Why a bitcoin futures ETF costs more than owning bitcoin
It is natural to question the idea of a bitcoin ETF, since investors can buy and sell bitcoin directly. However, in October 2021 ProShares listed the ProShares Bitcoin Strategy ETF under the ticker BITO. It was the first US ETF built around bitcoin futures. According to press reports at the time, BITO drew one of the strongest first-day debuts of any ETF. At the time of original writing, the fund reportedly held about US$1.2 billion in assets, and current figures may differ. Below, we explain why a bitcoin futures ETF costs more than owning bitcoin. In our view, its appeal may partly reflect the familiarity of a registered, exchange-listed fund.
The custody problem
Custody is a serious topic with bitcoin, because owners typically hold it in a digital wallet secured by private keys. For example, if an owner loses the keys or password, the owner may be unable to recover the assets. Many investors have reported losses from forgotten credentials, hacks, or fraud. Specialized custodians do exist; however, they add fees and carry their own counterparty risks.
ProShares built BITO to avoid holding bitcoin directly. Instead, the fund buys bitcoin futures on the CME. Each contract is an agreement to trade bitcoin at a set price on a future date. In practice, traders keep futures prices close to bitcoin through arbitrage. For instance, when futures trade at a premium, a trader may buy bitcoin and sell futures to capture the gap. Of course, this structure does not remove risk. Futures can diverge from the spot price, and the fund still carries bitcoin’s high volatility.
Why a bitcoin futures ETF costs more than owning bitcoin
The first cost is visible. According to the fund’s prospectus at launch, BITO charges an annual expense ratio of 0.95%. Investors should check current fund documents for updated figures. In addition, a larger cost often comes from rolling futures, known as the roll cost.
Where the roll cost comes from
Futures contracts expire, so the fund must sell expiring contracts and buy later ones. When later contracts cost more than expiring ones, the fund sells low and buys high. Traders call this condition contango. As a result, each new contract tends to drift down toward the spot price as it nears expiration. That drift can erode returns over time. In contrast, when later contracts trade below spot, rolling can add to returns. Some market analyses estimated a gap of up to about 5 percentage points per year versus spot bitcoin. That figure is illustrative and covers certain periods since CME bitcoin futures launched in late 2017. Actual results vary with market conditions, and past performance does not guarantee future results.
Taken together, the expense ratio and the roll cost can help explain why a bitcoin futures ETF costs more than owning bitcoin directly. Therefore, investors comparing the two may want to look beyond the headline fee. For example, they can review the fund’s reported performance against spot bitcoin over several periods. In other words, the full cost shows up in tracking results, not only in the expense ratio.
What could change
Several crypto firms offer institutional custody solutions for bitcoin. Meanwhile, some of them asked the US Securities and Exchange Commission to approve an ETF that holds bitcoin directly. Such a fund could avoid the roll cost and may lower the cost of bitcoin exposure. Since this article first appeared, the SEC approved several spot bitcoin exchange-traded products in January 2024. However, spot funds still charge fees and carry custody, security, and volatility risks. In our opinion, adoption of any structure depends on whether investors trust it.
Finally, this article is for educational purposes only and is not a recommendation to buy or sell any security or cryptocurrency. Investors should consider their own goals and consult a financial professional.
