Good, but not quite there
The chances of the US Securities and Exchange Commission (SEC) approving a Bitcoin Exchange Traded Fund (BTC) (ETF) against a physical Bitcoin ETF are higher than ever, according to the Chairman’s recommendation. Gary Gensler has now repeated the previous hobby.
But here’s the thing: an ETF built on crypto futures isn’t the most efficient, economical, or easiest way to go. Products are physically supported. They are likely to attract more assets and open the crypto market to more investors. And they are much easier for investors to understand.
For this reason, fund issuers better turn to the SEC to clarify what it takes to get a spot Bitcoin ETF approved, rather than rushing to be the first to deal with a hedged product of futures contracts that are more complex and expensive.
A complete framework Good – but with an incomplete justification?
One of the main arguments in favor of crypto futures ETFs is that the regulatory framework for futures at this point is clear and well established, especially when compared to physical crypto assets.
Futures contracts are targeted by the Commodity Futures Trading Commission. Contracts are standardized. In the case of Chicago Mercantile Exchange (CME) futures, forgoing a digital wallet and lack of physical assets means fewer questions about the crypto-custody puzzle. Know Your Customer, or KYC, is less of a concern because decentralized assets cannot be moved from one address to another. In general, the futures market is more regulated and regulated than the current spot market.
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These supported futures ETFs are registered under the Investment Company Act of 1940. That would make them “liquid alternatives” and allow them to invest using instruments or strategies. Mutual funds, including those with a hedge-like strategy, are registered as ’40 Act funds.
What are the benefits of having a Bitcoin Futures ETF registered as a ’40 Act Fund? They bypass many regulatory hurdles, in part because they are required to invest primarily in futures contracts that are listed on a US regulated exchange such as CME.
More complicated with the future
Yes, simplicity is good, especially when the goal is to attract new money that has been patiently waiting on the sidelines. But in essence, futures contracts are more complex, which goes against the spirit of ETFs to begin with.
ETFs are designed as a cost-effective, highly liquid alternative to actively managed funds. However, futures contracts are not particularly inexpensive. They require margin as security, which is disproportionately higher than with other asset classes.
In addition, the volume of trading on US regulated exchanges is relatively low, with most of the action taking place overseas. This begs the question: is there enough liquidity on SEC-approved exchanges like CME to meet demand, especially during periods of high volatility?
In fact, this first generation of ETF futures will likely contain a different basket of assets alongside Bitcoin futures contracts. Due to the tax complexity and diversification of assets, a subsidiary must also be established to hold these investments, typically in a low-tax area like the Cayman Islands. Of course, complexity means higher costs for investors.
There is also the question of the difference between the forward price and the spot price. Futures contracts do not perfectly replicate the underlying assets. With Bitcoin in particular, there can be a huge difference between the expected price of Bitcoin in 30 days (which the futures contract represents) and the actual price at that point in time. For the year ending September 2, 2021, a rotating position in Bitcoin futures pulled the Bitcoin price up 38 percentage points (295% to 333% each time).
Finally, it should be noted that investor demand for futures-based ETFs has historically been much lower than for their cash counterparts. One illustrative point: the largest spot gold ETF currently holds more than $ 50 billion in assets, while the largest gold futures ETF holds around $ 40 million.
Related: Mass Attraction: Can EFT Bitcoin Futures Power US Investors?
A logical step in the right direction
But does that mean that a Bitcoin futures ETF does more harm than good?
Absolutely not. Even if it won’t be as easy or cheap as a spot ETF, a Bitcoin futures ETF is still a step in the right direction to give potential investors access to cryptocurrencies.
It will open up crypto investing to a wider investor audience. The ETF structure will make it a lot easier for financial advisors and others to incorporate Bitcoin into their portfolios and standard processes. It would also implement all of the investor protection of the 1940 Act. The rigorous SEC scrutiny placed on funds under the ’40 Act should allay concerns of many investors and place governance controls on fund managers.
Related: Ethereum ETFs are there, making the case for US approval of BTC and ETH funds
Given the sharp rhetoric and critical stance the SEC has taken in recent crypto discussions, approving a Bitcoin futures ETF would be an important step forward. It will demonstrate the SEC’s willingness to allow crypto asset products to enter the market more broadly with regulatory oversight, which may allay concerns.
However, the success of these funds should not divert the focus of issuers from their primary goal: working with the SEC and other regulators to provide the clarity needed to deliver a spot Bitcoin ETF.
This process can take a while, but the results will definitely be worth it. Ultimately, it will provide investors with an inexpensive, highly liquid way to closely track Bitcoin – and thus better align their crypto investments with a portfolio. We believe this will ultimately bring about a new sizeable wave of assets that has long been anticipated by industry proponents, investors and issuers alike.
Katherine Dowling is General Counsel and Chief Compliance Officer at Bitwise Asset Management, which manages over $ 1 billion in its crypto funds. She was previously General Counsel and Chief Compliance Officer at True Capital Management and Luminate Capital Partners. Katherine also served as the U.S. Assistant Attorney for more than a decade, most recently in the U.S. Attorney’s Department of White-collar Crimes for the Northern District of California.