What are the differences between Bitcoin spot ETF and futures ETF? Does BlackRock's oversight sharing agreement have the potential to lead the spot ETF race?

Recently, the application by asset giant BlackRock for a Bitcoin spot ETF has sparked discussions in the cryptocurrency community. In recent years, several fund companies' applications for spot ETFs have been rejected, while multiple Bitcoin futures ETFs have been approved for listing. What are the differences between spot and futures ETFs in terms of operation? Why do most fund companies still insist on applying for spot ETFs?

Spot ETF vs. Futures ETF

ETFs that track the price of Bitcoin can be divided into two types: those investing in Bitcoin spot and those investing in Bitcoin futures.

Bitcoin spot is quite intuitive, using a trust structure to allow investors to benefit from the appreciation of Bitcoin prices through buying and selling Bitcoin; while futures track its trends through Bitcoin futures on exchanges. In other words, a futures ETF trades in cash-settled futures contracts. Therefore, there may be certain differences in returns between the two.

The Bitcoin Strategy ETF with the ticker symbol BITO is the first Bitcoin futures ETF in the U.S. market, listed on the New York Stock Exchange in October 2021, issued by the fund management company ProShares, with a management fee of 0.95%. BITO currently manages assets of approximately $913 million. According to information from their website, it tracks the value of Bitcoin through investing in Bitcoin futures on the Chicago Mercantile Exchange (CME). About one-third of BITO's assets are exposed to futures contracts expiring in July, while two-thirds are in contracts expiring in June. This means that BITO needs to constantly roll over, meaning it must close out existing futures before they expire in June and buy new futures for August to continue holding Bitcoin futures. Rolling over incurs trading costs, and there may be price differences among futures contracts of different durations. Therefore, the cost of ETFs tracking futures is usually higher than that of simply holding spot assets.

However, futures ETFs have another advantage in that futures are traded on margin, allowing for leverage in holding Bitcoin. This is why we see that BITO holds a large amount of U.S. Treasury Bills in the image below. With the current yield of U.S. Treasury Bills above 4%, it serves as a decent source of income.

Let's briefly compare the performance of BITO with Bitcoin this year. Bitcoin has risen by 64% from the beginning of the year to the end of May, while BITO has risen by 59.58%.

Learning from Gold ETFs for Bitcoin ETFs

Venture capital partner Adam Cochran analyzed in a tweet why BlackRock's entry into the market is so important! He mentioned the development of Gold ETFs, where before BlackRock's entry, the market was only worth $1 trillion, but after his entry, it grew to $13 trillion.

In 2004, State Street Bank launched the SPDR Gold ETF with the ticker symbol GLD, the largest in terms of scale among all Gold ETFs, with a market value of about $58.4 billion. BlackRock also launched IAU in 2005. Adam Cochran believes that BlackRock, through its advisory team, promoted a narrative that gave gold a broader legitimacy in investment portfolios. After nearly two decades of effort, young wealth managers and economists who have already occupied a place in central banks and sovereign wealth funds have come to take "gold as a safe investment in a portfolio" for granted.

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But BlackRock through its army of advisors pushed the narrative that gave gold broader legitimacy in a portfolio.

It's network told millions of users that you *needed* gold to have a well balanced financial safety net.

— Adam Cochran (adamscochran.eth) (@adamscochran) June 17, 2023

According to MoneyDJ's statistics, gold-related ETFs with assets exceeding $1 billion, except for GDX and GDXJ focusing on gold mining, are mostly spot ETFs tracking gold prices.

Let's take BlackRock's IAU as an example. IAU was listed on NYSE Arca in 2005, with a management fee of 0.25%, an asset size of $27.9 billion, holding 14.49 million troy ounces of gold. The New York Mellon Bank serves as the custodian, and JPMorgan's London branch serves as the trustee, targeting the LBMA gold price in London.

Observing its tracking performance, the difference between market price and net asset value (NAV) for IAU mostly falls within plus or minus 1%, with the latest figure on June 22 at -0.34%. It's clear that the performance of spot-tracking ETFs closely mirrors the spot market, considering that funds still need to deduct various expenses like management and marketing fees, with the management fee of 0.25% being relatively low. The Bitcoin futures ETF BITO mentioned earlier has a management fee of 0.95%, while Grayscale's GBTC is as high as 2%.

Could the Supervisory Sharing Agreement Help Approve Spot ETFs?

From the analysis of the gold market, it's not hard to imagine why most asset management companies prefer to apply for Bitcoin spot ETFs rather than Bitcoin futures ETFs. After all, costs such as futures rollover need to be considered in the fund's performance. For long-term investors who have the choice, of course, they would prefer to hold spot funds with better performance!

So far, only a few Bitcoin futures ETFs have been approved for trading. Although ultimately, the futures market is based on the price of Bitcoin spot. However, the reasons why the U.S. Securities and Exchange Commission (SEC) previously rejected Bitcoin spot ETFs were mainly due to concerns about market manipulation related to Bitcoin prices, as Coinbase and other companies were not regulated as exchanges, thus lacking trust in preventing fraud and manipulation.

BlackRock, the big player in the ETF market, applying for a Bitcoin spot ETF has attracted significant attention, leading WisdomTree, Invesco, and Valkyrie to reapply. BlackRock intends to list on Nasdaq, and Nasdaq will sign a surveillance-sharing agreement with spot trading platform operators. The surveillance-sharing agreement allows collaborators to share information about market trading activities, clearing activities, and customer identities, thereby reducing the possibility of market manipulation. This agreement can help exchanges discover and prevent potential fraud and manipulation, as well as improve market transparency and efficiency.

Whether this supervisory sharing agreement has the potential to convince the SEC that the Bitcoin spot market is transparent and difficult to manipulate, thus approving Bitcoin spot ETFs, may be revealed in early August!