Being right about Bitcoin won’t save your 3x leveraged ETF position

Bitcoin's next recovery could vindicate your investment thesis but leave your leveraged fund deep in the red, because the fund's daily reset can make waiting a pretty expensive habit.

Getting Bitcoin right and actually making money on Bitcoin are becoming two different skills, especially now that Wall Street is preparing products for people who don't find the ordinary version exciting enough.

On Oct. 2, the SEC approved exchange-listing rules for proposed 3x Bitcoin and Ethereum funds from VS Trust. The approval brings them closer to trading, with the appeal captured neatly in the multiplier: more exposure to a market you already believe will go up.

But what happens between buying the fund and being proved right? Bitcoin can fall, recover, and return to your entry price while a leveraged fund still nurses losses, even when it's doing exactly what the product promised.

That promise covers just one day, a much shorter relationship than many investors intend with their money.

The proposed funds seek three times their benchmark's daily return, before fees and expenses. Holding them for a month doesn't extend that promise to three times the month's return, because each day's gain or loss becomes the starting balance for the next.

The Bitcoin investor thinks about where the market will be in six months, while the fund continually resizes its exposure around how much money it has today.

When the market falls, leverage eats through the fund's capital faster than it reduces the size of its market position. To restore the intended multiple, the fund cuts exposure, leaving it with a smaller position when the rebound begins.

Gains then apply to that reduced balance, so getting the underlying market back to its old level doesn't necessarily get the shareholder there too.

During a rally, profits give the fund more capital, allowing it to take on more exposure for the next session. You can leave your shares untouched while the investment inside them grows and shrinks every day, indifferent to your long-term Bitcoin outlook.

The SEC describes in its investor bulletin on leveraged funds a real four-month period when an unnamed index gained about 8%, while a fund seeking three times its daily return lost 53%. That wasn't a Bitcoin fund or a forecast for these proposed products, but it puts a financial result behind an easily dismissed prospectus warning.

Daily compounding can also work beautifully during a sustained advance, allowing a leveraged fund to earn more than three times the benchmark's cumulative gain. The mechanism rewards some price paths and punishes others, which means a buyer needs to be right about more than the eventual destination.

Bitcoin's reputation for rewarding patience affects this, and not in a good way, since a daily-reset fund continually recalculates how much exposure your remaining money can support.

The listing approval showed that these funds use futures, adding another layer between the Bitcoin price people follow and the return they receive.