The new Bitcoin ETFs come close to the Platonic ideal of two things at the heart of the financial industry, arbitrage and gambling. And a third thing: Without the distortions that the financial industry created in the first place, they don’t. ‘would have no reason to exist.
The whole concept of a bitcoin ETF is strange. Bitcoin is a cryptocurrency; it is easy to buy and, for individuals who want to speculate on its future value, easy to hold. All you need to do is download some software, choose a secure password, register with a crypto broker, transfer the bitcoin to your blockchain wallet and you’re good to go. If you wanted a traditional currency, you wouldn’t pay a 0.95% annual fee, plus high forward costs, to get something that roughly tracks the value of a dollar – you would just hold a few dollars.
That didn’t stop many people from finding the idea appealing: The ProShares Bitcoin Strategy ETF, the first, attracted more money than any other ETF launch and had the second highest number. of transactions on the first day. A week after its launch, it has $ 1.2 billion. Much of this money is likely to be a new layer of gambling, as traders bet on other people who want it. But the underlying expected demand is coming from those who cannot or do not want to take the simple option of buying bitcoin directly, so prefer to use a publicly traded structure approved by the Securities and Exchange Commission.
It all sounds reasonable, until you ask why they prefer it, given the high costs and the ease of direct purchase. The answer is, it’s about trust, which is quite ironic considering that bitcoin was created to solve a trust issue.
Michael Sapir, chief executive of ProShares, compares the regulated futures market to what the SEC itself calls the “Wild West” of crypto trading. He warns that many exchanges “have a degree of manipulation built in,” so there could be hidden costs involved in buying bitcoin directly, as well as risks.
There are certainly risks. If you hold bitcoin directly on the blockchain and lose your wallet password, you’ve lost your bitcoin. If someone steals your password, you’ve lost your bitcoin. And if you give it to someone else, they now control your bitcoin. For an individual, it is manageable, so scary; choose a unique secure password that you will remember, do not write it down or store it on the internet where it could be hacked, and do not tell anyone.
But in the financial system, most of our investments are transferred to others, with the vast majority of assets in the world being managed by institutions such as insurance companies, pension funds, mutual funds and endowment funds, or through advisers. These institutional investors and advisers have a serious trust problem. Who do they trust to hold the bitcoin password? Ultimately, someone has to have custody of it, and that person can suddenly get very rich by running away with it, which they cannot (easily) do with stocks, bonds, or property. The trust issue is difficult to manage, as evidenced by the founders of crypto companies who sometimes disappear with all the bitcoin their investors thought they were dealing with.
The new ETFs get around the trust issue by buying bitcoin futures contracts instead of bitcoin, introducing a new layer of gambling and arbitrage. Bitcoin futures are just side bets on the price of bitcoin, settled in dollars; they owe Bitcoin what a bet on the Kentucky Derby is to the horse. Their connection to the price of bitcoin comes from the final settlement and arbitrageurs who profit from selling overvalued bitcoin futures and buying real bitcoins. (The same could apply in reverse, but usually the futures price is higher.)
In turn, the price of the ETF is kept in line with the value of the bitcoin futures contracts it holds by arbitrageurs, like other ETFs.
All of these arbitrage layers cost money – real money, not bitcoin. The ETF has an annual fee of 0.95%, but the main cost comes from the fact that futures are more expensive than bitcoin. The ETF buys them a month in advance, but their price drops as they approach maturity, resulting in a loss, known as the cost of rolling. This approach has been about 13 percentage points lower than bitcoin’s 118% so far this year, according to the Horizons Bitcoin Front Month Rolling Futures Index calculated by Solactive; Mr Sapir says it’s more like five points per year since 2017.
Many people are offering technical solutions to the problem of institutional bitcoin custody, and many are trying to persuade the SEC to approve an ETF that simply buys bitcoin. This would remove the layers of arbitrage and gambling created by the use of futures contracts, leaving only the arbitrage inherent in ETFs and the gambling inherent in bitcoin, but would only be successful if investors trusted the solution.
Yet the basic premise of any bitcoin ETF is an arbitrage between the blockchain and the traditional financial system, the reverse of what Tether and other stablecoins do. Stablecoins allow you to think in dollars on the blockchain; Bitcoin ETFs allow you to think bitcoin in the mainstream system. And like everything else in finance, it comes at a cost – costs that ordinary people can easily avoid if they want bitcoin, just by buying bitcoin instead.
Write to James Mackintosh at [email protected]
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