Who will win the bitcoin ETF race in the US?

Asset managers are jockeying to create the first US bitcoin exchange-traded fund after a top securities regulator signaled a path to approval.

In the past two weeks, ProShares, Invesco, VanEck, Valkyrie Digital Assets and Galaxy Digital have all filed plans for bitcoin futures ETFs. If approved, the funds would make trading bets on bitcoin’s future value akin to buying a stock.

Earlier in August, Securities and Exchange Commission chairman Gary Gensler indicated that he would be receptive to ETFs that will trade in bitcoin futures rather than cryptocurrency itself as long as they follow stricter rules usually reserved for mutual funds. The SEC has already approved the first US bitcoin-futures-based mutual fund, which started trading last month.

Futures let traders bet on whether an underlying market such as oil, gold or, in this case, bitcoin, will rise or fall. Futures trade separately from the underlying asset they are derived from; values between the two can deviate, sometimes widely.

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Asset managers have been trying to persuade regulators to green-light bitcoin ETFs for nearly 10 years. So far, the SEC has rejected or delayed a decision on the funds. The regulator has taken a cautious approach to regulating the volatile crypto market. The digital assets have boomed in popularity with amateur traders and a growing number of professional money managers.

Speaking at the Aspen Security Forum, Gensler said issuers who structure ETFs under the Investment Company Act of 1940 would help protect investors from illicit activities. The decades-old law is a more stringent set of guidelines that usually apply to mutual funds. For example, it requires an independent board and gives a fund the ability to stop accepting new money — something most ETFs can’t do.

“I look forward to the staff’s review of such filings, particularly if those are limited to these CME-traded bitcoin futures,” Gensler added. CME Group bitcoin futures contracts started trading in late 2017.

Unlike crypto exchanges, trading venues such as CME have agreements with the SEC, giving the regulator greater oversight.

Despite the additional safeguards, investors in such funds would have to deal with issues associated with trading futures, as well as the risks around cryptocurrencies.

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Todd Rosenbluth, head of ETF and mutual-fund research at CFRA, warned that futures-based ETFs rarely replicate the performance of the underlying market they track. The reason is pricing fluctuations between futures contracts and the spot market, especially if demand for the asset or commodity is expected to change significantly in the future. There are also costs associated with rolling over contracts when they expire.

“It’s likely that some of the investors who gravitate toward these products will either be disappointed in the performance or unaware of the risks they are taking,” Rosenbluth said.

Funds that trade in futures tend to buy contracts for the nearest month, known in the market as front-month contracts. Before the contracts’ expiration, funds roll their assets into the next month. If futures contracts trade higher than bitcoin’s real-time price, funds would be forced to pay a premium to roll them.

Bloomberg ETF analyst Eric Balchunas estimated that this rolling process would cost investors as much as 10 percentage points in annual returns — on top of expense ratios that are expected to be around 1% a year.

Funds that trade futures “really are more appropriate for institutional investors,” said Steven McClurg, chief investment officer at Valkyrie, whose proposed ETF will exclusively trade in front-month futures contracts. “But when there’s not a spot product available, like with oil or natural gas, retail investors look toward futures products.”

A worst-case scenario for investors would be a repeat of the United States Oil Fund debacle. That fund often rolled expiring contracts into more-expensive ones, causing it to lose twice as much over the past decade as the oil prices it tracked.

In 2020, when oil cratered, USO suffered enormous losses. The fund’s managers were forced to stop creating new shares and to revamp its holdings several times, ultimately diversifying its mix of contract expirations further into the future.

Some firms trying to launch a bitcoin futures fund detailed plans to diversify their asset mix. Invesco, for example, said in a regulatory filing that its fund may also invest in other bitcoin-related assets, such as ETFs listed outside the US. Invesco also said it won’t roll contracts on a predetermined schedule in an effort to generate the greatest roll yield.

Valkyrie’s proposal, meanwhile, is a pure-play bitcoin futures ETF, which is more in line with Gensler’s thinking, analysts said. McClurg of the firm played down the potential for a USO repeat starring bitcoin futures funds, saying the USO situation was a unique confluence of events, including Covid-19, overproduction of oil and too much supply.

“I can’t envision a world where that would happen,” he said.

Write to Michael Wursthorn at [email protected]

This article was published by Dow Jones Newswires

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