Is a Bitcoin Futures ETF Really THAT Bad?

Primer

The ProShares Bitcoin ETF launched yesterday, attracting over $500M in capital on day one. However, the ETF isn’t simply a product that buys spot BTC, instead it buys BTC futures. There’s a material difference between the two, which why we exploring the implications of this in greater detail for today’s Delphi Daily.

Futures Spreads Are Tight (Most of the Time)

• According to the ETF’s prospectus, ProShares will hold the current month’s futures contract. At the end of the month, when the futures are on the verge of expiry, they sell those contracts and buy futures for the upcoming month (i.e. sell Oct. ’21 futures to buy Nov. ’21 equivalents). This process is called “rolling,” and there are some important costs associated with it.
• When the price of an asset’s futures contract is higher than spot price, rolling contracts forces the fund to sell the contracts it holds at a lower price than the next month’s higher-priced contracts. For example, CME BTC futures for Oct. are trading at $64,560 at the time of this writing while Nov. futures are trading at $65,190. If this were the end of the month, and the ETF had to roll its contracts forward – in this case by selling Oct. futures and buying Nov. futures – it would incur a ~0.97% cost; and that’s just the cost of rolling futures for one month.
• From the above chart, we can see that futures usually trade within 5% of spot price, with anomalies occurring during liquidity crises. If the futures market is in backwardation, the next month’s futures contract will be lower than the current month’s, putting ETF investors at an advantage. However, this occurs less frequently as BTC rarely experiences prolonged periods of backwardation.

CME Wins Big on ETF Approval

• The ProShares’ ETF trades CME’s Bitcoin futures, so it’s no surprise CME BTC open interest has been making consecutive highs this week; yesterday also happened to be its third-highest volume day for its BTC futures segment. Notably, over $700M of open interest was added on roughly $6B of daily trading volume.
• If the ProShares ETF starts to experience more inflows, CME’s liquidity and activity will start to ramp up, and if there’s heavy demand to long BTC futures from the ETF, that could cause the futures premium to run up, thereby levying a higher roll cost on investors.

The ETF’s Effect on Futures Pricing

• The above scenario actually did happen, albeit very briefly. The ProShares’ ETF opened up to massive demand, causing annualized basis — the yield from buying BTC spot and shorting BTC futures at a higher price (thereby locking in a fixed return) — to spike abnormally. However, as you can see, those yields were too juicy to turn down, and basis quickly reverted to normal levels. Note: You can see the movement of futures prices that caused the basis spike here.
• When futures price excessively deviates from spot, it incentivizes well-capitalized investment funds to perform a cash and carry basis trade; short-sellers were the heroes for once.

Keeping Order in the Market

• BTC has been on a tear, yet leveraged funds on CME continue to short, as evidenced by their net open interest moving further and further negative.
• We’ve spoken about this before, but basically these are likely the funds carrying out the basis trade. They hold BTC spot, and short futures in order to earn a fixed yield of about 6%-20% depending on their spot purchase and short futures entries. For all intents and purposes, this is as risk-free a trade you can get excluding sovereign bonds (which have a much lower yield and also aren’t actually risk-free).
• All in all, the ETF will create demand for longs and when that happens, basis traders will step in to balance that demand by shorting; thus, futures should trade fairly close to spot. Obviously, this is a more costly and inefficient product compared to a pure spot ETF, but at least it’s a start.
• The silver lining in all this: maybe we get another big move in BTC once an actual spot product makes it through the regulatory ringer.

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— Zeneca_33 ? (@Zeneca_33) October 20, 2021

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