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App\Entity\Article {#1094
  -id: 10082
  -title: "U.S. Bitcoin ETF Is Net Zero Bitcoin"
  -slug: "u-s-bitcoin-etf-is-net-zero-bitcoin"
  -introtext: "<p><span style="color: #000000;">While a U.S. Bitcoin ETF sounds good in theory, peek under the hood and investors will find a futures-based instrument riddled with contradictions that has very little to do with bitcoin anyway.</span></p>\r\n"
  -content: """
    \r\n
    <p id="7291" data-selectable-paragraph><span style="color: #000000;">Considering that there’s an app for practically everything these days, it stands to reason that it was really only a matter of time before Wall Street lobbied Washington sufficiently to roll out its own version of bitcoin — the ultimate bitcoin app for institutional investors.</span></p>\r\n
    <p id="37c5" data-selectable-paragraph><span style="color: #000000;">While many investors cheered the arrival of the ProShares Bitcoin Strategy ETF, the first U.S. ETF to feature all of the flavor of bitcoin, with none of the fat, bitcoin maximalists chuffed at its lack of real bitcoin inside its ETF shell.</span></p>\r\n
    <p id="4b81" data-selectable-paragraph><span style="color: #000000;">Unlike some bitcoin ETFs in Europe and Canada, the American version is backed by bitcoin futures traded on the Chicago Mercantile Exchange, which themselves are cash-settled instruments.</span></p>\r\n
    <p id="ac08" data-selectable-paragraph><span style="color: #000000;">But what’s the big deal?</span></p>\r\n
    <h2 id="2e6c" data-selectable-paragraph><span style="color: #10228b;">What’s an ETF?</span></h2>\r\n
    <p><img src="/images/ETF_Debunked.png" alt="ETF_Debunked.png" /></p>\r\n
    <p id="ac8c" data-selectable-paragraph><span style="color: #000000;"><br />To understand why a futures-backed ETF, especially one that is cash-settled, is a bit like saying a pop tart is full of fruit, it’s first necessary to understand what an ETF is in the first place.</span></p>\r\n
    <p id="2d67" data-selectable-paragraph><span style="color: #000000;">In a nutshell, an ETF is a type of investment fund that can be traded on a stock exchange.</span></p>\r\n
    <p id="516c" data-selectable-paragraph><span style="color: #000000;">Similar to a mutual fund, the key difference between an ETF and a mutual fund is that shares in an ETF are bought and sold throughout the day as long as a stock exchange is open, whereas with mutual funds, these are bought and sold back to the issuer (also known as a redemption) based on the net asset value of the shares in that mutual fund at day’s end.</span></p>\r\n
    <p id="adb9" data-selectable-paragraph><span style="color: #000000;">ETFs and mutual funds also differ in terms of liquidity.</span></p>\r\n
    <p id="ce47" data-selectable-paragraph><span style="color: #000000;">Because the assumption is that having an open market like a stock exchange which any investor can plug into and buy or sell a security, ETFs are typically seen as more liquid instruments as compared to a regular mutual fund, which only has one liquidity provider of last resort, typically the issuer themselves.</span></p>\r\n
    <p id="76a3" data-selectable-paragraph><span style="color: #000000;">But even before getting to understand what ETFs are, it’s important to get a glimpse into what caused them to exist to begin with.</span></p>\r\n
    <p id="c045" data-selectable-paragraph><span style="color: #000000;">Prior to 1993, there wasn’t an easy way for investors to purchase a single share that gave them exposure to a broad index of American stocks.</span></p>\r\n
    <p id="2e23" data-selectable-paragraph><span style="color: #000000;">Think of an index like a buffet.</span></p>\r\n
    <p id="95c3" data-selectable-paragraph><span style="color: #000000;">For most of us, there’s no conceivable way to stuff a full portion of every single dish at a buffet, but broken down to bite-sized chunks, it is possible to sample a wide variety of foods.</span></p>\r\n
    <p id="4ec3" data-selectable-paragraph><span style="color: #000000;">So is it with an index.</span></p>\r\n
    <p id="583b" data-selectable-paragraph><span style="color: #000000;">When the benchmark S&amp;P 500 was created, it was intended as an index to represent a broad swathe of American companies and indirectly, the performance of the U.S. economy.</span></p>\r\n
