Bitcoin has shocked the world and made some people immensely rich.
If you live in the US, you could only buy bitcoin through a so-called wallet. Regular brokers didn’t deal with bitcoin and other cryptos. It changed when Robinhood offered crypto trading, but there are still issues you need to be aware of (we will discuss them below).
Until now, it has been complicated.
But just recently, the first bitcoin ETF was launched.
Should you consider adding it to your portfolio?
Let’s see. In this article, we will tell you whether the first bitcoin ETF in the US gives you the right exposure to this massively popular crypto.
How Does a Bitcoin ETF Work?
First, let’s be clear. The first ETF that has just been launched in the US, ProShares Bitcoin Strategy ETF (BITO), doesn’t hold the actual crypto.
It tracks bitcoin futures, and we will explain the difference and why it matters in a moment.
An ETF that wants to track the spot bitcoin price, Valkyrie Bitcoin Fund, is still a work-in-progress. Valkyrie, the investment manager that wants to launch the spot-based ETF, had its application delayed until early next year by the Securities and Exchange Commission (SEC).
So, to be clear… the only ETFs available in the US track the crypto’s futures, not bitcoin itself.
The reason for this is that futures-based ETFs “provide investor protection” as the SEC’s chair Gary Gensler said.
The only ETFs that track the price of crypto itself are based outside the US. In Canada, several of them are available to investors, like Grayscale Bitcoin Trust (GBTC). It holds actual crypto, so every share of this fund is backed by bitcoin.
The US investors can only buy ETFs that hold bitcoin futures. That is their underlying asset, not bitcoin itself.
Why Is It Important?
Put simply, if you buy a futures-based ETF, you don’t get complete exposure to the crypto itself.
Futures are based on future prices, not the current spot. The two may be different, so your gains on a futures-based fund will not likely match those of the BTC itself.
This difference is one of the reasons an ETF like BITO isn’t a perfect way to buy and hold crypto.
Another one is related to costs… in short, futures-based ETFs have high fees. These funds charge investors who want to buy and sell their shares. Over time, these fees add up and could make the fund underperform the crypto itself.
Buying bitcoin directly into a wallet might be cheaper for you. Your expenses could vary depending on the fees your brokerage charges.
For example, Robinhood, the famous broker that allows investors to trade with no fees, offers bitcoin and other cryptos.
Coinbase, a broker that rose to fame and became a multi-billion-dollar company, charges about 1.49% on all your trading.
It’s higher than BITO’s 0.95% fee, but keeping in mind the “hidden” costs, such as the “rollover” expense we discuss below, trading crypto directly could still be a better option.
Check with your broker to see all fees that would apply to your bitcoin trading.
The other risk of buying an ETF like BITO is what’s called “rollover risk.”
ETFs constantly buy and sell futures. They replace the ones that are about to expire with longer-term contracts. It can cost money to do so.
And in the crypto area, at least now, the longer-term futures are higher-priced than the ones expiring soon.
So this is almost a guarantee that an ETF like BITO will need to spend money and underperform…
And this cost could destroy your returns.
The math behind it is quite complex…
But you only need to know this shocking fact. Even if the price of crypto doesn’t change, this “rollover” might cost you an enormous amount of money.
And the more volatile the underlying price, the higher the risk of this “rollover” cost turning negative and eating your returns.
Of course, if you hold crypto directly, you don’t face this risk. The value of your holding is tied directly to the spot price of bitcoin.
What to Do?
Buying an ETF is convenient. And it comes with investor protection.
Buying bitcoin directly is more complicated from this standpoint.
Trading in ETFs is straightforward. To trade bitcoin and other cryptos directly you could be facing a learning curve.
In sum, you should always check with your broker to see what costs and risks you face when you decide to buy any asset.
But the question we asked in the beginning has a very simple answer: if you want to have the best exposure to cryptos, the ETFs available now don’t give you that.
To get the best out of bitcoin, it’s a good idea to find a way to buy the crypto itself — or wait until better options come up.
Thank you for your loyal readership,
The Financial Star team