2017 has been a transformative year for bitcoin, with the cryptocurrency vaulting into the collective consciousness of ordinary investors. Buying bitcoin involves a fairly complicated process, and so some investors would much prefer to buy shares of an exchange-traded fund if it were available. Several companies have filed to release bitcoin ETFs, with the ProShares Bitcoin ETF and Short Bitcoin ETF aiming to become the first ones available for listing on the New York Stock Exchange.
Yet for investors who think that an ETF-related bitcoin investment will be free of risk, think again. Even ProShares itself is up front about the risks of bitcoin ETF investing. Below, you'll find the risk factors that ProShares disclosed in its filing back in September to release its bitcoin ETFs. Although they're specifically related to the ProShares bitcoin ETFs, many of the same risks will be present in the other bitcoin ETFs currently under consideration.
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Why bitcoin ETFs are risky
Here's what ProShares has to say about the risks of its bitcoin ETFs.
- The value of bitcoin futures contracts may not track the price of bitcoin on exchanges.
- The market for bitcoin futures is new and could be less liquid and more volatile than other markets.
- Bitcoin is a new technological innovation with a very limited operating history.
- The price of bitcoin is highly volatile.
- The price of bitcoin may change dramatically when the markets for bitcoin futures are closed or when ETF shares aren't available for trading.
- Bitcoin exchanges are new, largely unregulated, and could be exposed to fraud and security breaches.
- Adoption of bitcoin could decline.
- New competing digital assets could challenge bitcoin's current market dominance.
- Regulatory initiatives by governments could impact use of bitcoin.
- It may be illegal now or in the future to own or use bitcoin in one or more countries.
- The bitcoin network could be subject to adverse intellectual property claims.
- Banks might not provide services to businesses that accept or use bitcoin.
- Bitcoin ETFs could experience large losses when holding, buying, or selling bitcoin.
- Bitcoin ETFs has no previous operating history.
- Active trading markets for bitcoin ETFs might not arise.
- Illiquid markets for bitcoin futures and ETF shares could make losses worse.
- Rolling bitcoin futures positions could have a negative impact on ETF performance.
- Bitcoin ETFs might not be able to track its objective of following bitcoin price changes.
- Fluctuations in bitcoin-related financial instruments could hurt the ETF's value.
- Bitcoin ETFs aren't actively managed and will merely try to track their respective benchmarks.
- Fees could deplete assets.
- Counterparty risks could exist that hurt the ETFs.
- Bitcoin ETFs can invest in options, which are also risky.
- Competition from rival bitcoin ETFs or investment vehicles could hurt the performance of these bitcoin ETFs.
- The ETF sponsor might choose not to continue to provide services to the ETFs.
- Bitcoin ETFs can terminate anytime, even if it's a bad time for shareholders.
- Redemption or creation orders for ETF shares from institutions can hurt individual investors.
- Net asset value of the ETF might not track the actual market price of ETF shares.
- The intellectual property rights that the bitcoin ETFs themselves use could be challenged.
- Misstatement of net asset value is possible if valuation methods are imprecise.
- If institutions don't maintain relationships with the bitcoin ETFs, liquidity could suffer.
- Noninstitutional investors can only obtain bitcoin ETF shares through secondary markets.
- Exchanges could halt trading of bitcoin ETFs.
- Legal protections covering many mutual funds don't apply to bitcoin ETFs.
- Indemnification of the trustees overseeing the bitcoin ETFs could result in losses.
- A bitcoin ETF bankruptcy filing could force clawbacks of ETF distributions.
- Companies assisting with futures transactions could improperly fail to segregate assets, resulting in greater bitcoin ETF losses.
- Courts might not recognize legal separations between bitcoin ETFs or with other ETFs in the same fund family.
- External events, such as disasters or power outages, could prevent the bitcoin ETFs from meeting its investment objective.
- Cyberattacks pose operational and information security risks.
- Taxation of bitcoin isn't entirely clear.
- Tax liability will exceed cash distributions on bitcoin ETF shares.
- The IRS could make adjustments to tax consequences of bitcoin ETFs.
- Bitcoin ETF shareholders will have to deal with K-1 partnership returns for tax reporting purposes.
- Changes in long-term capital gains rates could hurt bitcoin ETF shareholders.
- Bitcoin ETF shareholders could recognize substantial ordinary income and short-term capital gain.
- Regulatory and exchange accountability provisions could restrict bitcoin ETF operation and the creation of new ETF shares.
- For the inverse bitcoin ETF, returns over periods exceeding one day will differ from the benchmark return.
- The inverse bitcoin ETF's investments might not be correctly correlated to bitcoin prices.
- The inverse bitcoin ETF's intraday price might differ greatly from the behavior of bitcoin.
- Use of inverse positions could result in total loss for inverse bitcoin ETF shareholders.
Which bitcoin ETF risks are most important?
Out of these 51 risks, the most important for potential bitcoin ETF investors have to do with how the bitcoin futures markets will act. Bitcoin futures have traded for less than a month, and their behavior doesn't always correlate with the underlying cryptocurrency. Already, we've seen bitcoin prices be volatile enough to trigger temporary trading halts for bitcoin futures, and that could potentially pose a major problem for bitcoin ETFs in trying to value their shares.
Even if bitcoin futures settle down, it's possible that the nature of the futures markets themselves could pose a risk. Contango is a problem for commodity ETFs generally, in which the need to roll futures contracts to subsequent months slowly erodes the value of the ETF's assets. Early on, bitcoin futures are showing signs of contango, and if that persists, it could lead to a drag on performance for the regular bitcoin ETF -- albeit with a potentially positive impact on the inverse ETF.
Finally, bitcoin ETFs could see some of the same challenges that the Bitcoin Investment Trust (GBTC +1.24%) has experienced. ProShares will try to establish a market for ETF shares and enlist institutional investors to create or redeem blocks of shares when necessary. If ProShares doesn't succeed in finding reliable institutions to do so, then the bitcoin ETFs could trade at premiums or discounts to the underlying value of their assets. Theoretically, that could produce tracking errors for both ETFs that could cause losses for everyone.
Be careful with bitcoin ETFs
The bitcoin investing craze is likely to last for quite a while, and bitcoin ETFs will inevitably be popular. Only by understanding the risks fully can you be certain whether you're comfortable with the potential dangers of investing in bitcoin ETFs.