    <p id="43d3" data-selectable-paragraph><span style="color: #000000;">As soon as the index was created, there was a demand from investors, especially retail investors, to find a way to participate in such an index at relatively accessible ticket sizes.</span></p>\r\n
    <p id="8a59" data-selectable-paragraph><span style="color: #000000;">The problem is that copying an index like the S&amp;P 500 would be prohibitively expensive for an individual investor because they would need to hold shares of 500 American companies in the proportion of their weightage in the S&amp;P 500 index.</span></p>\r\n
    <p id="9527" data-selectable-paragraph><span style="color: #000000;">Just one Google share alone would cost an investor almost US$3,000, while shares of Tesla, just over a thousand bucks, and even then we’re just getting started.</span></p>\r\n
    <p id="9410" data-selectable-paragraph><span style="color: #000000;">Complicating the matter, the composition of the S&amp;P 500 is updated from time to time and investors who were trying to create their own version would need to stay on top of that as well.</span></p>\r\n
    <p id="f3bf" data-selectable-paragraph><span style="color: #000000;">Which is why in 1993, State Street Global Investors created the S&amp;P 500 Trust ETF, called the SPDR or “spider” for short, which till today, remains one of the most actively traded ETFs, as a means to provide regular investors a way to gain that broad exposure, in a bite-sized chunk.</span></p>\r\n
    <p id="357f" data-selectable-paragraph><span style="color: #000000;">So now if an investor wants to buy an exposure to the stocks in the S&amp;P 500, instead of needing to buy each individual stock, they can simply buy shares in the ETF, which will then use those proceeds to purchase the underlying shares, with a small fee for the service.</span></p>\r\n
    <p id="e3d9" data-selectable-paragraph><span style="color: #000000;">Investors in the ETF indirectly own the assets of the fund and will typically receive annual reports and a share of the profits such as interest, or dividends — as good as if the investors themselves owned constituent shares of the S&amp;P 500 in their own right — and that’s an important distinction.</span></p>\r\n
    <p id="2e06" data-selectable-paragraph><span style="color: #000000;">Whereas U.S. bitcoin ETFs invest in cash-settled futures, something like the SPDR actually buys shares of the very asset that it is intended to track.</span></p>\r\n
    <p id="8d9e" data-selectable-paragraph><span style="color: #000000;">When an SPDR ETF investor sells the ETF on the exchange, either another investor buys it, or the ETF issuer sells the underlying assets to realize the proceeds of that sale.</span></p>\r\n
    <p id="a3aa" data-selectable-paragraph><span style="color: #000000;">If more investors want to purchase more of an ETF, these additional funds will then be used to buy more of the underlying asset.</span></p>\r\n
    <p id="be35" data-selectable-paragraph><span style="color: #000000;">And in a nutshell, that’s what an ETF is.</span></p>\r\n
    <p id="f25c" data-selectable-paragraph><span style="color: #000000;">Some of the largest ETFs have an annual fee of just 0.03% of the amount invested, which is a real steal, considering the amount of service that you get in return.</span></p>\r\n
    <p id="1fcc" data-selectable-paragraph><span style="color: #000000;">Since then, ETFs have been created for a whole range of assets, from commodities to stock indices and you guessed it, bitcoin.</span></p>\r\n
    <p id="b04e" data-selectable-paragraph><span style="color: #000000;">Given their convenience and accessibility, it’s no surprise then that ETFs have soaked up a ton of investor dollars.</span></p>\r\n
    <p id="7d9a" data-selectable-paragraph><span style="color: #000000;">As of August this year, some US$9 trillion was invested in ETFs globally, with the U.S. accounting for some US$6.6 trillion alone.</span></p>\r\n
    <p id="d335" data-selectable-paragraph><span style="color: #000000;">The market for U.S. ETFs, at the risk of sounding lewd, continue to be the deepest and most liquid in the world.</span></p>\r\n
    <p id="504c" data-selectable-paragraph><span style="color: #000000;">So is it any wonder then that since as far back as 2013, cryptocurrency advocates have been pushing to list a U.S. bitcoin ETF?</span></p>\r\n
