For years, the US Securities Exchange Commission (SEC) has refused to approve a Bitcoin ETF. But it’s now allowing a Bitcoin Futures ETFs to be issued and bought by North American retail investors.
But I have no interest in buying any of them. They are almost guaranteed to underperform.
Now, most retail investors don’t understand the difference between buying a normal ETF and a futures ETF, due in large part that Wall Street doesn’t WANT you to know the differences.
Otherwise, most if not all retail investors would stay far away, and that would mean less fees for the big boys.
Arthurs Hayes of Crypto Trader Digest is on the money when he says this:
“When there is an asset or market that has past and present amazeballs returns, but for a variety of technical and regulatory reasons cannot be accessed by the vast majority of retail and institutional investors, there is an opportunity to create an access product in the form of an ETF that generates economic rent for the fund manager. Bonus points if the instruments purchased to generate exposure to the asset are derivatives. With derivatives, there exists a greater ability to skim cream from insto investors frothing at the keyboard for dat alpha.”
I have bolded relevant parts of the quote.
Arthurs Hayes’s essay on ETF is long, amusing, and somewhat detailed. I recommend you read all of it, but for those with not enough patience to absorb every nuance, here is the short version of why a futures ETF is usually not a good investment.
First of all, you need to understand the key difference between a straight-up ETF of a commodity and an ETF based on futures contract.
An ETF of a commodity is obligated to buy the commodity at the spot or street price.
A futures ETF is committed to buying the futures contract of said commodity, which is almost always more expensive than the spot price.
Here is an example.
Sam buys 10 bitcoin. The spot (market) price is $60,000. He pays $600,000 total.
Alice buys a futures contract for 10 bitcoin, priced to expire on November 30th. That futures contract cost $61,000 per bitcoin, for a total price of $610,000.
Now suppose by the end of November, bitcoin hits $80,000.
Sam has made a profit of 33%.
But Alice has made a profit of only 31%.
That’s not so bad, is it? But that’s a 2% slippage in one month
And she has to roll over the contacts every month.
Every month she has to pay a penalty of 2% if she decides she wants to buy futures instead of buying the actual bitcoin. That’s a slippage of 24% in one year.
Worse for Alice, the trading fees for futures contracts are usually much higher than for buying spot (that’s where the pro traders sneak off their cut which is of course taken from the investor).
A futures contract is the worst way possible to buy any type of commodity. You are guaranteed to get the worst return possible.
So why do they exist in the first place?
Futures contracts exist for one purpose only: For leverage.
Let’s go back to the initial example.
Sam buys his $600k worth of bitcoin with $600K of US dollars.
But Alice wants to use leverage. She puts up $305K to buy $600k of bitcoin futures (remember the futures contracts are almost always more expensive than spot).
She is leveraged at 2:1.
If bitcoin hits 80K at the time of expiry, she has made 65.5% on her initial investment (excluding trading fees), easily beating Sam.
Of course, if bitcoin goes down to $40k, Alice is feeling some serious pain but that’s what happens when you use leverage.
Now of course Sam could try to borrow money from a bank in an attempt to get the same leverage as Alice but it’s a lot easier to get leverage with futures contracts then it is borrowing on margin.
In the international crypto-derivatives markets, you can get 50:1 leverage on bitcoin futures contracts, but at most borrow 3:1 on margin when trading spot.
That’s what futures contracts are used for. Leverage.
Without leverage, they have no purpose. Or to put it another way, absolutely nobody buys a futures conrtact at 1:1 leverage, it makes no sense.
Except, of course, retail investors who think because the SEC approved this ETF, it’s a good investment.
So why did the SEC approve investment houses to issue bitcoin futures ETF with no leverage?
I don’t know and I don’t care.
I’m not a financial advisor. Anything I ever write is never meant to be financial advice.
But I can do basic math.
And the math tells me to stay far away.
DJ
