Summary ProShares Bitcoin Strategy ETF has faced about a 13% loss since July, but rate cuts and Chinese stimulus have triggered an upside. Loosening of monetary policy could help Bitcoin miners adapt faster to the post-halving landscape, which may stabilize the hash rate and profitability. Lower interest rates can also reduce miners' operating expenses, encouraging them to hold rather than sell Bitcoin, thus supporting higher asset prices. BITO offers a unique high-yield strategy through Bitcoin futures with a high dividend yield, despite share price volatility and income not increasing smoothly like for dividend growth ETFs. Capital appreciation is lower than for spot ETFs due to the income strategy, but dividends paid have tripled from 2023 to 2024, while there has been no capital erosion during this period. Since I last covered the ProShares Bitcoin Strategy ETF ( BITO ) on July 24, it has lost about 13%. At that time, I had a hold position based on the consolidation of the mining industry following the halving event. Still, I also mentioned that the Federal Reserve cutting rates would benefit the share price. This is indeed what happened since the beginning of September as charted below, as a result of the market beginning to price in a more dovish U.S. Central Bank, eventually culminating in a 50 basis point rate cut last week. Some impetus was also received by stimulus measures emanating from China. Data by YCharts This thesis aims to build a bullish case based firstly on how lower rates will benefit miners, as key stakeholders in the Bitcoin ( BTC-USD ) ecosystem, namely to HODL more coins instead of selling them and pressurizing asset prices downwards. Second, there is the income rationale for an ETF that leverages the dynamics around Bitcoin futures contracts to generate juicy dividend yields. First, five months after halving, I provide an update on how the mining industry stands. The Post-Halving Landscape Shows Adjustment Continues Since the April 19 halving event, miners have faced challenges given the block reward was reduced from 6.25 BTC to 3.125 BTC, putting pressure on profitability. In response, some have introduced new ASIC models or specialized hardware customized for cryptocurrency mining as part of a longer-term strategy of continually upgrading their hardware to become more energy efficient. Others have optimized existing computing machines through firmware (software) updates to produce more while using less KW of power. Looking further, some have migrated their operations to locations within the U.S. or in other parts of the world to benefit from lower energy costs, which helps them stay competitive in the face of lower rewards. To obtain an idea of how the industry has fared, it makes sense to study the evolution of the hash rate, which represents the total computational power in the Bitcoin network at any one time. As shown in the chart below, this metric has not maintained its progression after April, showing some miners have cut production because of higher operating expenses while others with weaker balance sheets have ceased production altogether or ended up being acquired as I explained in a previous article as part of the ongoing consolidation whereby smaller troubled players are being acquired by larger ones. Subsequently, July and August saw a slight reacceleration of the hash rate which at times exceeded the 720 million mark, but overall mining activity again decelerated from September. Data by YCharts This can be mainly attributed to two factors, the first being seasonal variations whereby in the summer months (July and August) mining farms can benefit from low-cost renewable energy, namely hydroelectricity due to higher rainfall. Logically, there was a drop in hash rate in September, accentuated by newer ASIC models coming online as more miners have been decommissioning older and less profitable equipment. Second, there is also Bitcoin's mining difficulty (above chart) to contend with, which is adjusted every two weeks (after every 2016 block) to prevent blocks from being mined too fast. The problem is the difficulty staying above the 85 mark despite the hash rate declining in June, which is abnormal and explained by the adjustment lag. This may be temporary but is enough to reduce miner profitability, with the situation made worse by Bitcoin's price not rising sustainably in the meantime. This resulted in some miners reducing participation (by stopping activity), bringing down the hash rate, which hints that the post-having adaptation is still ongoing. Lower Interest Rates Can Help Support Asset Prices Thus, in the current landscape, mining has become more difficult and the activity is less rewarding (profitable). Now, this can change, but not necessarily through higher asset prices or lowering the mining difficulty. Another option is to lower the operating expenses, enabled by lower rates. Looking deeper, this can take the form of lower interest payments on loans offsetting some of the effects of higher electricity costs, which constitute a significant portion of mining costs given Bitcoin production accounts for about 0.5% of global energy consumption. Additionally, with lower borrowing costs, there are more refinancing options that can provide miners with financial relief, crucial to navigating the current high-competition environment where they have to compete harder to validate a block while earning less in the process. Thus, lower rates should contribute to mining operations remaining viable without having to offload (sell) the Bitcoins produced. Subsequently, by HODLing more Bitcoins (than selling on the open