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ETF Explained: What are the differences and issues between Bitcoin Futures ETF and Spot ETF? FTX.US President Explains

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ETF Explained: What are the differences and issues between Bitcoin Futures ETF and Spot ETF? FTX.US President Explains

The ProShares Bitcoin Futures ETF BITO has officially launched on the New York Stock Exchange (NYSE) Arca, marking an important milestone. However, it is important to note that the trading mechanism of Bitcoin futures ETFs differs from that of Bitcoin ETFs and may involve various hidden costs. In response to this, FTX.US President Brett Harrison took to Twitter to educate the community about the mechanism of futures ETFs.

Arbitrage Model of ETF

FTX.US President Brett Harrison explained that the key to understanding BITO or any ETF lies in the assets held in the ETF basket, and the price of the ETF (in the secondary market) will be anchored to the price of a basket of assets because of the "Creation and Redemption" process.

While most people trade ETFs on the securities market (secondary market), ETFs also have another trading method: through the creation and redemption mechanism, allowing Authorized Participants (AP) in the market to directly exchange ETF component stocks for a basket of assets or redeem ETF component stocks for ETH shares.

Brett Harrison stated:

If the basket of assets is higher than the ETF, APs can purchase the ETF and use the redemption mechanism to exchange the ETF shares back for a basket of assets, then sell the assets for profit. As arbitrageurs, APs trading between a basket of assets and ETF shares ensure that the ETF price remains consistent with the asset price.

BITO Doesn't Directly Track BTC

A Bitcoin ETF is based on a commodity trust, so it directly holds Bitcoin spot and is custodied by a third party. On the other hand, a Bitcoin futures ETF is a "basket of financial instruments."

ProShares' Bitcoin futures ETF primarily includes two kinds of financial instruments: near-term expiring CME contracts and money market instruments such as U.S. short-term treasuries and repurchase agreements.

Brett Harrison further explained that looking at the allocation of CME contracts in the first part, due to arbitrage relationships, CME futures tend to correlate well with Bitcoin spot prices; however, the other money market instruments can be seen as cash reserves, meaning BITO's price movement may not align exactly with spot prices.

"The significant cash reserves in the basket also mean that spot prices and BITO ETF do not move in sync. If BTC goes up by 1%, BITO's increase should be less than 1%," said Brett Harrison.

Another complex issue is the "futures premium."

Brett Harrison mentioned that BITO holds futures, and futures typically have a higher premium as the delivery date approaches due to factors such as interest rates and future price expectations.

In addition, there are roll costs to consider.

Each time BITO's futures contracts expire, the ETF fund sells the expiring contracts and buys longer-dated futures. Since Bitcoin is seen as a long-term bullish asset, the prices of longer-dated contracts will be higher than the expiring ones, incurring hidden roll costs over time.

Brett Harrison stated:

"In this scenario, the fund would incur losses from rolling over futures before expiry, which is known as contango."

Do Retail Investors Have No Other Choice?

Undeniably, the SEC's approval of the first Bitcoin futures ETF is a significant step for the financial industry, indicating the introduction of "mini Bitcoin derivative" ETFs into the traditional financial market. Bitcoin ETFs can be seen as fractional shares of a CME contract.

It is worth noting that FTX.US's acquisition of the U.S. compliant derivatives exchange LedgerX is expected to be completed this month.

LedgerX is the only entity with all three complete CFTC regulatory licenses in the U.S., including DCM, DCO, and SEF, enabling FTX.US in the future (post-acquisition) to directly offer crypto derivatives to retail investors and even tokenized equities.

Previously, Brett Harrison tweetedthat, following the acquisition of LedgerX, FTX.US under CFTC guidance will be able to:

  1. Provide crypto futures and options to retail and institutional investors
  2. Offer clearing services to other exchanges. Providing this service requires obtaining both DCM and DCO licenses.

Moreover, Brett Harrison revealed that these three licenses will allow FTX.US to offer "derivatives not limited to crypto products," aligning with SBF's statement in a Bloomberg interview, expressing a desire to offer tokenized equities on FTX.US in the future.