Summary ProShares Bitcoin Strategy ETF has underperformed Bitcoin and faces competition from spot ETFs like iShares Bitcoin Trust and Fidelity Wise Origin Bitcoin ETF. BITO offers attractive dividend yields of above 20% but, this may come at the expense of price appreciation. The fund's holdings show a shift to a longer-term strategy, possibly due to expected pressure on crypto prices from miners adjusting to the halving. The ETF may experience further volatility and it is better to wait for the turbulence period to end before investing. In my last thesis on ProShares Bitcoin Strategy ETF ( BITO ) entitled “ Uptrend Likely To Continue Till Halving Amid Volatility” on March 6, I had a bullish position which materialized, but only to some extent when the share price increased from $30.83 to a peak of $33.65 one week later. However, subsequently, volatility reigned and it is now trading at around $27. Also, the chart below shows that BITO’s underperformance relative to Bitcoin ( BTC-USD ) may only be getting worse raising the issue of capital preservation. Data by YCharts Against such a backdrop, this thesis aims to show that BITO is a hold for shareholders because of its dividends, but for potential investors it is better to wait for the period of turbulence to end. For this purpose, I will show how the market dynamics have changed considerably this year and compare the ETF with alternative investments that allow exposure to crypto without actually owning coins. First, I provide reasons for BITO's not sustaining its momentum after its initial upside to $33.65. Understanding the Price Action After the approval of the 11 spot Bitcoin ETFs on January 10 by the Security and Exchange Commission, demand for the cryptocurrency did increase, but its price did not go to $79.3K according to my prediction. Instead, it only reached a peak of around $73K before sliding. One reason for this is total daily trading volumes for the 11 ETFs went down from $4.47 billion on March 6, to $2.87 billion at the end of April. Since this period also saw BTC lose 13% of its value, this means lower trading volumes was accompanied by lower crypto demand. In this respect, contrarily to BITO which holds Bitcoin futures contracts, the newly issued ETFs have to be backed by actual BTCs or require the fund managers to purchase coins on the open market. Therefore, as the price of Bitcoin suffered, it was the same for the ProShares ETF which is linked to Bitcoin as shown below. www.proshares.com A second reason explaining the underperformance of the ProShares ETF is some investors rotating away. In this respect, for those who want to get direct exposure to Bitcoin without owning a crypto exchange account or wallet, the 11 new ETFs two of which are the iShares Bitcoin Trust ( IBIT ) and the Fidelity Wise Origin Bitcoin ETF ( FBTC ) represent alternative investments to BITO. Thus, given more choices, investors may have switched to these spot ETFs which more closely track the price of Bitcoin as charted below. Data by YCharts Moreover, the added advantage of these new funds is that their fees remain much lower than BITO's 0.95% . However, this fee is largely offset by its dividend yields of above 20% which is particularly attractive for income seekers. Generating Dividends From Investment Income and Capital Gains Looking further, it may seem weird how a fund that invests in Bitcoin-related financial derivatives (or futures ) can pay dividends. To achieve this, the fund managers sell Bitcoin futures for cash every month, generating profits or net investment income, which are then all distributed to shareholders as dividends. Furthermore, distributions are also made out of capital gains. However, as charted below, dividends tend to vary and there is no guarantee that payments will be effected every month as in September 2023 and for January and June this year. Still, its dividend yield is nearly ten times higher than the 2.57% median for all ETFs. dividends/history (seekingalpha.com) Hence, with a dividend grade of A+ together with superior momentum and liquidity scores, BITO is rated as a strong buy by Quant ratings. However, given the post-halving volatility and for those wondering whether it is the time to be positioned, it is preferable to wait as it could fall further. The Futures Held Hints at Further Downside Looking deeper into the investment income strategy, BITO's holdings on April 24 are pictured below. In this case, the 24.15% of CME Bitcoin futures, which were set to expire on April 26, tend to show that fund managers expected short-term gains, or for crypto to rise in the immediate aftermath of the halving which occurred only on April 19 . BITO Bitcoin Futures Holdings (www.proshares.com) However, this did not happen and, on the contrary, the cryptocurrency lost around 10% in April. Still, the fact that BITO paid a higher dividend of $1.68 on May 1 as charted above shows that they may have sacrificed part of the capital appreciation. This is confirmed by the fact that BITO reached a trough of $23 on the same day while, at the same time, it's significantly diverged