Bitcoin ETF Approved But Be Aware of Potential PitfallsSubmitted by LWM | Linden Wealth Management LLC on October 27th, 2021
The long-awaited SEC approval of a Bitcoin ETF has finally come with the launch of BITO and then BTF. As an indication of demand, BITO reached more than $1.0 billion AUM in just two days, the fastest for an ETF to do so in history. The SEC approval of an ETF adds further credibility, consumer protections, and oversight to Bitcoin and the concept of digital assets.
However, investors need to know that they aren't actually buying Bitcoin but instead futures contracts or derivatives tied to it when they buy the ETF. This has the real chance of introducing what is known as basis risk:
"When a futures contract and the underlying asset it references differ in value."
Because of how futures contracts work and the need to be constantly rolling expiring contracts forward to maintain exposure, there's the real risk that the spot price (cash market) of Bitcoin and the ETF will vary wildly at times.
In addition, there's a limit to how many futures contracts any one entity can own. According to Steve Cook at Harbor Capital, the limit is 2000 contracts. Once an ETF manager exhausts that limit, they must look to buy longer-dated futures contracts, introducing even more basis risk.
The SEC approval is an additional positive step forward for Bitcoin and cryptocurrencies. Investors and advisors like myself are devoting more time and energy to understanding what role cryptocurrencies and digital assets might play in a portfolio. Influential investors like Elan Musk and Paul Tudor Jones add credibility to the subject as well. It's important that if you're considering purchasing the ETF, you weigh the risks of owning it in derivative form versus the asset itself.
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