If you hold Bitcoin (CRYPTO: BTC) and Ethereum (CRYPTO: ETH) and you want to experience even more volatility and risk than you already do, you’re in luck. On Oct. 2, the Securities and Exchange Commission (SEC) approved an exchange to list Volatility Shares’ 3x Bitcoin ETF and the 3x Ether ETF, both of which are leveraged exchange-traded funds (ETFs) that aim to offer exposure to triple the daily price action of those two coins.
Neither fund is available to trade yet, since a separate SEC registration step required before launch hasn’t been scheduled (as I write this on Oct. 21). But will either of these ETFs be worth buying after they start trading?
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Leverage doesn’t mean you get higher returns
Both of the proposed ETFs hold futures, contracts to buy an asset at a set price on a later date, and reset their exposure every day. That reset is necessary for the constant leverage provided by the ETFs to work, but it’s also the source of a dangerous trap for investors.
If a coin rises 10% in a day, the fund rises about 30% that day. This is the part that everyone gets excited about.
The problem is that if the coin’s price then proceeds to fall back to where it started, which is to say a drop of about 9.1% that would leave a spot holder with a gain of $0, the leveraged ETF shareholder ends up with losses of about 5.5% instead. This very example can be found verbatim in the Volatility Shares prospectus for the fund. It’s also the same drag that recently hit another very similar leveraged Bitcoin ETF, the Volatility Shares 2x Bitcoin ETF.
It lost 61.9% in the 12-month period ending on Oct. 21 despite Bitcoin falling only 25.1% in the same period.
The prospectus indicates that the Bitcoin fund will charge a 1.85% management fee per year, and it estimates that the Bitcoin and Ether funds must earn 1.98% and 2.78% a year just to break even. What’s more, while steady returns could well accumulate into a big paper gain, the leverage math means that it often only takes one rough down day to erase significant value.
Should you buy leveraged Bitcoin and Ethereum ETFs at all?
These ETFs are not really intended for average investors to buy and then hold for long periods of time. They’re for hedge funds and institutional investors making complex trades with multiple assets and hedges.
Most people should not buy them.
However, both coins are still worth buying for patient investors. Buying Ethereum or Bitcoin directly, or via spot ETFs, is a much better move than any leveraged play, as it costs far less in terms of fees, and they’re also not capable of experiencing leverage-induced downside volatility.
And that means you’ll be able to hold them for years — and hopefully, get a good return along the way instead of getting liquidated.
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Alex Carchidi has positions in Bitcoin and Ethereum. The Motley Fool has positions in and recommends Bitcoin and Ethereum. The Motley Fool has a disclosure policy.
