US SEC regulator seems to suggest that the way forward is to invest in Bitcoin-linked ETFs. Just last month, ProShares launched the first Bitcoin ETF in the U.S., with more to follow. In two days after the launch, the fund’s AUM reached $1 billion.

Fantastic! Once again, ETFs open the markets for retail investors, giving a straightforward way to buy Bitcoin!

Well, there is only one catch.

These ETFs aren't made from fresh Bitcoin - instead, they're just Bitcoin-flavoured funds, made from concentrate. As such, investors don't receive direct exposure to BTC but rather through Bitcoin futures.

So what, who cares!? Futures or spot - it's still going to the moon, right?

Sure, why not. But the ticket to the moon via futures is going to be a little more expensive.

Futures do not track Bitcoin exactly and have additional costs compared to holding Bitcoin spot. And unfortunately, if you're in the US, that's the only route you have for now.

A reasonable suggestion might be - well, in that case, why not just open an ETF that invests in the spot market rather than futures? This would be a fairly straightforward product and give investors the direct exposure they seek.

Well, the SEC has been rejecting applications for Bitcoin spot ETFs so far, and none are available in the US.

Twitter avatar for @EricBalchunasEric Balchunas @EricBalchunas
Spot Bitcoin ETF Has Been REJECTED:
sec.gov/rules/sro/cboe…

Eric Balchunas @EricBalchunas

6 HOURS: to go till SEC's decision on VanEck's spot bitcoin ETF (technically they have till Sunday but unlikely they drop it during wknd). Here's a look at the 2018 disapproval letter which was 92 pages altho the last page said it all... https://t.co/CXuxYQX6DW https://t.co/urBDF7Lj1q

They recently rejected a promising case for a spot ETF, citing “fraudulent and manipulative acts and practices” in Bitcoin markets. (Source:

Hence, futures-based ETFs is what we have.

So what's the problem then?

Caution! Not Compatible with Diamond Hands

Since the end of 2018, investors could purchase Bitcoin via cash-settled futures that started trading on the CME exchange. At 5 Bitcoins per contract, they were trading around $100k at the time.

However, the trouble with futures is that they don't always trade at the same level as the spot market. The difference between the two - called a basis - usually represents a cost of carry in traditional financial markets, but with Bitcoin, it has mostly to do with future expectations. As a result, futures are frequently priced at a premium to spot.

For example, at the time of writing in November 2021, Bitcoin was trading at $58,824, whereas the December CME future was priced at $59,615.

This represents a $791 premium or 1.34% over one month.

The issue is that as time goes by, this premium will eventually evaporate because the futures contract has to converge with spot at expiry:

Therefore, Bitcoin has to appreciate by at least 1.34% for the futures holder just to break even. Of course, given Bitcoin's volatility, it's not something that can't be done, but it still represents an additional headwind for the HODL'er.

And maybe it wouldn't have been such a problem if these were perpetual futures.

But CME futures have an expiration date, and you simply cannot HODL it forever. Once a contract expires, it will be cash-settled, and Bitcoin exposure will cease, effectively forcing paper hands.

If you want to keep playing, you have to "roll your exposure" and buy a new futures contract.

Also, at a premium.

And as you can see, this cost is a recurring problem.

Contango Bleed

If we were to plot a chart of Bitcoin futures against their expiries, it would look something like this:

The further the expiry, the more expensive the contract - a relationship called a contango. If we were to seek a constant Bitcoin exposure via futures, we would need to roll the expiring contract into next month.

Due to contango, every time we approach the expiry, we have to sell the cheaper futures and buy the more expensive one.

Buy high, sell low.

Over time, this adds up to an additional cost, usually termed a "contango bleed". Using current market data below, if we held November Bitcoin futures, it would expire at the end of the month. Selling November and buying December would cost us 1% on the roll, which is approximately 12% annualised.

However, this roll cost varies and can be lower or higher, depending on the futures term structure. Some estimate it can get to as low as 2.5% annually, while others have less optimistic forecasts:

Over time, this can add up to a significant underperformance compared to simply holding Bitcoin.

Don't believe me? Ask the volatility traders.

The concept of contango bleed is far too familiar to anyone trading VIX products, and there is nothing that demonstrates contango bleed better than a VXX fund.

VXX uses a similar strategy in that it holds VIX futures and rolls them as they expire. Given that VIX term structure is in contango most of the time, this results in a roll cost, which.... well... see for yourself:

Adjusting for reverse stock splits, since its launch in 2009, VXX lost 99.94% on contango bleed. Yes, VXX is based on a VIX index, which is a mean-reverting asset, but it still demonstrates what contango roll can do to a financial asset over long periods.

