Should You Use Bitcoin ETFs for Bitcoin Exposure?

I think it’s safe to assume that the news about a futures backed Bitcoin ETF being tradable on the New York Stock Exchange hasn’t gone unnoticed for anyone who hasn’t been living under a rock. However, what you might not know is the meaning of this development. Why do we need it? What even is a futures backed ETF? Why not just buy Bitcoin via exchanges like many others do? While all these questions remain you might have noticed that the ETF wasn’t a small deal and there was some high demand for it. This at least is what the trading volume data tells us.

Keep reading to learn what this ETF means to us regular folk, and if it’s at all a good way to get some Bitcoin exposure. I'll also talk about some other ways to get Bitcoin exposure and list the pros and cons so that you can go out there and make the best choice based on the information available.

What are Futures Backed Bitcoin ETFs?

When it comes to a crypto ETF we have two options, a spot ETF or a futures ETF. The difference between these two is quite substantial and you might even have read headlines on how bad futures backed ETFs are. So, what are they?

Futures backed ETFs are basically not tied to the underlying asset by any means. It’s based on futures contracts (in this case Bitcoin futures) and with these the purpose is to try and mirror the price of the underlying asset. But what are these futures contracts? They are derivative trading tools that allow two parties to buy/sell Bitcoin at a predetermined price and date. Here’s an example, let’s say I believe that Bitcoin will trade at $100k when December ends. I’m sure about this so I will enter into a contract saying that I’ll buy 1 Bitcoin at today's prices (roughly $65,000) at anytime through the end of December. Then when December ends, I will have to buy that Bitcoin I promised regardless of the price. Now, if Bitcoin in fact trades at $100k I’ll make an instant profit of $35k. However, Bitcoin’s price could also be lower than $65k and I would still have to buy. The reason the seller will enter this contract is because they protect themselves from price volatility, regardless of what happens they’ll get their $65k in two months, plus the premium for selling the contract. The reason why I will enter this contract is to speculate on something without maybe having the cash to currently buy $65k worth of BTC, I only have to pay for the contract, which might only cost 1% or less of that $65k. However, often these contracts are traded even before the price expiries, since if Bitcoin seems to go close to that $100k then naturally the contract that you can buy Bitcoin for $65k will be quite valuable.

Placing bets and predicting on future prices, that's what futures are all about. 

Hopefully, you got a quick sense of what futures are, but this was just a quick introduction and just by searching for futures contracts on the internet you’ll find loads of more information. The important part was just to highlight that these contracts are only bets on paper of a certain assets price action. There's no actual Bitcoin involved in Bitcoin futures.

So, using these instruments the Bitcoin ETFs we have today try to mirror the price of Bitcoin by trading these instruments on the CME (Chicago Mercantile Exchange). This means that by buying these ETFs you'll only own the paper on which these contracts are written. Buying the ETF will also not have an impact on the price of Bitcoin since no one is going to buy the physical asset.

Why Do We Need this?

The reason we need a Bitcoin ETF and preferably a spot ETF is because it allows many institutions, hedge funds and companies to gain access to crypto. I listened to an interview with Kevin O’Leary where he talked about institutional interest in cryptocurrency and if he’s right there’s a wave of capital coming. The question is why hasn’t it arrived already?

This is because there are legal issues. What O’Leary mentioned about his first crypto purchases is that it was a difficult process. All he’s advisors, both legal and business, told him that it isn’t possible. There are too many regulatory issues regarding different filings that have to be done to satisfy tax authorities, and the financial crimes department, and more. On top of that, for some institutions managing other people’s money storing crypto is a huge issue. They don’t know how or where they can reliably store their cryptos. Therefore, buying crypto directly isn’t an option for many. Also, many US companies and institutions aren’t allowed to go abroad buying products that aren’t approved by a US regulator, otherwise many would probably pile into Canadian Bitcoin ETFs. However, we'll talk more about other products and ways to gain Bitcoin exposure in the next section.

 Everyone should be allowed Bitcoin, no taxes no restrictions, am I right? 

These were just a few of the reasons why there are problems for US institutions to gain access to Bitcoin, and why O’Leary, along with others, believe a lot of capital will flood into the market once we see a good product for gaining exposure to Bitcoin. Of course, there are other issues too that restrain capital from flooding into Bitcoin like ESG (Environmental, Social, and Governance), but that’s out of the scope of this article. However, what I just want to mention is that when O’Leary talked about how much money there is waiting to come into crypto he used the term trillions, yes you read it correctly not millions, not billion but trillion with a T as in To the moon.

Other Ways to Gain Exposure

Although this article was supposed to only compare Bitcoin futures ETF to physical Bitcoin, I just want to point out that there are other ways to gain exposure. For many, those other options could even be better.

First, I want to mention something that I bet many of you have heard about, the Grayscale Bitcoin trust. Grayscale is the largest digital asset manager in the world with over $60 billion in AUM (assets under Management) and the Bitcoin trust takes up a huge chunk of that with just over $40 billion in AUM. The GBTC works almost like a Bitcoin spot ETF but there are a few structural differences. ETFs are more flexible than GBTC, ETFs can create and redeem shares based on demand which makes them typically trade extremely close to their net asset value (NAV). This is compared to GBTC where there’s a fixed number of shares and low flexibility. This has caused GBTC to trade at either a high premium or discount compared to its NAV. Therefore, although your purchase in HBTC is backed by physical Bitcoin its price can differentiate due to factors unrelated to Bitcoin.

