The SEC Just Approved 3x Bitcoin ETFs – But is the Product Built to Decay?

CBOE BZX's regulation modification was approved by the Securities and Exchange Commission on October 2, allowing the first US exchange-traded products utilizing 3x leveraged Bitcoin and Ether to be introduced.

Bitcoin, Ethereum, Gold, Silver, Crude Oil, and Natural Gas are the six funds included in the order from Volatility Shares' VS Trust.

Less than three years after it was involved in legal disputes with Grayscale over a regular spot Bitcoin ETF, the SEC has authorized Bitcoin to use the same leveraged techniques as commodities.

The headline says it all.

Having said that, the approved product is not an accelerator for Bitcoin.

It is a daily-reset product that caters to a specific type of trader, and its architecture almost guarantees that anyone who invests in it over the long term would have their cash eroded.

With this green light, a major goal has been reached in terms of regulations. It can also be a trap for people who don't know what they're doing.

What the SEC Actually Approved

Futures, not spot prices, form the basis for all six products. They will all be devoid of Bitcoin, Ethereum, gold, and oil.

The cryptocurrency funds will keep an eye on the CME Group's futures prices and use collateral in the form of cash to maintain their exposure.

The current yearly management fee stands at 1.85%.

An ETP is not the same as an ETF from a legal standpoint.

The Securities Act of 1933, not the 1940 Act, governs these Commodity-Based Trust Shares, notwithstanding the "ETF" designation.

That rules out conventional exchange-traded funds (ETFs) with investor protections like board supervision and liquidity constraints.

No trades have started yet.

Volatility Shares must still wait for the SEC to announce the effective date of its Form S-1 registration, even if the revised exchange listing rules have been approved by the SEC order.

No due date is specified in the order.

The proposed tickers for Bitcoin and Ether are BITH and ETHK, respectively.

Volatility Shares through BITX and ETHU presently offer US cryptocurrency products a leverage maximum of 2x; the recent clearance raises that level to 3x.

It was a "significant victory" for the sponsor, according to Bloomberg's ETF analyst Eric Balchunas.

The Math That Kills Long-Term Holders

No product with a daily reset rate of three times Bitcoin's value can guarantee a return on investment of three times Bitcoin's value for any time period longer than a single trading day.

In highly unpredictable markets, the compounding mechanism can have a negative impact on the holder, a phenomenon known as volatility decay.

Volatility Shares' prospectus makes the problem apparent.

A daily leveraged fund with a 3x multiplier would lose about 5.45% of its value - not including fees and financing expenses - if the underlying asset goes back to its original value after a two-day fluctuation.

The chief executive officer of Blockstream, Adam Back, voiced his serious concern when he said that auto-releveraging schemes "bleed capital in a sideways chop," particularly when dealing with underlying assets with high volatility, such as bitcoin.

Consistent motions are produced by the methodical changes that support the 3x goal.

Near market close, the fund should raise its futures position after gains and lower it after losses.

As the fund grows, the forced flows have a greater effect on the market, which might amplify the intraday moves that prompted the rebalance.

An extra weight is added by futures.

Contracts with longer maturities typically fetch a premium in the market, so the fund switches to them as they approach expiration.

When the first Bitcoin futures ETFs debuted in 2021, that roll cost was a consideration, and it is still relevant now.

The prospectus makes it very obvious that the product is "not suitable for all investors," that it's speculative, and that only people who can afford to lose everything should consider it.

Why the SEC Approved It Now

This green light did not come in isolation. It shows that the current administration is changing the SEC's approach to cryptocurrency offers in general.

Authorities are working through a situation where legislation has broken down.

There has been a temporary halt to the development of comprehensive market structure legislation as the Senate recently rejected a proposal to move the Digital Asset Market Clarity Act forward.

Citing the legislative failure as having "narrowed the path" to statutory clarity, Citi experts went on to say that the SEC's administrative steps have "dampened negative sentiment."

That administrative response includes the three-pronged permission.

It shows that the SEC is ready to examine more complex crypto offers, even without legislative guidance on market structure.

Just three years ago, the agency was still debating spot Bitcoin ETFs, as Balchunas pointed out; so much has changed in that time.

Currently, it is helping with the clearing of futures contracts with triple leverage.

Across all six products, the same pattern emerges.

Volatility Shares has recast crypto leverage as a commodities offering by integrating Bitcoin and Ether with gold, silver, oil, and natural gas.

From that vantage point, the SEC's internal approval procedure was likely facilitated.

Market Signals Are Mixed

After the approval, there was no major uptick in institutional interest in the underlying assets.

Flows into Ethereum ETFs fell for four days after the ruling, with $59.58 million going out on September 30 and $37.36 million coming in on October 2.

About $155 million in total flows were lost due to the four-day reversal.

There is a notable disparity there.

Even while a leveraged product has a lot of trades, that doesn't mean institutions are still interested in the asset. It gets people involved, but it doesn't mean prices will stay the same.

Ether is becoming increasingly reliant on spot and derivatives activity and more susceptible to redemption pressures since membership in the ETH ETF has not increased despite the new 3x approval.

Citi's price targets shed light on a longer time horizon.

In the past 12 months, the bank has raised its Bitcoin price forecast to $113,000 from $82,000 and its Ether price forecast to $3,028 from $2,240.

The uptick in activity, the improvement in the macroeconomic climate, and the return of ETF inflows are all factors that have contributed to this shift.

It projects that next year there will be around $5 billion worth of bitcoin influx.

The pace of inflows is anticipated to be slower than previous cycles, according to Citi.

Instead of jumping to conclusions, the bank thinks wealth managers would take their time and gradually increase allocations, and instead of being propelled by a shopping frenzy, that fits in with a market that is being more institutionalized.

The Precedent and the Risk

Contrary to popular belief, the 3x clearance does not mean that the SEC is now accepting volatility as a product characteristic but rather establishes a standard for product complexity.

In other words, it shows that the government is ready to let regulated markets compete with offshore platforms for leveraged dollar opportunities.

The average retail trader may mistake a 3x product for a high-energy spot ETF if they conflate regulated access with appropriateness.

The penalties of that mistake will be imposed by the roll costs, the daily reset mechanics, and the volatility decay.

This information is stated explicitly in the prospectus.

Daily leveraged products could drastically deviate from their indicated multiple in a matter of weeks or months, according to the SEC's investor bulletin.

Whether the fund's performance goes up or down, Volatility Shares will always collect their 1.85% management fee.

With a charge of 2.75 percent, the current 2x Bitcoin offering (BITX) has seen a loss of over 58% year-to-date, although its assets are still at $850 million.

Rather than sharing in investors' profits, the sponsor stands to gain from asset appreciation.

There is no design behind such a structural incentive. It is the structure that allows money to come in.

With a focused directionality and disciplined risk management, the 3x products can be a useful tool for short-term traders.

Spot ETFs are the only alternative for those who want to track the price of Bitcoin without the daily reset affecting their performance.

A new opportunity has been launched by the SEC. The prospectus tells you what is behind it.