Derivatives and leverage are utilized by the ETFs to provide investors with exposure to price fluctuations among Bitcoin, Ethereum, and gold.
Regulatory approval has been sought by Defiance ETFs for four newly proposed exchange-traded funds (ETFs), with certain filings including positions that are simultaneously long on Bitcoin (BTC) and short on Ethereum (ETH).
A filing submitted on May 6 to the U.S. Securities and Exchange Commission (SEC) disclosed the proposed funds, which include the Bitcoin vs. Ethereum ETF—holding a long position in BTC and a short position in ETH; the Ethereum vs. Bitcoin ETF—long on ETH and short on BTC; the Bitcoin vs. Gold ETF—long on BTC and short on gold; and the Gold vs. Bitcoin ETF—long on gold and short on BTC.
Filed under the BattleShares branding, each fund has been structured to follow the leveraged performance of one asset against another through the use of derivatives. The funds are actively managed and aim to achieve total returns by generating synthetic exposure to the respective underlying assets.
Exposure targets are generally set between +150% and +220% for long positions, while short positions are typically assigned a range of -150% to -220%.
Leveraged Synthetic Strategy: Long Bitcoin, Short Ethereum
Instead of directly holding spot assets, leveraged exposure is created by the funds through a mix of futures contracts, swaps, options, and U.S.-listed ETFs or exchange-traded products (ETPs).
As outlined in the prospectus, the ETFs have been structured to capitalize on price disparities between paired long and short assets.
The Bitcoin vs. Ether ETF has been designed with an investment thesis focused on delivering returns when Bitcoin outperforms Ether during the holding period. In contrast, the Ether vs. Bitcoin ETF is intended for investors expecting Ether to exhibit superior performance.
Direct investment in the underlying assets is not made by any of the ETFs; rather, exposure is obtained through financial instruments issued by other funds or accessed via derivatives markets.
To preserve favorable U.S. tax treatment in accordance with Regulated Investment Company (RIC) rules, up to 25% of assets may be allocated, when necessary, to a subsidiary based in the Cayman Islands.
It is noted in the filing that the use of a derivative-based structure enables the funds to mitigate custody risks typically linked to directly holding digital assets or physical gold.
Nevertheless, the structure introduces added complexity, as it brings exposure to counterparty risk, potential tax limitations, and elevated turnover resulting from frequent portfolio rebalancing.
High-Turnover Strategy Backed by Dynamic Operational Framework
The funds have been structured as non-diversified and are expected to experience high portfolio turnover, resulting from frequent rebalancing triggered by market volatility, asset momentum shifts, and the expiration cycles of derivative instruments.
The strategy is implemented by continuously adjusting exposure in order to preserve the target leverage and maintain equilibrium between the paired long and short positions.
Because of the use of leverage, gains or losses experienced by investors may be magnified in comparison to the movements of the underlying assets. The product documentation states that performance is determined by the relative values of the paired assets rather than their absolute price changes, rendering the ETFs inappropriate for those seeking directional exposure to a single asset.
The “long Bitcoin, short Ethereum” strategy would have resulted in significant profitability for investors based on year-to-date performance. As of the time of reporting, Bitcoin (BTC) has increased by 1%, while Ethereum (ETH) has declined by nearly 47% during the same timeframe.
