The BTC ETF approval is not what it seems on the surface

What is an ETF? What is a Futures ETF vs Spot ETF? What exactly is this Futures based BTC ETF and why this is not good for retail? More importantly what does it mean in terms of opportunities in Q4 & 2022?

BTC has been holding back since May as there was no new narrative building up like in 2020 (Grayscale, governments opening up, institutions coming in etc). We played all of them very well and by May 2020 as open derivative interest and volumes exceeded all expectations. Even DeFi touched a TVL of around $99.5 bn and is again about to break that ATH as we write this.

But this narrative “BTC ETF approvals” started to build up again in September in-spite of GG’s (Gary Gensler) continuous negativity towards everything crypto. The market “seemed” right. Ity looks as of this weekend that the Proshares BTC ETF will be approved on Monday.

However those approvals are for a “Futures ETF”. Let’s see what that means and why that is NOT so bullish, although a very progressive step from the regulator and a positive indicator of things to come for crypto markets (HODL On, yes)

What is an ETF

An exchange traded fund, or ETF, is a financial instrument that tracks the value of a particular asset or a collection of assets. Its main benefit is that it allows investors to diversify their holdings without actually owning any of the assets themselves. ETF’s make ownership:

  1. Convenient
  2. Safer
  3. Cheaper

Types of ETF

  1. Physical-backed: The asset manager must own equivalent amount of physical coins from the market and closely resembles the price minus the holding & management fee. Value of the ETF moves with the price of coins largely.
  2. Futures backed: The asset manager is holding a specified Futures contract – simply an agreement to buy or sell an asset at a predetermined price at a specified time in the future. This is the type of bitcoin ETF the SEC is reportedly set to approve – having CME futures contracts as the underlying instead.

That is not same as physical ETF and that is where the “devil in the detail” lies as hardly any institutions would participate here. Let’s understand some concepts about a Futures ETF first:

  1. Contango – When higher prices are expected for BTC in the future, the futures curve positively slopes. That’s all that contango is. BTC has mostly been in a contango historically.
  2. Monthly Expiry – Before the contract expiration every month, ETFs must sell 1st-month futures and purchase 2nd- and further out futures to not receive physical or cash delivery.
  3. Negative Roll- When the curve is in contango, futures-based ETFs sell cheaper futures and purchase more expensive futures each month. This difference is called “Roll or Roll Return” and this number is negative when the futures curve is in contango
  4. Every month when the Roll is negative it starts to compound and eventually over a year (s) you have lost a large value vs just holding spot. Institutions know this. This is their territory but retail wants easier and safer access like Grayscale (which is almost -20% discount to spot today, although not the same as Futures ETF)
  5. Without institutions, who have direct CME access, why will they buy this ETF? This CME Futures based BTC ETF actually has no fundamental advantage if you see, just optics and perception and narrative. Which in itself is not a bad thing.

Consequences & Opportunities?

  1. Institutions realise this will not bring in any real advantages. There will be very limited money buying these BTC Futures ETFs and most will be from retail. They have limited capacity and will probably be moving from Grayscale to ETF.
  2. Without new money, any new ATH or a push beyond 70K is very difficult.
  3. Crypto cycles will come true. Traders & Institutions will start rotating money to ETH and SOL first and DeFI 2.0, NFT, Gaming etc vs BTC. They have made enough in BTC in Sep / October with over 75% gains. That move might not come till end of November however, as the retail narrative plays out gradually as well as money from other ETFs starts to flow to BTC Futures ETF.
  4. Also market had already priced in this ETF narrative and there is again a lack of new narrative, while there is a much stronger ETH narrative in my opinion. Also, the market will start building an ETH ETF narrative on top of this. Why not? and then SOL and others – keeping the Narrative Mills running for next 6 months.
  5. This should also push more Contango as every month the ETFs will have to buy further out Future months. This should give good basis risk free arbitrage opportunities.
  6. Just like Canada front ran US in ETFs. other countries will take advantage and give physical spot ETF approvals. Investors and institutions will go where the approvals are
  7. Comparisons to Gold ETF are abundant as more and more Gold ETFs were approved – Gold rallied crazily and we shall see some flow from Gold ETFs to BTC ETF’s

Conclusion: At a 36,000 feet level, however, everyone wins here with this one small step by the regulators – companies, holders, ETH & entire crypto community. It’s just a matter of time that spot BTC ETF is also approved along with an ETH ETF and derivatives & innovative products are build on top ( leveraged, inverse, DeFi etc)

Have a Great Day Ahead!

Leave a Reply