 Here's a look at GBTC. As you can see there's quite a hefty discount. Images via Grayscale 

Another way to gain Bitcoin exposure is buying equities with Bitcoin exposure. Typically, people turn to either mining companies or MicroStrategy. However, these too can fluctuate due to factors not related to Bitcoin. For example, mining companies do have to run their operations with purchases of hardware and electricity. If they were to purchase bad equipment or an accident happens in their facility it will drop their share price significantly. Therefore, these aren’t perfect when seeking Bitcoin exposure. However, it is possible to mitigate the risk of one company's failure by buying into an ETF that holds a variety of these companies. However, be careful when buying blockchain ETFs since many hold companies like IBM, Nvidia and some even Nokia, and just FYI these do not really mirror the price of Bitcoin, not even slightly.

 If you're looking to buy some crypto-related equities I suggest you take a look at this piece. Image via Coin Bureau 

The third way to gain exposure is to buy a spot ETF. As I mentioned earlier there are Canadian ETFs as one example. If you have the ability, you can buy a Bitcoin spot ETF from the Canadian stock markets. These are highly popular and even the CEO of Ark Invest, Cathie Wood, planned on switching their Bitcoin allocation from GBTC to one of these Canadian spot ETFs.

What’s Best?

For an individual retail investor like you and me I would almost always recommend buying the real deal. It's the only way you can truly participate in the network Bitcoin was meant to be. When owning your own Bitcoin and storing it without centralized entities there is no one that can take that away from you, which is exactly what Bitcoin is meant for. Only you have access to the coins, and you can do whatever you want with them. However, there are risks with this too, like losing your private key, which is why I suggest you watch Guy’s video on crypto custody to avoid these silly mistakes.

I said I would ALMOST always recommend the real deal, but not always. That’s because people have different needs, and from the top of my head I can come up with a few examples on when gaining Bitcoin exposure some other way could be the way to go.

First, some countries have restrictions on trading cryptocurrency. Also, if you’re extremely new and still unsure on what your country's stance towards cryptocurrency is, then it might be worth gaining Bitcoin exposure some other way. However, my preference would not be to buy a futures ETF but rather either a spot ETF from Canada or GBTC. This is because I feel like without some physical Bitcoin being bought it won’t be “real”. And additionally, the fees are often lower for physically backed since trading futures contracts to mirror the price adds up a lot of costs.

Second, which is kind of related to restrictions, is taxes. If it’s too much trouble for you to manually report taxes and keep track of everything then you might want to consider a simpler solution. For example, if I we’re to buy the BITO ETF then I know that since I’m buying it from a stock market through my traditional native stockbroker, they will automatically provide tax documentation. However, if I were to buy a physical Bitcoin, I’d have to keep track of the exact buy price, sell price, and trading fees. Then, I would also have to manually report and pay the taxes, and finally, I would have to be prepared to dig up the required paperwork if someone were to ask me to prove everything. This is naturally something many are willing to do, you just have to be careful and do it correctly.

 If you don't love paperwork then you can take the easy way out. I admit, taxes can be a pain in the ... 

This brings us also to the third and final reason, clumsiness. If you're clumsy and have a tendency to not be the most organized, then dealing with cryptocurrencies in a country with relatively strict regulations can be tough. You don’t want to be sitting on thousands of dollars in gains without having a clue how to pay taxes or do the correct filings. Additionally, and even more importantly, you need to store Bitcoin correctly. It’s not that great to store your Bitcoins in a cold wallet if you have a tendency to forget and lose passwords. Remember, if you lose your private key then that’s too bad, you won’t get your money back. So, if you have a tendency to lose stuff or not be organized then consider getting exposure some other way.

Lastly to remind you again, if you do decide to go with something other than Bitcoin itself then at least find something which buys that for you. GBTC might be a good bet and if you read the next section, I’ll tell you why. Additionally, mining companies can be quite good at mirroring Bitcoin’s price and can even outperform it. That’s because scaling up their business will impact their price just as much as a rise in Bitcoin’s price.

GBTC Possibilities

The reason why I said that GBTC could be a good pick is because they have plans to convert their trust to a spot backed Bitcoin ETF. Why this is bullish for all of us is the previously mentioned flow of money waiting to get in. But what makes it bullish for you if you buy GBTC is the possibility of instant profit. You might recall that GBTC currently trades at a discount to the underlying Bitcoin and it’s currently something above closer to 15 %. However, because the settlement mechanism is much more efficient for an ETF there is speculation that the discount would quickly vanish if the trust was converted to a spot ETF. This means that you as an GBTC investor would both benefit from the price action of Bitcoin as well as receive the free 15% profit if the speculators are correct.

Conclusion

I know I gave quite a negative look on futures backed Bitcoin ETFs, it’s just that the product really isn’t great. However, what is great is seeing that product being traded. That’s because getting a Bitcoin ETF approved by the SEC is a huge milestone. Speculation on a Bitcoin ETF has been going on since 2013 and now we finally got it. Yes, it wasn’t what we hoped for but it’s at least something. It shows that Bitcoin adoption is growing. Braking trading records with a product that isn’t even good shows everyone how much demand there is for Bitcoin. Now we just have to wait for the real ETF to be released. Hopefully, we’ll see that in early 2022.

Lastly, I quickly want to touch briefly on an article I read on Coin Telegraph about a carbon neutral spot ETF being launched in Canada. As a I mentioned there are doubts about Bitcoin ESG values with emphasis on the letter E due to mining. This just got me thinking that maybe a carbon neutral ETF could be something that not only the SEC might like, but also many institutions that are currently worrying about mining and its impact on our climate. Anyway, a spot ETF is coming sooner or later, whether it be by Grayscale or someone else, and when it comes it will be huge.