market), supply gets reduced, in turn, supporting the value of the cryptocurrency. Two other factors that can help are inflation having been brought down below 2.5%, which helps businesses in general to reduce costs, and massive stimulus by the Chinese government. Therefore, more favorable monetary policy on both sides of the Pacific Ocean could trigger a rally in crypto prices as broader risk-on sentiment emerges. In this case, learning from 2020 when the U.S. federal funds effective rate was drastically lowered, BTC climbed by around 80% ($5K to $9K) as per the chart below. Data by YCharts However, at that time, monetary conditions were less tight as the Fed fund rates were lowered from 1.58% in February to 0.60% in April, while today, they remain at 5% despite the cuts. Also, according to Mr. Powell, there is no preset course for future cuts, meaning rates will remain on the higher side for the foreseeable future. In the same vein, the above chart shows no sustained upside in BTC in the immediate aftermath of the Fed cutting rates, meaning that volatility is likely to persist as miners continue to adjust operations. Thus, considering the above risks, I have a modest target of $71.4K for BTC or its highest resistance level post-halving. This would mean a return of 18.2% from the $60.4K at the time of writing. Now, considering that as a Bitcoin-linked ETF, BITO's value depends on BTC as shown below, it could reproduce this return resulting in the ETF rising to $20.6 (17.4 x 1.182) based on its current share price of $17.4. ProShares To justify this bullish posture, there is BITO's income rationale. Annual Income Has Surged By More Than Three Times Amid Volatility For this purpose, based on the dividend history on Seeking Alpha, and except for Jan 2024 as shown in the table below, the fund managers at ProShares have been paying dividends regularly since February 2023. Still, this does not qualify for consistency because the amount paid has not increased gradually as for dividend growth funds. Along the same lines, BITO does not guarantee fixed returns on capital since yields can fluctuate widely based on the performance of Bitcoin futures, the fund's underlying asset, and the way ProShares calculates dividends. For clarification purposes, BITO is futures-based, signifying it does not hold actual Bitcoins but trades in futures contracts which indirectly provides price exposure to Bitcoin. In short, there are risks of not getting paid and one should not expect stable income. Table built using data from Seeking Alpha Shifting to a positive tone, its strategy to capitalize on Bitcoin futures has delivered on the income front, as it offers a forward dividend yield of 66% , but this can change rapidly depending on the share price. Still, in practice, this has translated into payouts of $3.1 in 2023 and $9.84 until September this year as shown above, which totals nearly $13. Therefore, for income seekers who are ready to embrace this rather unique way of capitalizing on crypto while facing volatility, BITO's high-yield strategy is appropriate. As an example, someone who had bought the shares in January 2023 at $10.59 each would already have enjoyed capital gains of $8 in September this year as illustrated below while netting dividend gains of $13. This means total gains of nearly $21 or nearly two times the amount invested within 21 months. Table built using data from Seeking Alpha However, on the cautious side, its share price has fluctuated widely, and the income provided isn't necessarily guaranteed for the future. For this purpose, BITO did not start paying dividends right after it was incepted in November 2021, but only as of February 2023. Therefore, someone who had invested in November 2021 would have suffered from a capital loss of $23.24 as shown above, which is significant and is only partially offset by the income of around $13. Fewer Capital Gains Compared To A Spot ETF But Has Still Appreciated While Generating Income Consequently, for those holding BITO's shares, one solution is to adopt an averaging down strategy and buy at current prices. The reason is BITO's unique approach consisting of managing (buying and selling) futures to derive monthly distributions from the profits earned has resulted in dividends rising sharply from 2023 to September 2024 (on an annual basis). Moreover, it does not offer the same level of capital appreciation when compared to the iShares Bitcoin Trust ETF ( IBIT ) as shown below because of the roll costs associated with making profits by continuously purchasing longer-term contracts and selling short-term ones. Also, it charges fees of 0.95%, compared to 0.12% for IBIT. Data by YCharts Still, despite paying three times more dividends from January to September 2024 than in 2023, BITO's current share price of $17.14 remains well above (or around 64%) its January 2023 share price of $10.59. Therefore, its strategy of regularly paying dividends has not resulted in its price decaying over time, like for some options trading strategies. On the contrary, during the past 20 months (February 2023 to September 2024), BITO's income strategy has delivered significant value while also offering price appreciation, all amid Bitcoin volatility. Finally, while there are volatility risks associated with investing in anything related to crypto as miners continue to adjust to the post-halving landscape, a more dovish monetary policy should prove helpful to support the mining ecosystem and reduce the likelihood of miner capitulation or selling their Bitcoin reserves to cover their costs resulting in asset prices becoming under pressure.
