On 18 Oct, when NYSE sounded its opening bell at 9.30am, Bitcoin HODL-ers had another reason to rejoice. The digital coin finally made history by being the first cryptocurrency ETF to list in the stock market. Even hours before the trading debuts, Wall Street could sense the excitement with the Bitcoin futures ETF up 4% during pre-market hours.
|Bitcoin YTD return source: https://www.marketwatch.com/investing/cryptocurrency/btcusd
Today, the crypto craze has subsided a little after the mother of all cryptos (crypto blue chip or crypto pioneer) had inched to an all-time high of $66k USD. Nevertheless, its year-to-date return has been an impressive 110%, after gaining much institutional acceptance, with visionary institutions like Tesla and Square pilling their cash into Bitcoin.
While bitcoin investors are generally getting eye-popping returns so far, it does not come without costs. Other than experiencing wild swings in prices (the need for diamond hands), Bitcoin investors who buy into the digital currency directly also face the risk of being susceptible to a crypto cyber-attack. The introduction of the Bitcoin ETF may seem to pave a less risky way for retail investors to jump into the crypto bandwagon, enjoying the upside exposure to bitcoin and minimizing the possibility of a hacking incident.
And that was what I exactly thought, until I did a deep dive on the ETF by reading its prospectus and fund fact sheet. It’s important to understand what you are buying before you buy. I admit I am not exactly a Bitcoin or any crypto aficionado; but I will share my thoughts on alternative ways to have a slice of crypto pie.
A Little Bit About BITO
1. Not a Pure Bitcoin Play
After looking through its fund holdings, I felt that the phrase ‘ProShares Bitcoin Strategy ETF (BITO)’ is quite misleading. I hope you feel the same way too…
When one invests in S&P500 ETF, he or she should expect a return roughly similar to the S&P 500 index, as the exchange traded fund aims to mimic the performance of the index. However, the same could not be said of BITO. Although this fund has exposure to Bitcoin futures, almost 30% of its value is tied to Treasury Bills. A treasury bill is a kind of bond issued by the government with a maturity value and pays a periodic coupon. While it is conventionally accepted as a safe investment, an investor will enjoy lesser upside if Bitcoin value appreciates. Moreover, bonds are susceptible to interest rate risk, and with the impending interest rate hikes, investors are faced with an additional layer of credit risk and market risk on top of the Bitcoin price fluctuations.
2. The Risk of Contango
What is Contango?
Let’s say if I am prepared to buy 100kg of silver coins from a seller in three months’ time. With a silver spot price of $768 (Silver Price per kilo), should the seller charge me a lower or higher price than the current spot rate today to ship it to me? The logical answer should be a higher price. The reason is this: in the meantime, the seller will have to incur the (1) costs of storage and the (2) costs of carry. Before the silver reaches me, the merchant may have to cover expenses for insurance, delivery, opportunity costs of getting the funds three months later. The normal market in futures is contango, where the future price of an asset is higher than the current spot price.
From the chart above, we can infer that the further the time to expiration, the higher the price. This is because the seller has to incur a higher holding cost for storing the commodity.
Similarly, in the case of Bitcoin futures, the seller will incur storage risks or platform risks and all these costs are reflected in the costs of rolling future contracts. As this ETF does not invest in Bitcoin directly, but in Bitcoin futures, in a contango situation, the fund manager may end up selling the expiring Bitcoin contracts at a lower price and purchase a longer dated Bitcoin futures at a higher price. It’s also stated in the BITO ETF prospectus that Bitcoin futures have experienced significant periods of contango.
So again, returns on investment in BITO may be lower as compared to buying Bitcoin directly due to a possibility of negative rollover.
3. Relatively High Operating Expenses
One of the hallmarks of investing in an ETF is its low expense ratio. Yet, it’s unfortunate that the opposite is true for Bitcoin ETF, which charges 0.95% in operating expenses. To give you some perspective, Vanguard S&P 500 Index Fund ETF has an expense ratio of 0.03% and even the actively managed Ark Innovation ETF, which is led by star stock picker Cathie Wood, charges an expense ratio of 0.75%.
While Bitcoin Futures may require some active management in hedging of Bitcoin futures contract, paying 0.95% of the fund value yet holding a significant amount of Treasury bills and incurring contango ‘bleed’ is something that I am not comfortable to pay. In my opinion, the total costs of owning this ETF outweigh the ability to buy and sell the ETF easily like a stock.
Alternative to Gaining Exposure to Cryptocurrency via Stock Exchange
If you are still FOMO-ing over the crypto craze, here’s some other suggestions for you to ponder. Firstly, you need to ascertain if you are (1) bullish on Bitcoin or just (2) cryptocurrencies in general.
1.Bullish on Bitcoin:
Consider investing in MicroStrategy, ticker symbol MSTR. It is a business intelligence company (at face value?), but its assets are closely tied to the value of Bitcoin, with the digital currency making up 80% of its total assets. However, the IT company is funding the purchase of Bitcoin via the issuance of convertible notes, so there’s some form of leveraging effect. As of 30th Sept 2021, it holds approximately 114,402 Bitcoins with an average purchase price of $27,713 USD. Investors could end up with double strokes of luck if Bitcoin mania continues and the company reports strong revenue growth.
|Source: Microstrategy’s 10-Q filings
2. Bullish on Cryptocurrency in General
If you are bullish on cryptocurrency in general, look no further than Coinbase Global. Despite it went public via a direct listing, i.e. Special Purpose Acquisition Vehicle (SPAC) deal, it was already highly profitable prior to its listing. Founded in 2013 with hopes of being a Bitcoin mainstream payment platform, its business has evolved over time. Fast forward today it is now the largest cryptocurrency exchange platform by trading volume. It names SpaceX, and Tesla as clients, with hopes to be the Amazon of Assets.
Today, Coinbase makes money through a variety of ways: trading fees when someone transacts digital assets in its exchange, interchange fees when a user makes a purchase with Coinbase credit card, and lending fees when it lends out funds in customer accounts to other institutions, just to name a few.
Despite having multiple revenue streams, I believe the crypto platform is only barely scratching the surface. Recently, Coinbase announced that it will be launching its non-fungible token (NFT) marketplace, which is a digital marketplace where users can showcase, mint, and sell their NFT. The NFT graze is already gaining momentum, and it will only get bigger when the metaverse world truly materializes. Just last week, Facebook (now called META) announced a partnership with Coinbase for digital wallet Novi.
Many cryptocurrencies have been created in the past few years, yet many have failed and vanished into thin air when investors shunned them due to lack of adoption. Even if Bitcoin ever loses its shine as the ‘store of value’, I believe crypto is here to stay. Hence, investing in Coinbase stock means betting on a positive outlook for retail and institutional adoption of digital currency overall.
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The author owns Bitcoin, Ethereum, Solana and shares of Coinbase at the time of publication. This is not a recommendation or advice to readers to buy or sell crypto/ETF/stocks.