Crypto Funds Come With Different Risks. Bitcoin's Recent Volatility Shows How.

May 29, 2021

Bitcoin had lost nearly half its value since the April peak before finally seeing a small bounceback this past week, taking many of its investors on a tough ride. But some might have had an even bumpier ride than others, depending on how they are invested in the digital currency.

While many investors directly hold Bitcoin through their PayPal or Robinhood accounts, others have been seeking ways to ride along without hassles of securing and storing it. Investors can do so through Bitcoin funds, which allows them to trade the cryptocurrency more cheaply and integrate it into portfolios alongside stocks and bonds.

But crypto funds come in different shapes, and in a volatile market like today’s, they can bring risks beyond Bitcoin’s already fickle movements. Here are the different approaches:

Direct Bitcoin Holdings in ETFs

The most desired vehicle would be a Bitcoin ETF, an open-end, exchange-traded fund, backed by actual Bitcoin holdings in secure custody. An ETF can create and redeem shares freely according to investor demand. That means the fund can accurately track the price of its underlying assets without influence from the supply and demand for the fund itself. Investors won’t have to bid up the share prices when there is strong buying, or see shares plunge below the Bitcoin price when more people are selling. A Bitcoin ETF would also be very liquid, with shares traded on primary exchanges free most of the time.

As good as it sounds, there is currently no Bitcoin ETF in the U.S. Although a dozen of asset managers have submitted their application with the Securities and Exchange Commission and the public seems eager, the regulatory agency is still cautious about the digital assets’ high volatility and potential risk of manipulation. Six Bitcoin ETF applications are currently under the SEC’s official review, including one from funds behemoth Fidelity, with roughly 10 more pending.

But U.S. investors can get a glimpse of how Bitcoin ETFs work by looking at Canada. The Ontario Securities Commission has approved a few Bitcoin and Ethereum ETFs earlier this year, and this month’s crypto meltdown has proved that the ETFs can work just as they are supposed to.

As the price of Bitcoin cratered, the C$875 million

Purpose Bitcoin

ETF (ticker: BTCC. Canada)––the largest in size among its Canadian rivals——moved nearly in lockstep. The fund has also seen very minor outflows despite a nose dive in Bitcoin’s price. From the cryptocurrency’s peak on May 8 to Wednesday, the Purpose Bitcoin ETF had asset outflows of only C$27 million——a small drop relative to the fund’s size. This means most ETF shareholders are likely long-term Bitcoin believers that don’t easily flinch at short-term volatilities.  

Closed-End Bitcoin Funds With Price Gaps

For now, U.S. investors can go only for the second option: the closed-end Bitcoin fund whose shares can’t be freely created and redeemed but are publicly traded on exchanges. Depending on investor demand for the fund, the fixed number of shares could cause a significant premium or discount relative to Bitcoin price. 

The largest Bitcoin fund in the U.S., the $25.5 billion

Grayscale Bitcoin Trust

(GBTC), had traded at a substantial premium since its launch in 2013, as Bitcoin prices surged exponentially and investors were willing to pay for its high fee of 2%, thanks to a lack of options. The trend has reversed over the past few months, however, as anticipation for lower-cost Bitcoin ETFs and increasing volatility of the cryptocurrency made Grayscale shares less desirable.

Many investors had bought the Grayscale shares on premium——sometimes with borrowed money——and some were forced to liquidate as prices fell. The fund has been trading at a discount to the value of Bitcoin it holds since February and the gap kept widening. Over the past month, its share price dropped six percentage points more than the underlying assets. At one point, the discount was more than 20% and currently stays at 13%.  

But the price gap for such closed-end crypto funds isn’t always the same. The $109 million Osprey Bitcoin Trust (OBTC), a much smaller, newer, and cheaper option that started in February, hasn’t seen much of a discount or premium lately despite Bitcoin’s volatility.

“It’s been trading pretty much flat, which is great for second-market investors,” says Greg King, CEO of Osprey. Still, new shares creation for the fund through private placements has largely paused as demand dries up, King tells Barron’s

Both closed-end funds said they intend to convert to an ETF when allowed. If that does happen, any premium or discount should disappear soon. That means buying the discounted Grayscale shares could now offer a lower entry point. The Grayscale fund is also much more liquid than the Osprey fund, which means a narrower bid/ask spread when trading on the exchanges.

Funds Investing in Bitcoin Futures 

Whether closed-end or open-end, both types of funds mentioned above are backed by direct holdings of Bitcoin in storage, much like how the

SPDR Gold Shares

(GLD) and

iShares Gold Trust

(IAU) keeps gold bars in a vault for their shareholders. Another way to invest in Bitcoin is through ETFs that hold futures betting on the cryptocurrency’s price.

For example, two Canadian ETFs approved just a month ago, the Horizons

BetaPro Bitcoin

ETF (HBIT.Canada) and the Horizons

BetaPro Inverse Bitcoin

ETF (BITI.Canada), allow investors to take bets on whether Bitcoin’s price will rise or fall through long and short future positions. Recently, however, they ran into some issues when the

Chicago Mercantile Exchange

briefly halted trading in Bitcoin futures after their prices plunged by nearly one third——a mechanism intended to help slow panicky trading in the futures market.

The Horizons funds sent out “market disruption” alerts to market makers, who facilitate trading in ETFs on the futures exchange, warning that they would not be able to honor buy and sell orders if the futures price remained at its lower limit by the end of the trading day. The futures price eventually began moving again. But this highlights the additional risks in the crypto futures market that most retail ETF investors might not be aware of, especially when large price swings occur.

Earlier this month, the SEC released a statement focused on whether mutual funds should offer investors exposure to Bitcoin futures. Particularly, it raised concerns about liquidity in mutual funds, which need to have enough cash reserve to pay investors who sell their shares.

While still rare, some major asset managers have begun to consider investing in Bitcoin futures in mutual funds, including


(BLK) and

Morgan Stanley

(MS). The SEC statement also mentioned ETFs, noting that the SEC staff will consider whether “the Bitcoin futures market could accommodate ETFs, which, unlike mutual funds, cannot prevent additional investor assets from coming into the ETF if the ETF becomes too large or dominant in the market, or if the liquidity in the market starts to wane.”

A U.S. Bitcoin ETF, whether backed by direct holdings or trading futures, might still be far away. 

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