    <p id="8c86" data-selectable-paragraph><span style="color: #000000;">But many of those early U.S. bitcoin ETF applications were for instruments that would actually hold bitcoin as the underlying asset, and shares of the ETF would track the value of the underlying bitcoin based on supply and demand for the ETF itself.</span></p>\r\n
    <p id="6faa" data-selectable-paragraph><span style="color: #000000;">So far so good.</span></p>\r\n
    <p id="58d4" data-selectable-paragraph><span style="color: #000000;">The problem of course was that the U.S. Securities and Exchange Commission wasn’t keen on allowing “physical” bitcoin to underpin an ETF because of concerns over potential manipulation of bitcoin prices by bitcoin “whales” as well as concerns over wash trading, where the same institution is on both sides of the trade.</span></p>\r\n
    <h2 id="2b0c" data-selectable-paragraph><span style="color: #10228b;">The Futures of Bitcoin?</span></h2>\r\n
    <p id="4f86" data-selectable-paragraph><span style="color: #000000;">Which is why when crypto and <a href="technology/everything-you-need-to-know-about-blockchain-3-0" target="_blank" rel="noopener">blockchain</a>-savvy Gary Gensler took the helm at the SEC, expectations were high that he would give the greenlight to a U.S. bitcoin ETF.</span></p>\r\n
    <p id="0c43" data-selectable-paragraph><span style="color: #000000;">Gensler did, just not in the way most crypto advocates would have hoped for.</span></p>\r\n
    <p id="602c" data-selectable-paragraph><span style="color: #000000;">Gensler still had the same concerns over a bitcoin ETF that actually held bitcoin and so the SEC greenlit a bitcoin ETF that held bitcoin futures instead, but not just any futures, CME Group’s cash-settled bitcoin futures.</span></p>\r\n
    <p id="ece0" data-selectable-paragraph><span style="color: #000000;">Which brings us to another concept that U.S. bitcoin ETF investors have to understand — what are futures?</span></p>\r\n
    <p id="68c1" data-selectable-paragraph><span style="color: #000000;">Essentially, a futures contract is a standardized legal agreement to buy or sell something at a predetermined price at a specified time in the future.</span></p>\r\n
    <p id="fe79" data-selectable-paragraph><span style="color: #000000;">The first known futures exchange was the Dojima Rice Exchange of the Edo Period in Japan, in the early 17th century.</span></p>\r\n
    <p id="e56a" data-selectable-paragraph><span style="color: #000000;">In the early 17th century, Japanese rice farmers needed a way to guarantee the price of rice when brought to harvest to help hedge against the risk of being a farmer.</span></p>\r\n
    <p id="77cb" data-selectable-paragraph><span style="color: #000000;">Because there is a time lapse between when a farmer decides what and how much to plant and when the rice goes to market, prior to the invention of futures, the life of a farmer was one of constant feast and famine.</span></p>\r\n
    <p id="938b" data-selectable-paragraph><span style="color: #000000;">Is it any wonder then that farmers started off as some of the most superstitious people?</span></p>\r\n
    <p id="c7a5" data-selectable-paragraph><span style="color: #000000;">Because in years where harvest was bountiful, the price of rice would collapse, but in years with thin harvests, what little rice that they did bring to market attracted a premium.</span></p>\r\n
    <p id="1857" data-selectable-paragraph><span style="color: #000000;">Given these conditions, a Japanese rice farmer before the 17th century was just one more harvest away from financial ruin.</span></p>\r\n
    <p id="e471" data-selectable-paragraph><span style="color: #000000;">Rice futures contracts provided a possible way to hedge that risk altogether.</span></p>\r\n
    <p id="8c9b" data-selectable-paragraph><span style="color: #000000;">Investors could speculate on the future price of rice, while the farmer could sell the futures contract and was guaranteed a price for their produce come harvest time.</span></p>\r\n
    <p id="394c" data-selectable-paragraph><span style="color: #000000;">Between the time of physical delivery of the rice on the futures contract and the sale of that futures contract, the futures contract itself could be traded between investors, and so, the world’s first futures market was born, in the Dojima Rice Exchange.</span></p>\r\n