Buy High, Sell Low

So this leads us to the Bitcoin-linked ETF - BITO.

Despite being SEC-approved, the fund is actually a few levels away from physical (physical?) Bitcoin.

And even though it's supposed to track Bitcoin, it can't keep up with the cryptocurrency. Since its inception on 19 October 2021, it has already underperformed Bitcoin spot by around 2%.

And this is why the futures term structure is essential.

In order to obtain a consistent Bitcoin exposure for its investors, the BITO fund has to roll the contracts and pay the difference.

Add an expense ratio of 0.95% on top of that, and you got a substantial hurdle when investing in Bitcoin via BITO ETF.

At the moment, the fund greatly benefits from the TINA (There Is No Alternative) effect. But once a buy-and-hold Bitcoin spot ETF becomes available, it will be difficult for BITO to retain its 1 billion AUM.

Until then, it remains one of the few options in the US to gain Bitcoin exposure without a cryptocurrency wallet.

The key consideration is whether it’s worth the contango bleed.


Sources:
https://www.coindesk.com/policy/2021/10/20/contango-conmigo-why-a-bitcoin-futures-etf-could-be-a-bloody-ride/
https://www.coindesk.com/markets/2021/10/27/its-bito-vs-gbtc-vs-btc-as-bitcoin-etf-wars-heat-up/
https://www.proshares.com/funds/bito.html
https://www.bloomberg.com/news/articles/2021-10-20/proshares-bitcoin-etf-tops-1-billion-in-assets-in-just-two-days
https://www.bloomberg.com/news/articles/2021-11-12/sec-rejects-vaneck-s-bitcoin-etf-application-to-trade-on-cboe
https://www.cmegroup.com/markets/cryptocurrencies/bitcoin/bitcoin.quotes.html
TradingView

Disclaimer: The publisher does not guarantee the accuracy or completeness of the information provided in this page.  All statements and expressions herein are the sole opinion of the author or paid advertiser.

Grit Capital Corporation is a publisher of financial information, not an investment advisor.  We do not provide personalized or individualized investment advice or information that is tailored to the needs of any particular recipient.  

THE INFORMATION CONTAINED ON THIS WEBSITE IS NOT AND SHOULD NOT BE CONSTRUED AS INVESTMENT ADVICE, AND DOES NOT PURPORT TO BE AND DOES NOT EXPRESS ANY OPINION AS TO THE PRICE AT WHICH THE SECURITIES OF ANY COMPANY MAY TRADE AT ANY TIME.  THE INFORMATION AND OPINIONS PROVIDED HEREIN SHOULD NOT BE TAKEN AS SPECIFIC ADVICE ON THE MERITS OF ANY INVESTMENT DECISION.  INVESTORS SHOULD MAKE THEIR OWN INVESTIGATION AND DECISIONS REGARDING THE PROSPECTS OF ANY COMPANY DISCUSSED HEREIN BASED ON SUCH INVESTORS’ OWN REVIEW OF PUBLICLY AVAILABLE INFORMATION AND SHOULD NOT RELY ON THE INFORMATION CONTAINED HEREIN.

No statement or expression of opinion, or any other matter herein, directly or indirectly, is an offer or the solicitation of an offer to buy or sell the securities or financial instruments mentioned.  

Any projections, market outlooks or estimates herein are forward looking statements and are inherently unreliable.  They are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.  Other events that were not taken into account may occur and may significantly affect the returns or performance of the securities discussed herein.  The information provided herein is based on matters as they exist as of the date of preparation and not as of any future date, and the publisher undertakes no obligation to correct, update or revise the information in this document or to otherwise provide any additional material.

The publisher, its affiliates, and clients of the a publisher or its affiliates may currently have long or short positions in the securities of the companies mentioned herein, or may have such a position in the future (and therefore may profit from fluctuations in the trading price of the securities).  To the extent such persons do have such positions, there is no guarantee that such persons will maintain such positions.

Neither the publisher nor any of its affiliates accepts any liability whatsoever for any direct or consequential loss howsoever arising, directly or indirectly, from any use of the information contained herein.

By using the Site or any affiliated social media account, you are indicating your consent and agreement to this disclaimer and our terms of use. Unauthorized reproduction of this newsletter or its contents by photocopy, facsimile or any other means is illegal and punishable by law.

For Full Terms of Use Click HERE. For the Privacy Policy Click HERE.

A guest post by
Sergei is a former Goldman Sachs quantitative analyst. Besides writing for @Grit_Capital, he also makes videos for http://perfiliev.com/youtube. Follow him on Twitter at https://twitter.com/perfiliev