Why U.S. bitcoin ETF shows there’s nothing like the real thing

Futures-based structure of the country’s first bitcoin-based ETF could expose fundholders to opportunistic trading tactics

Why U.S. bitcoin ETF shows there’s nothing like the real thing

After much hand-wringing from the U.S. Securities and Exchange Commission, the country saw its first-ever bitcoin-based ETF, and investors are lapping it up – though they could be in for an unpleasant surprise.

The ProShares Bitcoin Strategy ETF managed to amass US$1 billion in assets within just a few hours of its launch last Tuesday. To allay the SEC’s concerns surrounding physical bitcoin, American fund issuers have submitted applications for ETFs that invest in bitcoin futures, which is more comfortably within the regulator’s purview.

But according to analysts cited by the Wall Street Journal, that workaround has a weakness. Because futures-based ETFs need to take large-positions in near-term futures and often “roll” those positions into the following month, rival traders can anticipate their purchases and buy the next month’s futures first, then selling into the demand that’s created when the futures fund rolls. The fund ends up paying a higher price, which inevitably comes out of its fundholders’ pockets.

“For us, it creates more trading opportunities,” James Koutoulas, CEO of the U.S.-based futures-trading Typhon Capital Management told the Journal.

The fund’s prospectus underscores the fact that the bitcoin futures market as of now is rather shallow, and that large positions could aggravate illiquidity risks and lead to higher prices.

Already, the ProShares ETF reportedly controls more than a fifth of bitcoin futures contracts expiring this month, and around one third of next month’s. According to analysts interviewed by the news outlet, the magnitude of those holdings will pressure returns of futures-based ETFs that have been launched and create a drag on new launches.

ProShares has had to already invest into the next month to keep within limits imposed by CME Group. That move could ease the stress that will come from rolling over this month’s contracts into the next one, but it raises the risk of the Proshares bitcoin fund’s performance lagging the returns of the actual cryptocurrency.

On the bright side, the CME-defined limits are set to double next month, which is expected to alleviate the issue. Still, asset managers and traders consulted by the Journal said ETFs from other issuers – like the Valkyrie Bitcoin Strategy ETF that debuted last Friday – could target the same contracts and aggravate the issue. A decision by Invesco to postpone its own bitcoin futures ETF was prompted by concerns over capacity, people familiar with the matter told the publication.

Both the ProShares and Valkyrie bitcoin funds are actively managed, which means their respective managers could take steps to limit the potential impact of futures front-running. Still, because both ETFs publish their daily holdings, rival traders still have a chance to know their positions and respond accordingly.

“It’s like poker,” Koutoulas said. “You lose an edge when the whole market knows your position.”