    <p id="0569" data-selectable-paragraph><span style="color: #000000;">Since that time, futures for a whole range of commodities have risen and have been used both as a hedging tool as well as an instrument for speculation.</span></p>\r\n
    <p id="c261" data-selectable-paragraph><span style="color: #000000;">But part of the complexity when it comes to the U.S. bitcoin ETF is that it invests in cash-settled bitcoin futures and not in bitcoin itself.</span></p>\r\n
    <p id="7a3c" data-selectable-paragraph><span style="color: #000000;">We’ll get to the cash-settled portion shortly, but let’s dive into some of the peculiarities with respect to futures first, starting with the concept of contango.</span></p>\r\n
    <h2 id="2805" data-selectable-paragraph><span style="color: #10228b;">It Takes Futures to Contango</span></h2>\r\n
    <p id="3f94" data-selectable-paragraph><span style="color: #000000;">To understand contango let’s take a look at the following chart, where the horizontal axis represents time and the vertical axis is the price.</span></p>\r\n
    <p><span style="color: #000000;"><img src="/images/Futures_to_Contango.jpeg" alt="Futures_to_Contango.jpeg" width="802" height="503" /></span></p>\r\n
    <p id="6dd9" data-selectable-paragraph><span style="color: #000000;"><br />Contango is the situation where the futures price of the underlying asset is higher than the current spot price and can be caused by several factors, including inflation expectations.</span></p>\r\n
    <p id="224e" data-selectable-paragraph><span style="color: #000000;">So let’s take bitcoin for instance.</span></p>\r\n
    <p id="4aa3" data-selectable-paragraph><span style="color: #000000;">Forward futures for bitcoin may be trading at higher than the current spot price because investors are expecting that the price of bitcoin will rise in the future on inflation expectations.</span></p>\r\n
    <p id="dfb4" data-selectable-paragraph><span style="color: #000000;">Other factors like expected future supply disruptions, for instance a bitcoin halving (where the reward for mining bitcoin halves), could also see futures prices at a premium to the spot price.</span></p>\r\n
    <p id="5311" data-selectable-paragraph><span style="color: #000000;">But wait, there’s more.</span></p>\r\n
    <p id="e8d2" data-selectable-paragraph><span style="color: #000000;">Futures are also subject to a phenomenon known as backwardation, where the futures trades at a discount to the spot price.</span></p>\r\n
    <p id="70bb" data-selectable-paragraph><span style="color: #000000;">Backwardation can occur as a result of a higher demand for an asset currently than the contracts maturing in the future through the futures market and the primary cause of backwardation is a shortage of the commodity in the spot market.</span></p>\r\n
    <p id="8bf1" data-selectable-paragraph><span style="color: #000000;">Since the futures price, whether in contango or backwardation converges as the futures contract nears its delivery date, when backwardation occurs, it favors investors who are net long on the underlying asset.</span></p>\r\n
    <p id="2514" data-selectable-paragraph><span style="color: #000000;">And therein lies the problem for investors in a bitcoin ETF that is underpinned by futures.</span></p>\r\n
    <p id="c6a1" data-selectable-paragraph><span style="color: #000000;">Because bitcoin futures lock in the price for the months ahead, the performance of the ETF can differ markedly from the spot price of bitcoin on any given cryptocurrency exchange.</span></p>\r\n
    <p id="b1cc" data-selectable-paragraph><span style="color: #000000;">In part, this is because the<a href="global-economy/forget-a-digital-dollar-bank-on-bitcoin" target="_blank" rel="noopener"> bitcoin</a> futures being traded in the ProShares Bitcoin Strategy ETF utilizes CME Group’s bitcoin futures, whose prices are based on composites at five crypto exchanges.</span></p>\r\n
    <p id="677a" data-selectable-paragraph><span style="color: #000000;">Making matters worse, an ETF that relies on futures can and most likely will, underperform the underlying asset it is supposed to track.</span></p>\r\n
    <h2 id="3351" data-selectable-paragraph><span style="color: #10228b;">What’s a Couple of Percentage Points for the Privilege of an ETF?</span></h2>\r\n
    <p id="8765" data-selectable-paragraph><span style="color: #000000;">Futures contracts expire on a fixed date and have to be “rolled over” into newer versions, the transaction costs and management fees for thousands of new contracts comes out of the ETF, acting as a drag on performance.</span></p>\r\n
