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Crypto Trading: Why Knowing the Difference Between ETFs and Futures-Based ETFs Is Key

·5 min read
ferrantraite / iStock.com
ferrantraite / iStock.com

The first futures-based exchange-traded fund (ETF) for Bitcoin, the ProShares Bitcoin Strategy ETF (NYSE: BITO), has continued to rise in its third day of trading. It’s trading volume hit $1.2 billion after just two days, the fastest an ETF has ever reached the $1 billion mark, according to Bloomberg data.

See: 8 Best Cryptocurrencies To Invest In for 2021
Find:
6 Best Crypto ETFs To Look For in 2021

The launch of the ETF has also driven the price of Bitcoin higher; the presence of an ETF for Bitcoin futures lends further legitimacy to crypto as an asset class. Bitcoin approached the $67,000 mark per coin Wednesday and, near the end of the day Thursday, was hovering around the mid-$62Ks.

At a price between $40 and $45 per share, the BITO ETF is more accessible than Bitcoin, although trading apps make it easy for retail investors to purchase fractionals of Bitcoin. There’s another advantage to the ETF, as well. “BITO will open up exposure to bitcoin to a large segment of investors who have a brokerage account and are comfortable buying stocks and ETFs, but do not desire to go through the hassle and learning curve of establishing another account with a cryptocurrency provider […] or are concerned that these providers may be unregulated and subject to security risks,” said ProShares CEO Michael L. Sapir.

Related: 10 ETF Myths Debunked

With all the buzz about this new futures-based ETF, you might wonder what makes futures-based trading different from purchasing regular ETFs, which are based on the prices of stocks that make up the fund.

The ProShares Bitcoin Strategy ETF is a way for investors to get exposure to the Bitcoin markets without directly investing in Bitcoin. This is a new type of investment vehicle, so it’s important to understand what exactly a Bitcoin Futures ETF is and whether or not it’s a good idea to invest in it, said Tony Molina, CPA at Wealthfront.

Here’s a brief breakdown of ETFs on the whole, along with how the two differ:

What Is an ETF?

Let’s go back to basics first: an ETF is a collection of securities sold as a single fund. The asset tracks a specific index, such as the S&P 500, specific sectors such as FAANG stocks, assets like gold, or various industries such as clean energy or manufacturing. Therefore, a Bitcoin-based ETF, for example, tracks the performance of Bitcoin.

More: What’s an Exchange-Traded Fund (ETF?) Here’s How To Invest

Like stocks, ETFs are publicly traded, making them more accessible to retail investors than mutual funds and some other types of investments.

What Is a Futures-Based ETF?

When people trade in “futures,” such as oil, grains or precious metals, they are not purchasing a commodity. Rather, they are making a legal agreement to buy or sell that commodity at predetermined price at a specific time. For most investors purchasing futures, you never take delivery of the commodity. You simply sell the future without any actual product changing hands.

In the case of a futures ETF, you are purchasing an agreement to buy or sell shares of the ETF at a date in the future. No Bitcoin changes hands in the exchange.

Related: Crypto Pop-Up Exchanges on the Rise as Retail Investing Grows in Popularity

“A futures contract allows an investor to speculate on the future direction of a security, commodity, or financial instrument,” Molina said. “Bitcoin Futures ETF tracks the price of futures contracts that speculate on the future price of Bitcoin, rather than the current price of the cryptocurrency itself. In other words, BITO is investing in what the market thinks Bitcoin could be worth in the future. As a result, the prices of the BITO and Bitcoin usually will not be the same.”

Risks and Benefits of Futures-Based ETFs

As with any investment, retail investors should exercise caution. No one can truly predict the future of crypto, so it’s wise not to invest beyond your current risk tolerance. That is, don’t invest more than you could afford to lose in the short term.

Other risks associated with futures-based ETFs come with tracking errors, which could under- or over-estimate the future price of the commodity. Another potential risk is that the futures price could exceed the current price. This market condition is called “contango,” and could lead to poor performance of an ETF over the long term.

Explore: 10 Best ETFs To Buy for Long-Term Growth
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One key benefit of futures-based ETFs is the same as regular ETFs: they are easy for retail investors to buy and sell since they are traded just like stocks. Futures-based ETFs combine the efficiency of traditional ETFs and an accessible entry point with the flexibility investors can find in futures trading.

“While this is a big step towards mainstream crypto adoption, this new Bitcoin Futures ETF might not be for everyone,” Molina emphasized. “Since Bitcoin futures allow you to invest in the speculation of the price of Bitcoin, a Bitcoin Futures ETF could even be riskier than traditionally owning Bitcoin. Many investors could be better suited to buy Bitcoin directly or invest with a brokerage that allows you to get Bitcoin exposure through a fund that actually tracks the price of Bitcoin.”

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Last updated: October 22, 2021

This article originally appeared on GOBankingRates.com: Crypto Trading: Why Knowing the Difference Between ETFs and Futures-Based ETFs Is Key