Even if bitcoin weren't in a bubble, it still wouldn't work well as an ETF, David Tuckwell argues.
With Chicago exchanges greenlighting bitcoin futures, it's only a matter of time until we have bitcoin ETFs.
And make no mistake: bitcoin ETFs are coming. Several issuers across the US have made filings for bitcoin ETFs, only to have their attempts thwarted by regulators. But now, with futures contracts on the table, bitcoins can be crammed into an ETF structure that regulators approve and recognise.
But before the stampede into bitcoin ETFs begins, investors may want to consider whether buying into them is a good idea - both with and without the ETF wrapper.
The consensus among financiers appears to be that bitcoin is a bubble. Jack Bogle called bitcoin the "plague", Jamie Dimon called it a "fraud", Larry Fink "an index of money laundering". Their sentiments are backed up by Nobel Laureates who warn of a bubble looking for a place to burst.
And there's good reason to think they're right. With bitcoin trading at $15,000 as of 8 December its price has risen 1100% in 2017. It is now bigger than the economy of New Zealand, and has achieved this size without any fundamentals to speak of.
What's driving bitcoin's Icarus-like rise is a three-fold coalition. This coalition includes money launders and darknet criminals; millennial "true believers"; and investors who, as in the run-up to the 2007 subprime crisis, know bitcoin is in a bubble, but want to make money while it inflates.
All this makes for a dubious investment proposition, and this dubiousness should be taken seriously by the ETF industry, especially considering the spotlight ETFs have been under this year. But as well as bitcoin being a questionable asset, there is good reason to doubt whether ETFs are the right wrapper for containing it.
The bitcoin ETFs of the future will likely be structured like some commodity ETFs (sometimes called ETCs), which use futures contracts to track whatever commodity they chose - from soybeans to cocoa to pigs. Commodity ETFs then roll these futures contracts before the commodities are delivered, meaning that exposure is maintained without ever having pigs rock up at an investor's door.
Why is this a problem? Because when futures contracts are rolled they can run into contango. Contango is when the new futures contract being bought is more expensive than the old one being sold. Contango means that investors lose money just by rolling a futures contract.
If contango poses a problem for normal commodity tracking ETFs, it could pose a particularly large one for bitcoin, the price of which has been hugely volatile. Given the leaps upwards (and downwards) bitcoin has seen, rolling bitcoin futures could make for a steep contango market, threatening any bitcoin investment even if the price of bitcoin is rising.
Bitcoin enthusiasts may object that futures markets can be in backwardation as well as contango. (Backwardation is the opposite of contango. It's where the new futures contract being bought is cheaper than the old one being sold, meaning investors make money from the roll). And that bitcoin ETFs could benefit from rolling futures contracts rather than lose.
This is possible to be sure, but the point here is that contango and backwardation will be part of any bitcoin ETF. And they add another layer of risk to what is an already risky investment.
Bitcoin ETFs could open a fissure for more money to enter bitcoin, which would surely be great for those who got into the cryptocurrency early. And bitcoin could continue to rise in price, making bitcoin ETFs a possible winner. But as with bitcoin itself there is good reason for investors to think long and hard about bitcoin ETFs.