Summary The 2X Bitcoin Strategy ETF is a 200% levered ETF based on Bitcoin futures. BITX ETF is not suitable for long-term buy-and-hold strategies due to significant contango and volatility decays. The Bitcoin halving event has come and gone, with little change in Bitcoin prices, as investors appear to have front-ran the event. With the Fed likely on hold for the foreseeable future, Bitcoin prices lack a meaningful catalyst to rally. The BITX ETF will likely continue to decay in a sideways Bitcoin market. The biggest digital currency news in the past few months has been the rather disappointing price of Bitcoin since the much anticipated 'halving' event. Since the April 19th halving, Bitcoin has been flat, leading to disappointing returns for Bitcoin-related investments like the 2X Bitcoin Strategy ETF ( BITX ). Should long-term BITX investors buy the lull in Bitcoin prices in anticipation of another leg in the Bitcoin rally? In my opinion, the BITX ETF is not suitable for long-term buy-and-hold strategies because of its significant contango and volatility decays. Furthermore, with no immediate catalysts to drive Bitcoin prices higher, the BITX ETF may continue to decay over the coming weeks and months, as Bitcoin digests its strong move since last year. I initiate on BITX with an avoid (hold) recommendation. Fund Overview The 2x Bitcoin Strategy ETF seeks to provide daily returns that are twice the return of the S&P CME Bitcoin Futures Daily Roll Index ("SPBTFDUE Index"). The SPBTFDUE Index measures the daily performance of a rolling position in front-month Bitcoin futures and is rebalanced on a daily basis between the front contract and the next month's contract. The BITX ETF's current holdings are shown in Figure 1. Figure 1 - BITX holdings (volatilityshares.com) Investors should note that BITX's 2x returns are achieved by holding 200% of the notional value of the fund's assets in the form of Bitcoin futures contracts. For example, the fund currently holds $3.06 billion in notional Bitcoin futures against $1.53 billion in AUM. BITX is basically a 200% leveraged version of the highly successful Bitcoin Strategy ETF ( BITO ), but BITX charges a peer-leading 1.85% expense ratio (Figure 2). Figure 2 - BITX charges a 1.85% expense ratio (Seeking Alpha) Beware Contango & Volatility Decay As I have written in multiple articles on leveraged ETFs, the main problem with the BITX ETF, and all futures-based ETFs, is that futures prices tend to be in contango , where prices farther out in maturity are more expensive (Figure 3). Figure 3 - Illustrative Bitcoin futures contango (cmegroup.com) So every day, the BITX ETF must sell expiring front-month futures and reallocate to the next-month future contract in a mechanical 'roll' process. For example, in the figure above, the BITX ETF must sell June futures at $65,945 and buy July futures at $66,460. This constant 'sell-low/buy-high' leads to a gradual decay in value for the BITX ETF. Compounding the issue is BITX's leverage, with 200% exposure to Bitcoin futures prices. Levered ETFs have 'positive convexity' in the direction of their exposures. For example, assuming an investor bought $100 of BITX. If Bitcoin returns 5% in a single day and Bitcoin futures are 100% correlated to Bitcoin prices, then the BITX position will grow to $110 (2 times 5% return). If Bitcoin futures return 5% on day 2, the position will grow to $121. This is more than twice the theoretical 2-day compounded return of 10.25% or $120.50. However, if the return experience is +5% followed by -5%, investors will end up with $99.00, significantly less than twice the 2-day compounded loss of 0.25% or $99.50. This loss in value is due to 'volatility decay'. While 'volatility decay' may seem insignificant on a daily basis, over the long-run, volatility decay can turn into very significant slippage, especially for extremely volatile assets like Bitcoin futures. The combination of 'contango' and 'volatility decay' means that since its inception in June 2023, the BITX ETF has only returned 162.3%, compared to 94.9% for BITO and 119.8% for Bitcoins themselves (Figure 4). Figure 4 - BITX vs. BITO and Bitcoin prices (Seeking Alpha) The difference between BITO and Bitcoin returns is 'contango decay' (24.9%) while the difference between BITX and twice Bitcoin returns is the combination of contango and volatility decay (77.3%). Traders considering the BITX ETF should ensure they fully understand the tracking error risks involved with levered and futures-based ETFs by consulting these FINRA and SEC warnings. What Happened To The Halving Rally? In February, I wrote a bullish article on the ARK 21Shares Bitcoin ETF ( ARKB ), noting that the upcoming 'halving' event could be a major catalyst for Bitcoin. For those not