    <p id="759b" data-selectable-paragraph><span style="color: #000000;">By one estimate from Refinitiv, the United States Oil Fund, a US$2.4 billion oil futures ETF has underperformed the price of WTI crude that it is supposedly meant to track, by a whopping 70% over the past decade.</span></p>\r\n
    <p id="742f" data-selectable-paragraph><span style="color: #000000;">According to Solactive, an index provider, bitcoin futures have made about 13% less than the cryptocurrency’s 120% rise so far this year, and while that may not seem like a lot, it adds up over time.</span></p>\r\n
    <p id="b861" data-selectable-paragraph><span style="color: #000000;">And all this comes on top of a 0.95% management fee.</span></p>\r\n
    <p id="7adb" data-selectable-paragraph><span style="color: #000000;">But wait, there’s more.</span></p>\r\n
    <p id="547d" data-selectable-paragraph><span style="color: #000000;">Because the U.S. bitcoin ETF is intended to closely track bitcoin’s price, the most in-demand futures contract will be the one that expires closest to the current date, to try and avoid the contango and backwardation that affect futures.</span></p>\r\n
    <p id="e994" data-selectable-paragraph><span style="color: #000000;">These contracts, known as the front month or spot contracts will most closely converge with bitcoin’s current spot price and is the reason why ProShares holds all its 3,900 futures positions in November contracts.</span></p>\r\n
    <p id="fb31" data-selectable-paragraph><span style="color: #000000;">But there’s a catch.</span></p>\r\n
    <p id="d36a" data-selectable-paragraph><span style="color: #000000;">CME Group imposes limits on the number of contracts any one counterparty can buy, to prevent a single entity from cornering the market, especially because the market for bitcoin futures is relatively small.</span></p>\r\n
    <p id="5167" data-selectable-paragraph><span style="color: #000000;">When a counterparty hits the limit of 4,000 contracts, it has to buy longer-dated futures contracts, for which there are no limits, exposing investors to the phenomenon of backwardation and contango that we talked about earlier.</span></p>\r\n
    <p id="f9bb" data-selectable-paragraph><span style="color: #000000;">Because as long as the futures contract is not for the front month, spreads can really start to widen the further out a trader goes.</span></p>\r\n
    <p id="eae8" data-selectable-paragraph><span style="color: #000000;">If the market expects the price of bitcoin to rise over the longer term, then the price of longer term futures contracts will rise above the short term contracts, or contango, incurring higher costs for the fund, when the futures contract is rolled into the next month and literally forcing the ETF to sell low (the front month contracts) and buy high (long-dated contracts).</span></p>\r\n
    <p id="5ff2" data-selectable-paragraph><span style="color: #000000;">These costs, also known as “roll costs” means that a futures-based bitcoin ETF will underperform the price of bitcoin itself, and industry estimates put the underperformance at between 5–10% per year making a bitcoin ETF that invests in bitcoin futures, more expensive for investors wanting to hold a position over the longer term.</span></p>\r\n
    <p id="79da" data-selectable-paragraph><span style="color: #000000;">And what does your money in a U.S. bitcoin ETF buy anyway?</span></p>\r\n
    <p id="adc6" data-selectable-paragraph><span style="color: #000000;">Well for starters, these futures-based bitcoin ETFs aren’t even completely constituted of futures.</span></p>\r\n
    <p id="7329" data-selectable-paragraph><span style="color: #000000;">Around 25% of the ProShares Bitcoin Strategy ETF is made up of money on margin, while the remaining 75% will go into money-market instruments such as Treasury bills, constituting a hedge against resulting exposures.</span></p>\r\n
    <p id="d9b6" data-selectable-paragraph><span style="color: #000000;">Because a futures ETF will only give investors modest exposure to bitcoin via any ordinary brokerage account and returns will be eroded by the relatively high costs, investors who are looking to own bitcoin should just go ahead and buy it outright.</span></p>\r\n
