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Exploring the Hidden Costs of Bitcoin ETFs: Understanding the Contango Effect on BITO

In an era marked by a notable Bitcoin (BTC) resurgence, ProShares’ futures exchange-traded fund (ETF), BITO, lags. Despite the prominent appeal of such ETFs as investment instruments, recent analyses reveal a dwindling performance that raises questions about their efficacy. One such analysis comes from digital asset research firm K33 Research, which has shed light on the underwhelming performance of BITO compared to BTC’s price appreciation.

Unearthing the Underperformance: A Look at Bitcoin ETFs

According to the report, BITO has seen a year-to-date increase of 47%, which falls short when juxtaposed with BTC’s impressive 60% gain in the same timeframe. The discrepancy between these numbers exposes the covert drawbacks intrinsic to the fund’s structure, specifically concerning the recurring costs of futures contracts.

BITO operates distinctly from conventional investment methods, eschewing direct token purchases. Instead, the fund positions itself on BTC futures contracts via the Chicago Mercantile Exchange (CME). Unfortunately, this unique approach necessitates a monthly rollover of contracts upon expiry. This regular action exposes BITO to the potential disparities in the pricing between contract terms.

In scenarios where the forthcoming contract is priced higher than the one closest to expiry, a situation commonly referred to as contango, the fund is susceptible to compounded losses over time. This risk, known colloquially as the “contango bleed,” intensifies during a bullish market, thus contributing to the fund’s underperformance.

BITO’s Past Performance and Future Projections

When BITO debuted in the trading realm in October 2021, industry experts projected a potential underperformance of 10% to 13% annually compared to the spot market. In its inaugural year, however, the fund defied these predictions by trailing BTC’s performance by a mere 1.8%, with the crypto bear market tempering the effects of the contango bleed.

Conversely, this year’s market rebound has increased BITO’s vulnerability to rolling costs. In addition, the return of the CME futures market trading in contango has amplified the performance gap, which aligns with analysts’ initial projections for an entire year in just the first five months.

Veteran analyst Vetle Lunde of K33 predicts a continuation of this trend. However, he cautions investors about the implications of the strong term structure for BITO’s long-term viability. His report elaborates on the complications of using BITO as an instrument for sustained long exposure.

The SEC’s Stance and the Implications for Future Bitcoin ETFs

While industry experts have vouched for the potential benefits Bitcoin ETFs that directly hold BTC, the U.S. Securities and Exchange Commission (SEC) remains resistant. The SEC has consistently rejected applications for such funds, underscoring the dilemma facing future ETFs.

This performance gap, Lunde argues, serves as a stark reminder of the limitations of futures-based ETFs when compared to spot ETFs. Moreover, he asserts that the SEC’s stringent opposition to direct BTC spot ETFs negatively affects investors, reinforcing the need to reevaluate current regulations.