There shouldn't be Bitcoin ETFs

good morning. Many great reactions to yesterday's margin piece; I go into some of the points mentioned below. But first a short rumor about the wrong type of financial innovation. Email to me: robert.armstrong@ft.com

Bitcoin ETFS: A bad idea whose time has come

You can now buy a Bitcoin Exchange Traded Fund. Or rather, a Bitcoin derivate ETF: Proshares Bitcoin Strategy, who tries to achieve returns from cryptocurrency with the help of futures contracts, took up the trade yesterday.

I am sure that this is good news for someone, but at first glance it is difficult to imagine a less attractive financial product.

The original idea of ​​an ETF was that it offers an inexpensive way to get the beta available in a certain market, which would otherwise be difficult to grasp efficiently. Reproducing the return of the Russell 3000 would be a nerve saw at home, but the ETF from Vanguard does an almost perfect job for me for all 10 basis points.

The Bitcoin strategy offers an expensive way to capture some of the beta in a market that would be simply more efficient to grasp in other ways. The annual fee is 1 percent. It takes its commitment to changes in the Bitcoin Prize from short-term Bitcoin futures contracts, which means that it has to sell regular contracts and buy new ones. Since the long-term contracts are usually more expensive than the short ones, the extension of the contracts burdens the performance, which could be estimated to be 5-10 percent annually. The chances that the ETF will do almost as well as Bitcoin are very low.

This is not very attractive because I can jump up to a crypto exchange and buy bitcoins directly, use the entire performance of the digital wealth value and pay a lower fee.

other Bitcoin funds could be worse. The large Grayscale Bitcoin Trust has Bitcoin directly, but demands 2 percent. It is a closed fund, i.e. h. No new shares are created when assets flow into it. The trust units therefore act according to supply and demand, instead of maintaining a bond with the value of the underlying assets, as with an ETF. This year, the value of the shares for a discount of 25 percent compared to the underlying bitcoins (perhaps because the investors saw an ETF), which means that the relative performance was terrible. But at least one discount on the net inventory value does not apply year after year, such as the costs for rolling futures contracts.

Grayscale wants to convert the trust into an ETF that has bitcoins rather than futures to lose the discount. What a question raises: Why did the Securities and Exchange Commission approved a Bitcoin futures ETF and not yet simple Bitcoin ETF? Bitcoin is tricky enough. Adding futures increases the difficulty.

I am not sure what the answer is, but it seems to be that Bitcoin is startled by the SEC, because God knows where it comes from (in a server farm somewhere in China?), Who thinks most of them (cyberbaddies?) What it is used for (illegal activities?) Or what risks it can bring (hacking?). In contrast, Bitcoin futures are created and traded within the borders of the CME under the watchful eyes of the Commodity Futures Trading Commission in the emerging American city of Chicago.

Now it seems to me that every derivative market should have all the risks of the underlying cash market and more. But then I am not a financial supervisory authority.

So why should someone want to buy the Proshares fund? Or any Bitcoin ETF? I asked a manager in the Bitcoin fund industry, and here is what they said:

"The analogy to which I refer to when I ask this question is gold. Investors had it in bars or coins for years, but then a gold ETF was created in 2004 and tens of billions [of dollars] were invested in it..

"It's about comfort and access. When you think about where the capital pools of your investors are-in a 401k broker account-the fact that the possibilities of accessing Bitcoin are generally outside of this system..

"In the event of a Bitcoin ETF, it takes the individual investors from the possession of these coins, and that can be good. Purist will say that they have no real control if they do not have their own private key, etc. But many investors want to access and do not want to research according to the countless custody. trust. "

This is the core of the matter. People want access to crypto returns, but they want the process to work like a standard financial product and they want Bitcoin to be in their portfolio right next to the other products. For this reason, there are products like Proshares.

But it's a bad reason. Bitcoin is not like standard finance products at all. It is worn by highly complex technology, the source of its value is generally controversial and is currently most often used as a vehicle for the purest speculation by far. If you don't bother to learn the unique subtleties that are connected to the possession of this stuff, you can understand the risks and should therefore not have it at all. There shouldn't be Bitcoin ETFs.

A few points to the edges

Several readers suggested that the reason for the high margins and (I think) is sustainable that the US economy is dominated by industrial oligopoles, especially in the technology area. This could be true. Certainly rising margins always point out a little for competition. Just because the competition is limited, not all companies' productivity and efficiency gains are immediately passed on to the consumer. Software is not a great business just because your limit costs of production are almost zero. It is a great business because its tiny border costs are paired with a legal system that protects intellectual property.

I think we don't have to worry about it anymore. Ultimately, a non -competitive economy will stop being innovative and growing, and the returns for investors have to decrease. But I'm not sure what we see in public markets as a deterioration in competition. I rather believe that the mix of public companies and the mix of companies within public companies shift to brand, research and intellectual property-intensive products, and these products have higher margins. Here is a graphic that Michel learner sent to me from Credit Suisse and that I think that records this point. It shows the changing proportion of listed companies in various markets that make significant expenses for research and development. The United States is on the left:

I would also like to note that technology companies are a large driver for rising margins, but not the only ones. We have also recorded remarkable margin increases in industrial and non-basis consumption goods. Whatever the type of phenomenon develops, it is not limited to technology.

other readers pointed out another, more urgent threat to the margins: inflation. Paul O’Brien noticed that inflation does not cause a deterioration in margins, but “some inflationary forces - rising wages, restrictions on offer - are bad for margins. And higher inflation can also lead to a tighter monetary policy and a recession, which is also not good for the margins.” He sent this scatter diagram, which represents the profits as a share of gross domestic income against inflation (using data from the Federal Reserve). It shows an unpleasant trend when inflation increases well over 4 percent:

Here is a different view of the same idea, again from Credit Suisse. It shows how inflation tips were followed in the 1970s and 1980s from falling operating margins. The order is certainly suggestive:

When inflation becomes bad, it makes sense that the margins sink.

A good reading

Sotheby’s auctions the collection of the late master magician Ricky Jay. He was super cool. Here is the catalog, and here is a great description of the New York Times. Maybe I can afford a poster.