relative to BTC as illustrated in the blue chart below. seekingalpha.com Therefore, in addition to the possibility of some investors rotating away toward Spot ETFs to get more direct exposure to the crypto, BITO's income strategy looks to have played against its price performance. Going forward, the fact that the holdings on June 4 hold futures expiring on June 28 and July 26 (above holdings picture) shows that the fund managers have shifted to a relatively longer-term strategy, possibly because they do not expect a short-term appreciation in the price of BTC. This longer-term strategy is aligned with the possibility that crypto prices will be under pressure as miners adjust to the combined halving/difficulty issues in the short term. In this respect, one factor that is pressurizing Bitcoin prices is miners offloading their treasury of HODLed BTCs to face up to the halving event which has reduced the rewards perceived for each block mined. At the same time, increasing mining difficulty makes it more time-consuming to produce the same output out of existing computing power (hash rates). Hence, they may have to liquidate about $5 billion worth of Bitcoins to fund their operating expenses which is a lot especially considering that they were mostly HODLing them before the halving event. Looking for a Floor Amid the Turbulence Miners selling crypto assets could also be motivated by an economic environment characterized by high capital costs as interest rates continue to remain above 5%. Additionally, operating costs remain high as inflation persists at above 3%. Thus, any news that raises the chances of the Federal Reserve switching to a dovish stance is welcomed by crypto enthusiasts, and this was the case on June 3 when both BTC and BITO gained more than 1% each. This followed news about manufacturing weakness which in turn led to a downward revision in GDP growth from 2% to 1.8% through May. However, making an investment merely based on the Fed cutting rates because of economic slowness amounts to speculation, as the related upside is not likely to be sustained. Moreover, Bitcoin has to appreciate sustainably as in 2023 to allow BITO to fund its distributions through trading of futures or using investment income, in a way that does not impact capital appreciation. In the absence of such a possibility at this juncture, this would mean the share price may continue to trend lower, a possibility also hinted at by the momentum indicators: the share price being lower than the 10-day and 50-day moving averages. Therefore, the price could again flirt with the $23 level last reached in May as charted below, together with a possibility that it does descend further for three reasons. First, this is the lowest price reached by BITO after the halving, which as I mentioned above, a period also synonymous with more miner-led supply. Second, inflows into the spot ETFs seem to have stabilized as mentioned earlier, which may prevent further capital outflows from BITO. Third, to counteract further downside, the fund managers have the option to fund dividends only using investment income, which seems to have been the case on June 1 when no dividend was paid, thereby not putting BITO's share price under further pressure. Chart prepared using data from (seekingalpha.com) In these circumstances, $23 can be viewed as the support price in the current turbulence period. Key Takeaways In conclusion, this thesis has shown that market dynamics have changed drastically in 2024. While 2023 was a more normal environment with Bitcoin gaining 153%, making it easier for BITO to generate investment income from futures trading to pay regular monthly, this year seems completely different. Noteworthily, the cryptocurrency has gained 56% but its path has been much more volatile, with three factors impacting the demand-supply equation, starting with the advent of spot ETFs, followed by halving without forgetting mining difficulty. To complicate matters further, the SEC has approved spot Ethereum ( ETH-USD ) ETFs which could attract up to $4.8 billion in net inflows. Now, this money could come from investors wishing to diversify away from Bitcoin as was the case during previous post-halvings, where crypto enthusiasts opted for altcoins like Ethereum at the expense of BTC for some months. Therefore, the turbulence period is likely to continue, implying that it is not the right time to invest. In such conditions, the income rationale makes a lot of sense for existing shareholders, with BITO already having paid a total of $3.9 of dividend per share this year compared to only $3.1 for the whole of last year. However, the risk is that going forward, acute volatility may prevent the fund managers from using the derivative trading mechanism to generate sufficient investment income. Finally, for those contemplating putting in new money for the long term, $23 could constitute an entry price, but bearing in mind that BITO is likely to be range-bound with an upper limit of $28.47 for some time to come, unless the Fed cut rates or Bitcoin miners rapidly adjust to the post-halving landscape.
