The SEC is set to approve five futures exchange-traded funds by the end of October. While the entire market expects a huge parabolic move, it is important to consider a bearish scenario. The bitcoin-related companies listed under the ETF will help investors gain exposure, but the cost of holding the underlying asset will get expensive.
In the next two weeks, many of us expect the price of BTC to go up significantly, as investment firms are ready to roll out their ETFs for all their clients. And most of them can afford the rollover in futures contracts. If you are unfamiliar with rollovers, traders take a position to continue holding the contract if they feel the trend is not going to change. Now, the price of BTC can go higher and maybe even go past its previous all-time high. This will lead to a negative yield return for bitcoin futures.
The market dynamic we refer to here is Contango Bleed. When the fund underperforms the actual spot price of the asset, investors have to pay a higher premium to roll over their futures contract.
Futures-based Bitcoin ETFs could turn out to be inefficient
The forward curve is something we use to determine whether the futures market is in a state of backwardation or contango bleed. Right now, the market is optimistic towards bitcoin ETFs, but it will face major pullbacks once we experience a huge parabolic explosion. It may not be this year, but it will happen.
The other day, even Willy Woo mentioned on Twitter that “futures ETFs will dominate the markets, bringing down the price with extreme volatility.” This is beneficial for hedge funds, as they can easily short the market and earn a decent annualized yield. At the same time, the portfolio performance of normal investors will go down, as contango bleed will not stop. The bullish picture may be alive, but once the futures price goes below the spot, we will be in a backwardation period, resulting in a correction.
To help you understand, let us take an example of why bitcoin ETFs could turn out to be inefficient. The October contract is currently trading at $58,000, with a premium of $500. In the consecutive month, the price would be $58,500, making investors sell at a loss of $500 (0.86%). In one year, this is 10.34%. So, if investors choose to trade extended periods of contango, they can face significant losses for the fund.
Now, will this impact investors’ decision-making? Experts say—it will not change a thing. Institutions want high exposure to this new asset class, and they are willing to pay the roll-over charge. However, if the BTC ETF experiences a very steep contango, we can see investors directly investing in bitcoin.
History will repeat itself
In the second half of 2017, the price of BTC skyrocketed to $20,000 and came down in the latter part of the year. This happened mainly because of the CME group launching the first futures market for bitcoin. The peak price hit in 10 months and immediately dropped by more than 60-70%.
When futures were exposed to traders, they could bet on the decline in bitcoin price. Short selling was made possible by CME. The speculative demand soon ended when the futures started trading on the CME on December 17.
Futures were not something everyone knew at that time, but times have changed in the last five years. The difference between spot and futures will not be 180,000 bitcoin like it was in 2017. The bearish case might as well be more significant than the previous bull cycle.
So, please do not expect the price to go only higher and higher in this current bull cycle. When the ETFs roll out, traders can bring the price down and increase selling pressure. The pricing dynamics will change when futures become more prominent in the crypto industry. In the end, it is better to plan an exit strategy to get maximum profits and avoid getting caught in the contango bleed.
Born and brought up in India, Karthikeya Gutta is a crypto journalist and freelance contributor for ItsBlockchain. He covers various aspects of the industry with in-depth analysis and research. His passion towards blockchain and crypto ecosystem is mainly because he believes it can really change the world and help millions of people.
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