    <p id="9b4f" data-selectable-paragraph><span style="color: #000000;">Which brings us to our final hang up when it comes to a bitcoin futures-based ETF — there isn’t any actual bitcoin involved in the entire ecosystem.</span></p>\r\n
    <h2 id="bfef" data-selectable-paragraph><span style="color: #10228b;">Where’s the Bitcoin?</span></h2>\r\n
    <p id="2649" data-selectable-paragraph><span style="color: #000000;">Considering that cryptocurrencies are a conceptual form of value, it seems somewhat disingenuous to then take an abstract of an abstract, hammer it into an ETF, and then declare it investable.</span></p>\r\n
    <p id="535b" data-selectable-paragraph><span style="color: #000000;">A futures-based bitcoin ETF is as far away from bitcoin as an Impossible Burger is to a cow, and therein lies the problem with the specific form of bitcoin futures selected for the U.S. ETF — a cash-settled futures.</span></p>\r\n
    <p id="34de" data-selectable-paragraph><span style="color: #000000;">At least with the Dojima Rice Futures, a futures trader could still have the option for physical delivery of the commodity — they could literally have their rice and eat it.</span></p>\r\n
    <p id="3fe2" data-selectable-paragraph><span style="color: #000000;">Not so with cash-settled bitcoin futures — all they are is a betting contract.</span></p>\r\n
    <p id="40af" data-selectable-paragraph><span style="color: #000000;">So all of that talk about bitcoin’s inflation hedging properties — poof, up in smoke like the value of the dollar.</span></p>\r\n
    <p id="4c18" data-selectable-paragraph><span style="color: #000000;">So who are U.S. bitcoin futures for then?</span></p>\r\n
    <p id="bde6" data-selectable-paragraph><span style="color: #000000;">Traders primarily.</span></p>\r\n
    <p id="80a8" data-selectable-paragraph><span style="color: #000000;">Short term traders who are looking to get in and out quickly or fund a simple basis trade — buying spot and selling futures, can make a cool 30% per annum by arbitraging the wide spreads between forward futures and spot prices (at time of writing).</span></p>\r\n
    <p id="0167" data-selectable-paragraph><span style="color: #000000;">The other type of investors are institutions for whom buying bitcoin outright is simply not an option because it is outside their investment mandates.</span></p>\r\n
    <p id="7989" data-selectable-paragraph><span style="color: #000000;">According to JPMorgan, in the first two days of trading, retail investors accounted for only around 12% to 15% of net buying of the ProShares Bitcoin Strategy ETF, meaning that the bulk of buyers were institutional investors.</span></p>\r\n
    <p id="06be" data-selectable-paragraph><span style="color: #000000;">For global investors who want all the exposure of bitcoin, but none of the cryptocurrency, there are ETF products that hold the underlying bitcoin in institutional custody in Canada and Europe.</span></p>\r\n
    <p id="69fb" data-selectable-paragraph><span style="color: #000000;">While it’s not clear if the holders of these ETFs have any redemption rights in the underlying bitcoin itself in a time of liquidation, at the very least, these ETFs that purchase and custody bitcoin are exerting buy-side pressure on the underlying asset.</span></p>\r\n
    <p id="9cd2" data-selectable-paragraph><span style="color: #000000;">But for retail investors who actually want to hold on to bitcoin for its alleged inflation-hedging properties, buying the bitcoin ETF makes little sense.</span></p>\r\n
    <p id="c1c4" data-selectable-paragraph><span style="color: #000000;">Institutional investors have little choice but to stay within the matrix, they have to take the blue pill, and for them their trip is over.</span></p>\r\n
    <p id="65a4" data-selectable-paragraph><span style="color: #000000;">But for retail investors who want to genuinely have exposure to bitcoin, the red pill is the only option, they will need to apply themselves, figure out how to handle a bitcoin wallet, complete their KYC on a cryptocurrency exchange of their choice and buy and hold some actual bitcoin.</span></p>
    """
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  -metakey: "U.S. Bitcoin ETF Is Net Zero Bitcoin"
  -metadesc: "While a U.S. Bitcoin ETF sounds good in theory, peek under the hood and investors will find a futures-based instrument riddled with contradictions that has very little to do with bitcoin anyway."
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