familiar, having refers to the fact that the reward of mining Bitcoins decreases as the number of Bitcoins mined increases. Original Bitcoin miners were paid 50 BTC per block when Bitcoin was first established in 2009. However, the reward rate is halved for every 210,000 blocks mined, and the 'fourth' halving event occurred recently on April 19th. Historically, Bitcoin prices tend to rally significantly around halving events (Figure 5). Figure 5 - Bitcoin prices tend to rally around halving events (techopedia.com) However, the current halving has been a dud so far. Since the halving event on April 19th, Bitcoin prices have been flat, and BITX and other Bitcoin-related investments like BITX and ARKB have done little in the past two months (Figure 6). Figure 6 - Bitcoin and related investments have done littel in the past few months (Seeking Alpha) Bitcoin Prices Front-Ran The Halving Of course, two months is a relatively short period of time and the rally may still occur in the coming months and quarters. However, one reason for the weak performance so far could be that the recent halving event was well anticipated by investors, and Bitcoin prices may have front-run the event. For example, Figure 5 above shows that in the year prior to the previous halving in 2020, Bitcoin prices only rallied 37%, which set up a strong 538% rally in the year after the event. However, this time, Bitcoin prices rallied 134% in the year to April 19, 2024, driven by speculation about the introduction of Spot Bitcoin ETFs and the upcoming halving (Figure 7). Figure 7 - Bitcoin prices rallied strongly into halving (Seeking Alpha) So a lot of the typical post-halving rally could have been pulled forward to the months before the halving. Bitcoin Also Driven By Loose Financial Conditions Furthermore, while Bitcoin's perceived scarcity (i.e. halving events increases Bitcoin's scarcity) is a large driver of its valuation, I believe there are other factors in play as well. For example, I believe Bitcoin is also heavily dependent on financial market conditions and liquidity. Historically, there is a strong negative correlation between Bitcoin prices and the Chicago Fed's Financial Conditions Index (Figure 8). When financial conditions tighten, like they did sharply in 2020 and 2022, Bitcoin prices tend to weaken. Figure 8 - Bitcoin prices negatively correlated to financial conditions (Author created with data from stockcharts.com and Chicago Fed) The most recent up impulse in Bitcoin prices coincided with the Federal Reserves's dovish pivot at the end of 2023, when they hinted of multiple 'insurance' rate cuts in 2024. This led to a wild rally in all risk assets, culminating with investors expecting the Fed to cut interest rates 7 times in 2024. However, with inflation readings staying elevated, the Federal Reserve has been pushing back on rate cut expectations in the last few months, such that the market is currently only pricing in 1 or 2 rate cuts for the rest of this year (Figure 9). Figure 9 - Markets only expecting 1 to 2 rate cuts (CME) This modest reduction in risk appetites and 'animal spirits' could be another reason why Bitcoin has not been able to continue its rally. Looking forward, I believe the Fed is likely on hold for the foreseeable future, which means Bitcoin is likely 'stuck' around current levels as well. Technicals Suggest Caution Warranted Technically, Bitcoin spot prices have a negative divergence on the PPO Indicator (a measure of momentum), suggesting caution is warranted (Figure 10). Bitcoin prices are also close to breaking a steep uptrend, in place since October 2023, with a potential double-top pattern forming. Figure 10 - Technical picture suggest caution warranted (Author created with stockcharts.com) Conclusion The 2X Bitcoin Strategy ETF is a levered bet on Bitcoin Futures prices that suffer from strong contango and volatility decays. Due to the decays mentioned, the BITX ETF is not recommended for long-term investors. Back in February, I noted that the outlook for Bitcoin looked bright, as an expected halving event would increase Bitcoin's scarcity value. However, the actual halving event has come and gone with little movement in the price of Bitcoins. The issue could be that the current halving event was widely expected and prices have already front-run the event. Furthermore, Bitcoin prices are very sensitive to financial conditions and market liquidity. With inflation still elevated, the Federal Reserve has been reluctant to cut interest rates and further ease already loose financial conditions. With the Fed likely on hold for the foreseeable future and the major halving catalyst come and gone, I am turning more cautious on Bitcoin and its related investments. I rate the BITX ETF an avoid (hold) for now.
