BITO is making waves.
If you've seen it scrawling across the news ticker but aren't quite sure what it is or what all the lingo means, you're not alone. BITO was recently approved by the U.S. Securities and Exchange Commission as the first-ever Bitcoin futures-backed Exchange Traded Fund, or ETF. Its full name: the ProShares Bitcoin Strategy ETF.
An ETF is a basket of securities you buy or sell on a stock exchange through a brokerage firm.
Investors moved $1 billion in assets into BITO faster than any previous ETF launch. Based on its popularity, it likely won't be the last ETF of its kind, said BOK Financial® Chief Investment Strategist Steve Wyett.
Wyett said it could be a bit confusing at first glance—but understanding some common investor terms and concepts might help break it down.
The basics
"The first thing to know is that owning crypto coin and owning a futures-based Bitcoin ETF are not the same thing. BITO invests in futures tied to Bitcoin," Wyett said.
He added that an equity ETF is simply a group of stocks bundled together whose performance is based on the group, not one stock individually.
And a futures contract is an agreement between two parties to complete a transaction—either buy or sell—on a specified asset, at a specified time and at a specified price.
Futures contracts have differing delivery methods. "For some contracts, an actual good or asset is delivered against the contract—think about a cereal company buying corn on the futures market," he explained.
The company wants to lock in the corn price by using the futures market and they actually want delivery of the corn. In this scenario, there is a producer of the commodity, a farmer or refiner, who can deliver the corn to the cereal company.
Other futures contracts, like those on Bitcoin, do not involve the delivery of the underlying asset because there's nothing tangible to deliver. Wyett said Bitcoin futures settle in cash, which means the buyers and sellers calculate who owes money and who is due money, and then settle up in cash.
Regulation and risk
"Since BITO ETF is not investing in actual Bitcoin," he said. "You might be asking yourself why the SEC would approve it this way—based on futures, not crypto coins. And the simplest answer is that futures contracts, which are a time-tested and broadly used strategy, trade on regulated exchanges. So, the oversight on how futures trade, pricing and operational issues are well known.
"This isn't to say that futures aren't risky—they are. But the risks inherent in futures are known and understood," he said. "On the flip side is crypto, which still trades on unregulated exchanges and are therefore outside the purview of regulators like the SEC and FINRA."
There are still significant issues, like safekeeping and reporting, which limit the ability of major financial firms to provide due diligence and recommendations on crypto coins, Wyett said. This means investors are potentially accepting some level of risk that can't be mitigated.
“I can't emphasize enough—buying Bitcoin and investing in the BITO ETF are not the same thing. Outcomes can, and will, vary. Ultimately, it's important to understand the speculative nature and exercise caution. I've said it before, and it applies here too: Speculate responsibly.”- Steve Wyett, chief investment strategist at BOK Financial
Looking ahead
"Eventually, we expect the crypto market to move toward a more regulated environment, which may mean ETFs backed by actual crypto coins could be approved," he said. "But there's a lot of work to be done between now and then."
In the meantime, those eyeing a BITO investment need to remember that futures contracts have an expiration date. In this case, it's the shortest futures contract option, called the front month contract.
"This means the Bitcoin futures ETF will have to continually roll forward its contracts, which involves fees and other costs," he said. "When you're reaching the expiration date, you could buy another contract to continue the investment. Knowing the prices are going to fluctuate, this could mean you buy high and sell low, which isn't ideal."
Overall, the pricing structure of the futures market means the performance of a futures-based ETF will vary as compared to the underlying asset. Meaning you could wake up one morning to see Bitcoin has gone up 4% and BITO only up 1.5%. The two aren't necessarily linked.
"As a result, futures-based ETFs have been better 'trading' vehicles than 'investment' vehicles," Wyett said. "In fact, futures-based ETFs have generally been poor investment vehicles as opposed to the underlying asset. The trading of these ETFs could result in significant tax issues depending on an investor's individual situation and the type of account used to purchase this type of ETF."
While BITO is currently dominating investment news—the popularity of these futures-based ETFs might also cause some problems. In the future, there might be issues based on exchange limits on the number of front month contracts any one ETF can own.
As of this writing, BITO owns a total of 3,812 such contracts against a limit of 4,000. Size limits are put in place by the exchange to help mitigate the risk of any one participant within a single futures contract. If BITO would have to start buying longer-term contracts, this could widen the disparity of performance between Bitcoin and the ETF, Wyett said.
"I can't emphasize enough—buying Bitcoin and investing in the BITO ETF are not the same thing. Outcomes can, and will, vary," he said. "Ultimately, it's important to understand the speculative nature and exercise caution. I've said it before, and it applies here too: Speculate responsibly."
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