Bitcoin ETFs and Mutual Funds

Although re-written and edited by a human being, the information in this article was generated by ChatGPT and is based on an original transcript from the ever informative YouTube channel called Bitcoin University - the link to the original video can be found here: https://youtu.be/WIriDoNry6g?si=ovj0PClM_NQ0TmAF

Today, I'd like to delve into the realm of Bitcoin Futures ETFs, specifically discussing the BTC Futures ETF (btcfx) issued by ProFunds. Additionally, we'll explore the concept of Bitcoin-backed mutual funds and consider the implications of these products on the market. Furthermore, we'll touch on the topic of leverage and its connection to Bitcoin-backed ETFs.

Before we proceed, let's clarify the abbreviation. ETF stands for "exchange-traded fund," a trading instrument akin to a stock but backed by a diverse range of assets, not just a single company's equity. ETFs offer advantages such as lower fees and increased flexibility compared to traditional mutual funds, which settle at the day's end.

The core argument I'll be presenting revolves around the inherent challenges associated with Bitcoin products, particularly ETFs and mutual funds, backed by Bitcoin Futures. It's crucial to understand that these products are likely to face significant value erosion over time and, in many cases, fail to effectively mirror the actual price performance of Bitcoin.

To comprehend this, it's necessary to grasp the concept of contango in the context of Bitcoin Futures. Contango refers to a situation where prices for Futures contracts in distant months trade at a premium compared to those in nearer months. If we observe the data from the Chicago Mercantile Exchange (CME) for Bitcoin Futures, it becomes evident that contango is a common occurrence.

In contango, prices increase as we move further into the future, creating an upward-sloping curve. This discrepancy in pricing results from factors like storage costs, interest rates, and opportunity costs. Notably, Bitcoin Futures typically experience contango, leading to a price curve that progressively rises over time.

The negative carry cost of contango becomes apparent when analyzing specific contract months. Consider the case of the August and September prices: September settled at $26,265, while August settled at $26,020. Holding September Futures until they become the front month would lead to a loss of approximately $245 per contract, translating to a negative carry of around 0.93 percent per month, or approximately 11 percent annually when compounded.

Now, coupling the negative carry with mutual fund fees, which usually amount to around 1.15 percent, we can deduce why products like btcfx are destined to underperform. The combination of constant value erosion due to contango and management fees results in a structural inability to compete with simply holding Bitcoin.

To substantiate this claim, let's compare the performance of these Bitcoin-backed products with the actual price trajectory of Bitcoin. Year-to-date in 2023, Bitcoin has risen by around 56 to 57 percent. However, products like btcfx and bito (an ETF backed by Bitcoin Futures) have significantly underperformed, only gaining around 29 percent.

Taking it a step further, the introduction of leverage into the equation exacerbates the issues. Leveraged ETFs, like bitx, can amplify losses disproportionately due to the way compounding works, leading to severe tracking errors. Such products are particularly dangerous for retail investors, as their returns can significantly deviate from expected outcomes.

Despite these shortcomings, there's a ray of hope on the horizon. The BlackRock Bitcoin spot ETF, expected to be approved in the coming months, presents a more promising alternative. While this ETF introduces counterparty risk, it also offers an opportunity for investors to seamlessly integrate Bitcoin exposure into their portfolios. Institutional investors can leverage these ETFs, providing them with additional financial tools.

However, it's important to stress that holding actual Bitcoin on a hardware wallet remains the safest strategy, free from multiple layers of counterparty risk. Even with the introduction of Bitcoin ETFs, owning and safeguarding your private keys ensures control and security over your holdings.

In conclusion, the intricacies of Bitcoin-backed ETFs, mutual funds, and leverage necessitate caution. The challenges posed by contango and fees make these products likely to underperform compared to direct Bitcoin ownership. As the market anticipates the arrival of the BlackRock Bitcoin spot ETF, it's crucial to remember that true ownership of Bitcoin lies in possessing the private keys.